Ethereum (ETH): What Is It & How Does It Work?

Ethereum is the brainchild of computer programmer and co-founder Vitalik Buterin. Launched in 2015, it has since become the largest cryptocurrency in the world by market capitalization. Unlike Bitcoin, Ethereum is an entire ecosystem where developers can create decentralized software programs, from apps that let you borrow money without a bank to contracts that execute themselves without a middleman. And Ether (ETH) is the blockchain’s native cryptocurrency that powers it all. Here’s what to know about Ethereum and how it works.

Ethereum vs Bitcoin at a Glance:

What Is Ethereum?

Ethereum is an open-source blockchain that evolved from the foundational ideas of Bitcoin (BTC) but with some distinct and ambitious differences. Like Bitcoin, it supports simple peer-to-peer transactions. Anyone with access to the internet can send Ethereum to someone else anywhere in the world. Recipients can either store it in their crypto wallet or convert it into their local currency. Unlike Bitcoin, it supports advanced functions that go far beyond simple transfers. 

In simple terms, Ethereum is a software platform that stores data across a decentralized network of computers around the world. And it’s open-source, which means anyone can access it to create programs that operate exactly as programmed.

Developers use the Ethereum blockchain to build all sorts of digital applications the way kids use Lego to build cars, castles, and entire Minecraft dioramas. These programs are capable of moving money around, making decisions, automating contracts, and even running themselves without human intervention. 

At the heart of it all is a cryptocurrency called Ether (ETH). This is basically your key to the kingdom. If you want to build something, send money, or use any of the cool apps people have created on the Ethereum network, you need ETH. 

Who Created It & Why?

The Ethereum concept was first introduced in 2013 by Vitalik Buterin, a Russian-born Canadian who studied at the University of Waterloo but dropped out after freshman year. Vitalik and co-founders Charles Hoskinson, Gavin Wood, Joseph Lubin, and Anthony Di Iorio launched the Ethereum blockchain in 2015. 

According to the whitepaper, its purpose was to expand beyond the limited functionality of Bitcoin to support a broad range of innovative software programs that are “resistant to censorship, downtime and fraud.” Their mission was to create an open-source platform that leverages blockchain technology to enable developers to build and deploy decentralized applications (dApps). Unlike traditional applications, which are controlled by single entities, dApps operate on a peer-to-peer network.

Since its inception, Ethereum has done more than redefine financial services. It has evolved into a sort of global super-computer where decentralized applications are paving the way for the next generation of the internet, known as Web3.

How Does it Work?

Like Bitcoin, Ethereum's blockchain is also a decentralized ledger that no single person or group owns or controls. Everyone can see the data that’s been recorded but no one can make changes to it. Every time you do something on the Ethereum network, like send ETH to a friend or use a smart contract, that information is added to the blockchain. 

Verifying Transactions

Before a transaction can be added it has to be verified to ensure it is legitimate. To do this, Ethereum uses a Proof of Stake (PoS) consensus mechanism, which is fancy tech jargon for the set of rules that dictate how transactions are validated. This is done by a network of users, called validators. And the majority of validators must agree that a transaction is authentic for it to be validated and added to the blockchain.

Mining vs. Staking

Bitcoin uses an energy-intensive consensus mechanism called Proof of Work (PoW), in which nodes compete to solve complex math puzzles. The first to solve it gets to verify the block and add it to the chain. In return, they earn rewards. This is what powers and secures the Bitcoin blockchain. 

Ethereum started with PoW but moved to a more energy-efficient mechanism called Proof of Stake (PoS) in 2022. This system does not require special high-powered machines or hardware, just a regular computer that stays connected to the internet. Coins that run on a PoS blockchain are considered “green cryptocurrency.” 

With PoS, users compete for the chance to validate transactions by committing a certain amount of ETH to the blockchain, called staking. It works kind of like a lottery, the more ETH you stake, the more chances you have to ‘win’. Stakers who validate transactions receive rewards, kind of like earning interest on the balance in your savings account. This process is what powers the Ethereum network. 

The Supply Mechanism

Ethereum does not have a fixed maximum supply, unlike Bitcoin. This means that there is no hard cap on the total amount of ETH that can be created. However, there are some guardrails in place. 

For example, only 25% of ETH’s initial supply can be created each year, which is 18 million coins. And the EIP-1559 update introduced a burning mechanism for gas fees, which could potentially make ETH deflationary, meaning it would gain value over time. Burning is the process of permanently removing coins from the circulating supply by sending them to a digital wallet with no keys. 

Unique Programming Language

One of Ethereum’s standout features is the built-in programming language, called Solidity, which supports sophisticated functions like decentralized applications and smart contracts, to name a few. It is influenced by JavaScript, Python, and C++ and is designed to be easy to understand for most developers. 

Solidity is a statically typed language, which means you are required to define each type of variable. I won’t bore you with the techy details, but this characteristic is crucial for spotting coding errors early on. It’s also very versatile because developers can program a huge variety of functions. 

Smart Contracts

Smart contracts are Ethereum’s marquee innovation. These are self-executing contracts that have the terms of the agreement written directly within the lines of code. When certain conditions are met, the contracts automatically execute, control, and record legal events on their own without a middleman. 

When a smart contract is deployed on the Ethereum blockchain, it actually becomes part of the blockchain itself. Each contract has its own unique address, just like a cryptocurrency wallet. Smart contracts have become the backbone of Decentralized Finance (DeFi) and present revolutionary use cases for industries like real estate, supply chain management, voting systems, healthcare, identity verification, and countless more. 

Decentralized Applications (dApps)

Decentralized applications (dApps) are computer programs that run on a decentralized blockchain instead of a single computer or server. This is a radical shift from how traditional applications work and offers a new level of transparency, security, and immunity from censorship. 

While regular apps run on centralized servers, dApps run on a blockchain which records all transactions and interactions between users. That data is stored and distributed across a network of computers. All transactions and changes within a dApp need to be agreed upon by the network through the PoS consensus mechanism. This ensures every transaction is valid and secure. 

Real-World Examples

How Ethereum Is Valued

Like all cryptocurrencies, Ethereum is a speculative asset. Its value is based on supply and demand. However, Ethereums innovative technology and real-world use cases give it a competitive edge. That utility is a significant driver of ETH’s value. As more developers build dApps on Ethereum, and more users engage with these applications, the demand for ETH naturally increases. 

ETH is also used to pay for transaction fees, called gas fees, and to engage with other services on the platform. This creates a direct link between network activity and demand for ETH. Constant innovation and upgrades make Ethereum more accessible to an ever-growing user base. This could potentially lead to increased adoption, which would put upward pressure on the price too. 

But at the end of the day, the price is driven by speculation and market sentiment. If people feel optimistic about the future of Ethereum, it will likely become more valuable. If they feel pessimistic, it will likely lose value. 

Pivotal Moments in Ethereum’s History

Are You Ready For Ethereum?

This cryptocurrency is more than a one-trick pony. Ethereum is a comprehensive platform driving innovation in the real world. Decentralized applications (dApps) and smart contracts are already changing the way we transact, do business, play games, engage with each other, and so much more. If you’re intrigued, investing in ETH is a great starting point. 

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