What is Ethereum? The Ultimate Guide

CONTENTS:

1. What is Ethereum Summary
2. Understanding Ethereum
   • A Brief History of Ethereum
   • What is Ethereum?
   • How does Ethereum Work?
   • Ethereum Use Cases
   • Ethereum Pros and Cons
3. The Future of Ethereum: Ethereum 2.0
4. FAQs
   • What is en ERC-20 Token?
   • What is an ERC-271 Token?
   • What’s the difference between Bitcoin and Ethereum?

1. What is Ethereum Summary

Ethereum is the second-largest cryptocurrency by market cap (~$360B at March 2022), just behind Bitcoin (for now). Ethereum is known as the “Mother of All Altcoins.”

We can trace back the idea of Ethereum to cypherpunk Nick Szabo, who coined the term “Smart Contracts” in 1994, in addition to developing Bitcoin’s blueprint, “Bit Gold.” Nick Szabo envisioned a digital economy, a digital society built on secure and autonomous cryptographic processes or contracts that did not rely on third-party intervention. In other words, he envisioned a completely decentralized society led by users rather than central organizations. Ethereum makes Nick Szabo’s concept a reality.

However, Ethereum cannot be understood without first understanding Bitcoin. The sole objective of Bitcoin was to establish decentralized digital money. Ethereum was created to address Bitcoin’s “programming limitations (turing incompleteness).”. Ethereum was first proposed in 2013 by Vitalik Buterin in the Ethereum Whitepaper and brought to life by the Ethereum Foundation in 2015. Ethereum is one of the most successful ICOs to date, raising approximately $18.3 million at the time. 

Ethereum plugs small computers, that run code (smart contracts), into the blockchain to create a “supercomputer (EVM)” that powers decentralized applications (dApps). Ethereum makes blockchain and money programmable. Ethereum goes beyond payments by offering a platform with built-in tools for selling goods and services (dApps). Think of Ethereum as the “crypto iPhone.” We classify Ethereum as an infrastructure/platform altcoin. 

Ethereum’s adaptability opens up the cryptocurrency industry to a wide range of applications and use cases. The three most important ones are Decentralized Finance (DeFi), Media & Entertainment (Non-fungible tokens or NFTs), and Non-financial such as identity & reputation systems, governance (DAOs), and decentralized storage. 

The major advantages of Ethereum include its Do It Yourself Platform, Removal of entry barriers, the Ethereum Virtual Machine (EVM) or “supercomputer,” faster block creation than Bitcoin, and the largest developer community.

Scalability, energy efficiency, the “code is law” approach, complicated smart contracts are more difficult to enforce and secure, and the latest Ethereum iteration (Ethereum 2.0) has yet to be tested on a larger scale are all disadvantages of Ethereum.

To address these issues, the Serenity upgrade (Ethereum 2.0) will change the Ethereum consensus mechanism from proof-of-work (PoW) to proof-of-stake (PoS), among other changes such as sharding and roll-ups. 

The Serenity update is planned to be completed by the end of 2022, with the Ethereum 1.0 and 2.0 merging, known as the Docking.

Here is a short summary of Ethereum Definitions. Continue reading if you want to discover more!

2. Understanding Ethereum

In this section, we’ll journey back in time to learn about Ethereum’s origins, how it works, its uses, and its benefits and drawbacks.

A Brief History of Ethereum

Ethereum cannot be understood without Nick Szabo, Blockchain, and Bitcoin.

Nick Szabo (1994): Nick Szabo, a cypherpunk who proposed “Bit Gold,” a cryptocurrency comparable to Bitcoin, coined the term smart contracts in 1994. Later, in 1996, in his essay Smart Contracts: Building Blocks for Digital Markets he envisioned a fully functional digital economy based on these secure and autonomous cryptographic processes or contracts that did not require the involvement of third parties. Nick Szabo was attempting to use cryptography to store and execute legal contracts. Ethereum turned his vision into reality with the help of smart contracts.

Bitcoin (2009): In 2009, an anonymous developer called Satoshi Nakamoto published the Bitcoin whitepaper, titled “Bitcoin: A Peer-to-Peer Electronic Cash System.”

Satoshi created the first cryptocurrency. A decentralized digital “cash” system that allows money to be transferred via the internet without the need for a central bank.

Bitcoin’s primary use case is money, which is why it is referred to as “digital gold.”

“The root problem with conventional currency is all the trust that’s required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust.”

Satoshi Nakamoto

To make it work, Satoshi Nakamoto employed a revolutionary technology called Blockchain. Blockchain is a distributed ledger (DLT) secured by cryptography that records digital data into a sequence of blocks (ledger pages) without the use of a third party. 

Blockchain 1.0’s primary goal was to record and transfer money till…

Ethereum (2013): In 2013, programmer Vitalik Buterin published the Ethereum whitepaper. Shortly after, other brains such as Gavin Wood, Charles Hoskinson, Amir Chetrit, Anthony Di lorio, Jeffrey Wilcke, Josep Lubin, and Mihai Alisie co-founded the Ethereum Foundation in 2014. The Ethereum Foundation is a non-profit organization in charge of overseeing the Ethereum project. By the end of 2014, Ethereum, raised roughly 31,000 BTC, or approximately $18.3 million at the time. Ethereum is one of the most successful ICOs to date. 

With Ethereum, blockchain becomes programmable (Blockchain 2.0). Ethereum, like Bitcoin, allows to transfer money over the internet without the need of a third party but unlike Bitcoin, Ethereum goes beyond payments. In simple terms, Ethereum plugs small computers (smart contracts) into the blockchain to run applications (dApps) that do not require third parties (decentralized). Consider Ethereum to be the “crypto iPhone” that allows anyone to launch ICOs (Initial coin offerings), build applications (on top of it), and provide products and services. 

This is why Ethereum is viewed as a next-generation smart contract and decentralized application platform. A DIY platform for dApps.

“Ethereum is a general-purpose blockchain. The original blockchain was designed to facilitate the creation, validation, recording, and transferring of Bitcoins. That’s it, that’s all it does. Later blockchains emerged that provided multiple functions, but ones that were pre-defined. Blockchain is like glue between systems. 

The idea of Ethereum was to have a blockchain whose programming language made it possible to let people write any kind of application on it. It’s like a decentralized operating system for blockchain.”

Vitalik Buterin

Ethereum Phases

The Ethereum project is divided into four distinct phases. They are required updates in order to deliver the Ethereum Roadmap.

PHASE 1 – Ethereum 1.0, Frontier (July 30th, 2015 – 2016): Basic technical foundation

The first version of Ethereum (Ethereum 1.0), which was launched in July 2015 was dubbed Frontier. The purpose was to test the network and get it up and running,

Frontier was a basic infrastructure that included the following features:

• A Proof-of-work (PoW) consensus mechanism to mine Ether (ETH). Ethereum was inspired by Bitcoin and employs Satoshi Nakamoto’s Consensus (Nakamoto Consensus) to solve the Byzantines Generals’ problem and the double-spending problem by allowing participants to reach consensus in a peer-to-peer network. 
• Basic Infrastructure to run and test Smart Contracts (computer programs) and decentralized applications (DApps). This is the innovation that Ethereum brought to the table. 

During this time, a minor fork called Frontier Thawing limited gas (power to run applications) to 5,000 per transaction in order to keep transactions low. 

PHASE 2 – Ethereum 1.1, Homestead (2016-2017): Improve security issues

The Frontier version was the working version of Ethereum. One of the most disastrous ICOs to date, the DAO hack, brought up security concerns. 

The DAO: Launched in 2016, DAO was a venture capital decentralized autonomous organization that offered a new business model without the need for a traditional management structure or board of directors. The DAO project raised $150 million, but a hacker stole one-third of the assets by exploiting a bug in its smart contract code. To recover the stolen funds, community members offered improvements to the Ethereum network that were rejected by a portion of the community, resulting in a hard fork known as Ethereum Classic.

To address the security concerns raised by the DAO hack and several DoS (denial-of-service) attacks on the Ethereum network, two sub-upgrades known as Tangerine Whistle and Spurious Dragon were implemented. They essentially adjusted gas fees and constructed state clearinghouses (removal of empty accounts to reduce the time of syncing on the network).

PHASE 3 – Ethereum 1.2, Metropolis (2017-2020): Addressing Scalability issues. 

The goal of Metropolis was to address Ethereum’s security, privacy, and scalability challenges. Metropolis improved the user interface for both users and developers. Metropolis aided the 2017 ICO craze while also paving the way for DApp development and tokenization. With Metropolis, The Ethereum network became more scalable. 

It was released in two steps: 

• Byzantium: The first stage introduced Ethereum Improvement Protocols (EIP), which are standards procedures for new features or processes on the Ethereum network. 
• Constantinople: Constantinople was delayed for more than half a year due to a severe flaw detected hours before deployment. Constantinople’s goal was to solve any problem of the Byzantium’s implementation and pave the way for the transition from proof-of-work (PoW) to proof-of-stake (PoS) consensus algorithm, which will significantly improve scalability (above visa transaction per second levels) and mitigate the energy consumption problem derived from proof-of-work (PoW). 

PHASE 4 – Ethereum 2.0, Serenity (2020 – 2022):

The Serenity stage is still in development. This stage is also known as Ethereum 2.0. The main goal of Ethereum 2.0 is to prepare the Ethereum network for massive adoption (high-volume transactions) while sustaining a robust level of security. 

Ethereum, like Bitcoin and other Blockchain 1.0, is currently facing two major issues as a result of a consensus mechanism based on proof-of-work (PoW) or mining.

• Scalability: Ethereum can only handle 15 transactions per second. This is far behind Visa at 1700 or Mastercard at 5000 transactions per second. Also, a congested network means higher transaction fees. 
• Energy-efficiency: Proof-of-work (PoW) uses computer power to solve cryptographic puzzles and reach consensus in a network. The Energy consumption levels go against the carbon footprint. 

The Serenity implementation has three main steps: 

• Beacon Chain and PoS (Casper): The Becon Chain is the primary coordinating protocol for the new Proof-of-stake (PoS) consensus mechanism that ensures the security of the Ethereum 2.0 network. These functionalities went live in December 2020 and operate in tandem with the Ethereum 1.0 blockchain.
• Sharding Framework: Sharding is a fancy term for spreading the workload of a network and releasing bandwidth. It divides the Ethereum network into small autonomous shards that can process transactions. The sharding design also employs roll-ups, which aggregates transactions off-chain for increased speed.
• The Docking: The final stage is when Ethereum 1.0 and Ethereum 2.0 will merge together. Ethereum 1.0 will become one of the 64 shard chains that will operate under the new Ethereum 2.0 PoS protocol. This is anticipated to occur by the end of 2022.

What is Ethereum?

Ethereum was first proposed in 2013 by Vitalik Buterin in the Ethereum Whitepaper and brought to life by the Ethereum Foundation in 2015. The primary purpose of Ethereum was to adapt blockchain technology to support uses other than monetary transactions. While Bitcoin creates digital or “internet money,” Ethereum enables the creation of a fully viable economy and society without the use of centralized control.

In other words, Bitcoin design lacks turing-completeness. The Bitcoin blockchain was designed particularly for payments or digital money. Turing incompleteness is another way of saying that the Bitcoin programming language is limited and does not support everything. Ethereum includes its own turing-completeness programming language, Solidity, which is flexible and allows developers to build decentralized applications (dApps) on top of it, ranging from banking to games to social media, and so on. It is similar to an app store supported by independent computers (peer-to-peer network) rather than Google or Apple. Ethereum’s functionality earned it the name of a “world computer.” 

Ethereum is designed to be open-ended, is a Do It Yourself blockchain or platform for decentralized programs (Dapps). With Ethereum, we don’t need to build our own blockchain each time we want to provide a product or service. 

Elements of Ethereum: 

The following are Ethereum’s major components:

• Peer-to-Peer Network (Decentralization): Ethereum is an independent network of computers (peer-to-peer) that serve as network nodes. Unlike Bitcoin, Ethereum nodes not only store a copy of transactions but also a copy of the most recent state. Ethereum doesn’t require third parties to run. 
• Cryptography: Ethereum uses public-key cryptography for identity and hash functions such as Keccak-256 to produce unique signatures and chain blocks of transactions together (blockchain). 
• Consensus Mechanism: Ethereum currently uses Proof-of-Work (PoW) or mining as its core consensus mechanism to secure the cryptocurrency ledger, but it is migrating to Proof-of-Stake (PoS) or Staking. 
• Smart Contracts: Smart contracts are the key element of Ethereum. Smart contracts are computer programs or rules that govern when and how money is exchanged. In other words, smart contracts are simply code. 
• Ethereum Virtual Machine (EVM): The Ethereum Virtual Machine is the computer’s terminal. It converts human-readable programming languages into computer-readable languages. All nodes maintain a copy of the EVM. 
• Ether: Ethereum’s token, which is used to conduct transactions and execute smart contracts (programs) on the Ethereum platform.

How does Ethereum work?

The first thing we need to understand is what Smart contracts, dApps, ether, and gas really are. Then, we will put everything together. 

What is a Smart Contract?

Nick Szabo defines a smart contract as a computerized transaction protocol that executes the terms of a contract. In other words, a smart contract is simply a set of conditions (ifs) and actions (thens) that are carried out by code rather than a third party. It is referred to be smart since it executes itself under particular conditions, and it is considered a contract because it enforces agreements between parties. Ethereum transforms “code into law.” This code is immutable (can’t be changed once inserted on the Blockchain), and open (anyone can see it and use it).

For instance, If I pay my landlady $1000 on the 1st of the month Then she lets me use my apartment. In Ethereum, developers write the conditions for their program or DApp, which are subsequently executed by the Ethereum network (EVM).

Nick Szabo uses a vending machine analogy to explain its mechanics. A vending machine is an example of a simple contract that is being executed. If you want to get snack X, insert coins into the machine, and it will dispense it for you. The same mechanics apply to smart contracts in a digital setting. For example, return/execute the program “Hello, World!” when the smart contract receives 3 ether. 

What is a Decentralized Application (dApp)?

A decentralized application (dApp) is a collection of smart contracts with an interactive frontend user interface (UI). Similar to your phone’s applications, but instead of being managed by a single computer or authority (e.g., Google, Apple, Twitter), they are governed by a network of computers. Examples of dApps include openSea, Uniswap, Axie Infinity, cryptokitties, etc. 

What Is Ether?

Ethereum’s coin or cryptocurrency is called Ether. Ethereum miners, like Bitcoin miners, receive cryptocurrency in exchange for solving a cryptographic hard or proof-of-work puzzle. In this sense, Ether is an incentive, a reward for keeping the network secure.

However, keeping the Ethereum computers running costs money. Anyone willing to use the platform must pay an “entry fee” to run smart contracts and power decentralized applications (dApps). As a result, Ethereum is classified as an infrastructure/platform altcoin or cryptocurrency.

What is Ethereum Gas?

Gas is small amounts of Ether paid to a node in order for it to execute smart contracts and process transactions. On Ethereum, transaction fees are measured in gas. It is more sophisticated than Bitcoin, but the concept is the same. To accomplish the tasks listed above, solving the first cryptographic puzzle (digital signature puzzle), Ethereum miners (validators soon) receive transaction fees. 
However, ether and gas are not the same thing. Gas quantifies how much “work (computational resources)” is required to complete a specific task. Each unit of gas has a “gas price,” which is expressed in ether (ETH). To be precise, it is expressed in gwei (tiny amounts of Ether), in honor of cypherpunk Wei Dai. 1 gwei is equivalent to 0.000000001 (or 10^-9) ETH. Demanding tasks will have higher gas fees.

Total Fee = Gas limit * (Base fee + tip)

• Gas Limit: This is the bare minimum of gas that a user is ready to spend for a transaction. Users can choose how much gas they wish to pay, although some networks require a minimum gas amount to perform a certain task. 
• Base Fee: The congestion of the network determines the minimum gas fee in order to be included on the Ethereum Blockchain. These are dynamically adjusted based on supply and demand dynamics. 
• Tip: Miners prioritize transactions with higher fees. Depending on the transaction’s urgency, users may choose to pay higher fees to incentivize miners to confirm it faster.

Note: Currently, Ethereum is the smart contracts and dApps platform of choice. Ethereum 1.0, unable to handle such demands, has drastically hiked gas prices. To address this issue (scalability), Ethereum 1.0 is transitioning from a proof-of-work (PoW) consensus mechanism to a proof-of-stake (PoS) consensus mechanism, or Ethereum 2.0. 

Ethereum as a State Machine

We can describe the Ethereum Blockchain as a State Machine that records not only the history of transactions (like Bitcoin does) but also the “state” – or current information – of all these smart contracts and applications. In other words, at all times you have a snapshot of all the account balances and smart contracts. Transactions (either from users or other contracts) execute smart contracts and trigger the state to change.

Each node in the Ethereum network stores a copy of: 

• Accounts: User’s account and balances
• Smart contract code: The code or rules necessary to execute smart contracts
• Smart contract state: Every node on the network executes the contract’s code (using the Ethereum Virtual Machine) and records the output or state of the smart contracts. 

To update the Ethereum Blockchain and achieve consensus, special nodes known as miners solve a cryptographic hard puzzle (proof-of-work puzzle) in order to find a special key that will link the new block (containing transactions and smart contracts) to the previous block, resulting in a chain of blocks (blockchain). This consensus process is known as proof-of-work (PoW). The new version of Ethereum (2.0) will, however, employ a less energy-intensive consensus mechanism known as proof-of-stake (PoS).

Here is how Ethereum works:

Ethereum Use Cases 

Ethereum’s adaptability opens up the cryptocurrency industry to a wide range of applications and use cases. There are three main applications on top of Ethereum: 

1. Financial – Decentralized Finance (Defi): Defi aims to put the traditional financial industry on the blockchain. In other words, the goal is to build a fully functional digital economy that does not rely on third parties. A new system built on public, open, trustless, censorship-resistant blockchains in which users interact with one another in a peer-to-peer network powered by decentralized applications (DApps) and run by smart contracts. The benefit of DeFi is that users retain ownership of their funds at all times, and no authority can deny them access to this new system. 
   
   
   • Financial Services include lending, trading, asset management, savings, real estate, Auto lease, financial derivatives, stablecoins, prediction markets, etc. 
   • Examples include Compound (COMP), PancakeSwap (CAKE), Augur (REP), Waves (Waves), etc. 
     

2. Media & Entertainment – Non-Fungible Tokens (NFTs): NFTs are tokens that are unique and cannot be exchanged with one another. NFTs, give a unique value to art, music, sports, and gaming (avatars, land, and other in-game items). The Ethereum blockchain protects them and ensures that they can only be owned by one person at a time. NFTs are purchased and sold through marketplaces such as OpenSea.
   
   
   • Examples include OpenSea, Decentraland, Axie Infinity, Royal, NBA Top Shots (NBA moments), etc. 
     
     
3. Non-financial: These include the non-financial altcoins that Ethereum supports.
   
   
   • Identity and Reputation systems: Examples include Internet domain name systems (DNS) such as Ethereum Name Service (ENS) domain, email authentication, and digital identification systems such as BrightID or ShoCard. 
   • Governance – Decentralized Autonomous Organizations (DAOs): DAOs are a novel new form of governance. DAOs are jointly owned and governed by their members (rather than a board of directors), and their rules are enforced using smart contracts. DAOs use cases include charity, freelance networks, ventures, and grants. Examples include MakerDAO, MolochDAO, etc. 
   • Storage: Ethereum also offers decentralized file storage, similar to Dropbox but decentralized (managed by the Ethereum Network). Examples include Siacoin (SC).
     

Note: Ethereum, like Bitcoin, can be used for international payments (e.g., remittances) banking the unbanked, or as a store of value. However, Ethereum goes beyond payments and was designed to be a do-it-yourself platform.

Ethereum Pros and Cons

As a versatile blockchain with the unique capacity to handle smart contracts, Ethereum offers numerous benefits. However, Ethereum has certain drawbacks, including scalability, energy efficiency, and the “code is law” approach.

Here are some Ethereum Pros and Cons:

3. The Future of Ethereum: Ethereum 2.0 

Ethereum is the mother of all Altcoins, which are cryptocurrencies other than Bitcoin. Is the second most valuable cryptocurrency in terms of market capitalization, just behind Bitcoin (for now). Its built-in, versatile, and customizable blockchain has opened doors for cryptocurrencies that no one could have imagined. With the help of Ethereum, Nick Szabo’s vision of building a fully functional digital society that returns power to its users (decentralized) is becoming a reality. Web 3.0 is becoming a reality. 

However, Ethereum 1.0, like most 1.0 and 2.0 Blockchains, suffers from a significant flaw: it cannot scale to serve millions of users. It is slow and energy-intensive, and it is not yet suitable for mainstream use. This is where Ethereum 2.0 comes into play.

Ethereum 2.0 development began in 2017 with the release of Ethereum Phase 3, known as Metropolis, and its two updates. Byzantium and Constantinople paved the way for Ethereum 2.0. 

After some challenges, In 2020, developers activated the Beacon Chain, the first step to Ethereum 2.0, called Serenity. By the end of 2022 is expected that the Casper protocol will replace the Ethereum mining algorithm (Proof-of-Work (PoW) for Proof-of-Stake (PoS). Also, the sharding framework (which does not use the full network to confirm transactions and approve smart contracts) is expected to be operational and ready for the Docking, which will merge Ethereum 1.0 and Ethereum 2.0.

Ethereum, like Bitcoin, is one of the most tried and proven cryptocurrencies, and it should be included in any investment portfolio.

4. FAQs 

What is an ERC-20 token?

ERC-20 is an Ethereum standard used to create Fungible Tokens (interchangeable) on the Ethereum Blockchain. They are essentially rules and protocols that Ethereum tokens or smart contracts must follow in order to be deployed correctly. 

ERC stands for “Ethereum Request for comment,” while the number 20 comes from the EIP in which it is described. 

Altcoins that use the ERC-20 standard, include Maker (MKR), Basic Attention Token (BAT), Augur (REP), OmiseGo (OMG), Chainlink (LINK), etc. 

What is an ERC-721 token?

Similar to ERC-20, an ERC-721 token is a token that follows a standard for the creation of a specific cryptocurrency. ERC-721 refers to non-fungible tokens, which are unique tokens that cannot be exchanged for one another.

What’s the difference between Bitcoin and Ethereum?

Comparing Bitcoin to Ethereum is akin to comparing apples to oranges.