Crypto Basics: What is Ethereum

What is Ethereum? 

In short: Ethereum is a public platform that uses blockchain technology to facilitate smart contracts and cryptocurrency trading securely without a third party.

Ethereum
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A public platform that uses blockchain technology to facilitate smart contracts and cryptocurrency trading securely without a third party.

Bitcoin uses blockchain technology to manage and create a digital currency securely without a centralised third party. The Ethereum blockchain also supports decentralised digital currency - known as Ether - but with the added innovation of something called Smart Contracts. 

Smart Contracts are automated, enforceable agreements that don’t need third-party intermediaries. They are essentially programmable agreements, executed without any human involvement. 

So if you think of Bitcoin using blockchain technology to store currency transaction data, Ethereum uses blockchain technology to store contractual data (along with transaction data).

Ethereum uses this innovation to provide an open-source platform that software developers can build applications on top of (a concept introduced in a previous article discussing Bitcoin's limitations).

Applications built on Ethereum are decentralised and can be created and used without permission or regulation from any centralised third party. They are called DApps - decentralised applications. 

Hence, Ethereum as the ‘World Computer’. It is the world’s first programmable blockchain. In this sense, Ethereum provides a platform that allows applications to run without any possibility of downtime, fraud or third-party interference, powered by network of computers participating based on economic incentive.

Just as personal computers run local applications such as Microsoft Word, Ethereum runs global applications that are decentralised and distributed. 

The Origin of Ethereum & Its Objective

To better understand why Ethereum is important and where the platform is heading, it’s useful to examine its origin and get a sense of its original objectives. Ethereum was first proposed in a 2013 white paper by Vitalik Buterin. 

Vitalik was a programmer who wanted to build on top of Bitcoin’s innovation and bring application development capability to the blockchain world. Vitalik’s vision for the blockchain space was that instead of having individual blockchains for individual applications, there would be one blockchain platform that anyone could build decentralised applications on top of.

So, instead of having bitcoin for currency and another blockchain for another application, Ethereum could provide the blockchain foundation for anything that can be reduced to programmatic logic.

Here we can begin to understand Ethereum’s divergence from Bitcoin. Bitcoin uses blockchain to provide a reliably secure and decentralised medium of exchange.

Though  Ethereum also has that capability, it is intended as a  blockchain to provide a reliably secure and decentralised platform to build applications on top of. Hence the idea of a ‘world computer’. 

The objectives of Ethereum can are summarised as follows:

To provide a platform that allows developers to build applications, and users to use applications that are 

  1. Decentralised - there is no central third party control. 
  2. Reliably secure - fraud and third party interference are very difficult if not impossible
  3. Universally accessible - anyone can build, deploy and use Ethereum applications without the need for permission.

Ethereum's Unique Characteristics & Ecosystem

So how does Ethereum achieve these objectives? Ethereum was designed as a blockchain with a built-in ‘Turing complete’ programming language - called Solidity - that can be used to create smart contracts. 

Turing Complete
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The characteristic of a computer or computer language which means it is able to simulate any other computer/computer language and with enough time/resource solve any computational problem. The Ethereum Virtual Machine is an example and is described as the ‘world computer’ as it is intended to be able to support any computational problem, though it isn’t infinitely scalable.

All that ‘Turing complete’ means is that Solidity is a programming language capable of programming for any hypothetical computation. Thus, in theory, any computer application can be programmed in Solidity and run on the Ethereum platform. This language, therefore, is what Ethereum’s ‘smart contracts’ are written in. 

Just like Bitcoin uses blockchain technology to store its transactional data in a secure and decentralised way, Ethereum uses blockchain technology to store transactional data and contractual data.

By providing a blockchain complete with a programming language, Ethereum can achieve its objective of being a platform for decentralised, reliably secure and universally accessible apps to be built on. 

From this, we can start to understand the ecosystem that Ethereum enables and why there is so much interest in the platform. 

Before Ethereum, the blockchain world was limited to one main application (cryptocurrency through Bitcoin) and other speculative projects such as Namecoin that used blockchain to sell decentralised domain names. Ethereum provides the platform for any decentralised application to be built on top of. 

But how will these DApps work? Well, a key component of their functionality is Ethereum’s native currency Ether used as sound money for transactions on the Ethereum platform. As with Bitcoin, the Ethereum platform rewards users that verify transactions by charging fees. Ethereum’s transaction fees are known as Gas (more on this later).

Unlike Bitcoin, however, Ethereum also allows for other currencies to be used on the platform. Anyone can create assets and use Ethereum to trade them. These are known as tokens. 

Some famous applications of tokens include:

  1. Stablecoins: tokens tied to a traditional currency’s value, solving much of the volatility problem with current cryptocurrencies. 
  2. Governance tokens - these can represent voting power for a decentralised app. 
  3. Collectables tokens - these tokens can represent collectable items such as digital art or collectable game items. These are commonly known as NFTs (non-fungible tokens).

Ethereum Ecosystem & Innovations

Since 2013, many decentralised applications have been built on Ethereum. The surrounding Ethereum ecosystem has grown to a market cap of over $140 billion. Famous decentralised applications include digital art marketplace Foundation and browsers such as Brave that let you earn cryptocurrency from browsing the internet. 

More recently, Ethereum has powered the explosion of the decentralised finance industry, otherwise known as DeFi.

DEFI
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An umbrella term for various financial applications in cryptocurrency or blockchain aiming to disrupt and improve upon financial intermediaries.

Innovations include decentralised exchanges and lending platforms amongst many others. The industry is young, moves fast and is continually growing and is an excellent example of the power of Ethereum. 

Another interesting example of the power and perhaps the dangers of the Ethereum platform is the DAO. The DAO was a digital Decentralised Autonomous Organisation and a form of investor-directed venture capital fund. 

The DAO aimed to be a new venture capital fund that allowed investors to vote via tokens granted based on the amount invested. It is estimated that the fund reached an Ether value of over $150 million. 

It lasted around 6 months in 2016 before an attack that saw nearly $50 million worth of Ether stolen. This Ether was eventually returned to its original owners via a ‘hard-fork’. This fork means the original Ethereum blockchain is no longer the main Ethereum chain (known as mainchain) and is now called Ethereum classic. 

The DAO highlighted specific vulnerabilities with creating DApps at scale. Namely that the complex codebases needed to develop large DApps such as the DAO can be exploited.

To get the whole story of Ethereum and understand where the platform is heading next, we need to look at these vulnerabilities in more detail and evaluate the platform in light of its limitations.

Ethereum's Limitations 

The most significant limitation of Ethereum - like with Bitcoin - is its scalability, which, as with Bitcoin, is hard to achieve without sacrificing  decentralisation or security, 

Fiat currency achieves security and scalability but sacrifices decentralisation to do so. In contrast, Bitcoin achieves decentralisation and security but sacrifices scalability to do so. At the moment it’s a similar story with Ethereum, while its critics also point to its founder as a point of failure, along with a lack of clarity over its total supply. 

When Ethereum launched, it was seen as an upgraded version of Bitcoin not just because it made DApps possible, but also because it upgraded the number of transactions that could be processed per second. 

This lent more scalability to the platform, but it’s still constrained. Bitcoin can handle around 5 transactions per second, whereas Ethereum can handle about 30. Compare this with a platform like VISA that can run 50,000 per second, and we can see the current limitations of cryptocurrencies. 

This limitation of Ethereum, coupled with its ability to empower developers to produce DApps, led to the rise of the ICO ecosystem. An ICO - initial coin offering - initially funded Ethereum; inspiring many developers to raise funds similarly. 

Many promised things that they couldn’t deliver on the current Ethereum platform. Thus, the resulting ICO frenzy where teams raised lots of money but often failed to deliver on their promises. 

How then, can Ethereum be claiming to be a ‘world computer’? If it can’t scale, surely it can’t compete? 

ETH 2.0 - Proof of Stake

In its current form, Ethereum cannot compete with Fiat systems such as VISA. Here we come to the advent of ETH 2.0 or Ethereum 2.0. 

Eth2 refers to a series of upgrades to the Ethereum platform that are currently being worked on. The three main objectives of these upgrades are increased scalability, security and sustainability. These objectives are being achieved in two main ways, the introduction of sharding and the migration to a new consensus mechanism known as proof-of-stake. 

Sharding is a computer science technique used to distribute the load on a particular network. In Ethereum’s case, the idea is to spread the transactional and contractional data processing load across 64 different chains. It is hoped that this technique will improve Ethereum’s capacity to process transactions to up to 100,000 per second. 

Proof-of-stake is an alternative way for blockchains to achieve consensus. These are known as consensus mechanisms. Up until now, Bitcoin and Ethereum have used a mechanism known as proof-of-work.  

Proof-of-work is very costly in terms of computer processing power which translates to high energy costs. It also risks the network being corrupted if mining centres grouped together and took control of more than 50% of the network. 

Proof-of-stake aims to address these two problems by randomising the consensus burden rather than having it as a competition. Switching to proof of stake will see a transition from miners to validators. There will still be a reward for confirming transactions; however, it will be more of a random selection than proof-of-work. 

As we saw earlier Ethereum’s transaction fees are known as Gas and naturally, these fees fluctuate with demand and are limited by Ethereum’s transaction processing limitations. Increased demand and a limited supply are a recipe for high fees.

It is hoped that the Eth 2.0 upgrades will dramatically increase Ethereum’s capacity to process transactions and therefore Gas fees (transaction fees) will become much lower. 

Through these two main upgrades and a promise of a more easily upgradeable infrastructure, Ethereum 2.0 aims to be the platform that Vitalik initially envisioned for Ethereum. The community launched the first phase of Eth2 in December 2020, and the full rollout is planned to take place over the next two years. 

It remains to be seen if Ethereum can fulfil its promise of being the ‘world’s computer’, but you certainly can’t fault them for their ambition.

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