February 24

Ethereum: How Does it Work? Why Does it Matter?

0  comments

Ethereum: How Does it Work? Why Does it Matter?

​Disclaimer: Many or all of the products featured here are from our partners. Read our advertising disclosure for more information

After Bitcoin, Ethereum is the second biggest cryptocurrency by market capitalization. But what is it, how does it work, and why does it matter? These are some of the questions we’ll be looking at here. First, how did Ethereum begin?

A Brief History of Ethereum

Bitcoin brought about a simple but revolutionary innovation; an immutable ledger— the blockchain. With Bitcoin, it was possible to secure an unchangeable record of transactions, which allowed a public record of who has how much money. 

This is much like a ledger used by bank, except that anyone can see the entries, and only the account owner can change the amount of money in the account. A marvel of cryptography.

Bitcoin was originally built so that transactions could contain additional data. At first, this additional data was just used for making notes about a transaction. At some point, however, people started to realize that you could also put programming code inside of this extra data. And so the idea of “programmable money” was born. 

But the amount of data that could be included with bitcoin transactions was very small. So some bitcoin developers proposed expanding this limit, in order to allow more space for code. After a fierce debate, this proposal was shot down on the grounds that it would take too much space. 

All bitcoin transactions are stored by many people, all around the world, and this also makes the network secure. No government can shut down the bitcoin network, since it would be impossible to track down all the nodes. It was feared if the ledger got too big, fewer people would be able to maintain a copy of it, which could make the network vulnerable and threaten bitcoin’s unique value.

The authors of the rejected proposal were not discouraged, however. They developed a concept for a new cryptocurrency network, specially designed to allow programs on its blockchain. Envisioned as a “world-computer,” it would allow for the decentralized execution of immutable programs stored on a blockchain. 

And so Ethereum was born. 

Related: ​Visit Coinbase.com to start investing in Ethereum today

What’s the difference between Ethereum, ether, and gas?

Ethereum describes the entire network, which includes all of the nodes. Nodes are people or organizations that maintain a copy of the Ethereum blockchain.

Ether (ETH), on the other hand, is the native currency of the network. Any operation that involves making a change to the blockchain— creating a contract, storing data, or making a transaction— requires ether. 

Since cryptocurrency prices tend to be very volatile, a separate unit called “gas” was created to make the cost of using the network more stable. The cost of an operation is paid in ether, so when you run an operation, you have to define how much ether you are willing to pay per unit of gas. 

Ethereum: What is it? Why does it matter? #Ethereum #ETH

Click to Tweet

Why is Ethereum such a big deal?

If Bitcoin is disrupting the monetary and banking system, Ethereum stands to disrupt the government and legal sectors. Including code on an immutable ledger like a blockchain opens the possibility of running smart contracts.  

What this term actually means is that they can be automated, which could save an enormous amount of paperwork. Ethereum developers created a new programming language called “Solidity,” which is used for coding smart contracts, and is easy to learn and read. 

 

The reason this is so special is because just as bitcoin allows a record of accounts to be public, removing the need to trust banks, Ethereum can make legal and governmental records open for everyone to see, removing the need to trust governments and lawyers.

Let’s consider a few of the ways in which these contracts can be used.

Title Transfers

Consider, for example, the process of buying a car. You give the seller the money, then he reports the sale to the licensing agency. He gives you a bill of sale and a title for the car. Then you go into the licensing agency with your ID, show them the bill of sale and the title, pay a fee, and then wait several weeks to receive a new title in the mail. 

All of this is necessary to prove ownership of the car. Otherwise a car thief could steal a car, claim that it belongs to him, and no one would be able to disprove the claim.

With a smart contract, all of this can be automated. The seller of a car (let’s call her Alice) can have a secure digital identity represented as a wallet address (similar to an email address). The title of the car is represented as a unique digital token on the blockchain. If that token is held inside of Alice’s address, it means it belongs to her. 

If Alice wants to sell the car, she can put the title token into a special smart contract wallet address. This wallet address could contain instructions like “If $10,000 are transferred into this address by Bob, then transfer car title token to Bob, and transfer $10,000 to Alice.”

The record of the transaction and the transfer of title is saved on the blockchain, and is visible to everyone. The government doesn’t need to maintain a secure database with all the records of vehicle ownership. Nor do they need to verify anyone’s ID’s if the wallet addresses are already been confirmed. And the car can be resold instantly. 

Millions of cars are sold every year, so a process like this could save countless hours of labor. And this applies to many other processes as well; real estate, escrow, and notarization as well.

Crowdfunding 

Crowdfunding has been the most commonly used application for smart contracts so far. Contract logic might look something like this: “If $1 million dollars is received, release funds. If not received by January 30th, then return funds to senders.” 

This is exactly what platforms like Indiegogo or Kickstarter do, except with Ethereum, no one controls the contract. One advantage of this is that fees are lower than with traditional crowdfunding campaigns. The most common form of crowdfunding on Ethereum is initial coin offerings (ICO’s).

Tokenization of Assets

Tokens on the Ethereum network can represent just about anything; gold, real estate, shares in companies, land, or even virtual trading cards.

Diplomas and Certificates of Authenticity

Just as smart contracts can verify the authenticity of ownership, they can also prove the authenticity of diplomas, professional training certifications, or authenticity certificates for food or jewelry.

Voting

Digital identity can allow more transparency around elections and help prevent electoral fraud.

what is ethereum?

Sounds great. But what’s the catch? 

It might sound too good to be true. The theoretical potential of the technology is vast, so some people started dreaming of a utopian future where blockchain would solve all of the world’s problems. 

This turned into a speculative frenzy in late 2017 to early 2018. If Ethereum could really do all of these amazing things, and you need ether to use the network, the demand for ether in the future would be vast. All of this demand would mean that ether could one day become very valuable. 

So the ether price increased from around $10 dollars in January of 2017 to over $1,300 a year later— a 13,000% gain for those who held ether during this period. 

Related: Crash-proof your retirement account with bitcoin, ethereum, litecoin, and other cryptocurrencies...

But there’s a big difference between theory and reality. As Ethereum gained popularity, it quickly became clear why the Bitcoin community rejected the idea in the first place. 

One of the early dapps was a card trading game called “Cryptokitties.” Similar to Pokemon, the game featured cute cats, each of which was unique and represented by a unique token. When the game started gaining popularity, the volume of trades clogged the network, leading to long delays. 

The question was, if Ethereum cannot handle a spike in popularity of a cartoon cat trading game, how is it supposed to replace the world’s legal and governmental systems? 

The Ethereum developers responded with a number of proposals to make the network more scalable. Two years later, these proposals have not yet materialized, although the network is functioning. Most dapps have also been criticized for poor user experience, and have failed to gain serious traction.

ICO Scam Bonanza

To date, the vast majority of activity on the Ethereum network has been crowdfunds, many of which were fraudulent. It quickly became clear that Ethereum enabled the creation of unregulated securities—  and there is a reason that securities are regulated. 

Without regulation, many completely fraudulent projects promised to revolutionize the world with amazing technology. But a lot of this was just hot air, and anonymous developers disappeared with millions worth of funds. Other developers were sincere but completely unable to deliver on their promises, leaving some investors bankrupt.

In addition to these challenges, Ethereum also has to deal with increasing competition.

Ethereum Competitors

Once Ethereum started to take off, a large string of competitors appeared, each claiming to be technically superior to Ethereum. NEO, Ark, Lisk, EOS, Tezos, and others all jumped into the game, eager to take a piece of the market. Each of these has different strengths and weaknesses, and there are dozens more, some of which are legitimate, interesting projects, and others which are not. 

How do I buy Ethereum?

Since ETH is the most popular cryptocurrency after bitcoin, many people include it in their cryptocurrency portfolio. There are a number of trusted cryptocurrency exchanges available for you to create an account and purchase ETH. It's recommended that you do your research before choosing a cryptocurrency exchange.

The most well-known, reputable and user friendly online exchange for buying ETH is Coinbase.

CoinBase

Coinbase is a safe and secure platform that makes it easy for investors to buy, sell, and store cryptocurrency. The U.S. based company currently supports the major coins such as Bitcoin, Ethereum, Litecoin, Ripple, as well as fifteen additional crypto assets.

Purchasing ETH requires verifying your identity and linking a bank account, but once you do this purchasing ETH is relatively straightforward. If you're brand new to investing in crypto markets, I'd recommend using Coinbase. Just link your bank account or credit card and get started. 

Binance

Binance is another one of the larger cryptocurrency exchanges. Binance does more than $3.5 Billion in daily volume and at the time of this writing allows you to buy, sell, and store more than 120 crypto assets.

Ethereum in your IRA

Another investment strategy that is growing in popularity is buying ethereum (ETH) with your retirement funds. Investors can now rollover or transfer funds from a qualifying retirement account into a self-directed IRA. You can use this self-directed IRA to buy Ethereum and other cryptocurrencies.

Sound complicated?

There are "bitcoin IRA" companies that specialize in these transactions and are ready to walk you through the process. While often referred to as a "bitcoin IRA," these self-directed IRAs can hold a diverse mix of cryptocurrencies and other alternative assets such as physical gold or silver.

Most of the reputable Crypto IRA companies support ethereum (ETH) for their clients. 

Regal Wallet

RegalWallet.com: One of the top Crypto IRA providers

What does the future hold for Ethereum?

In spite of all the challenges facing Ethereum— the struggle to scale, a reputation damaged by scammers, and intense competition— it remains the largest platform of its kind. Solidity now has a lot of traction, and is the most widely used smart contract language in the world. 

Some of the developers who got rich from Ethereum are using their wealth to help grow the Ethereum ecosystem. Big names like Microsoft, JP Morgan, the United Nations, and various governments are testing and developing Ethereum applications. 

Will Ethereum be able to overcome its scaling issues and become a “world computer?” Or will we see a future with many different blockchains tailored to different uses? Only time will tell.

Loved this? Spread the word


About the Author

Ilir is the editor at incomeinsider.org. He is a cryptocurrency and precious metals enthusiast and has been publishing articles on alternative investments since 2013. He also blogs about entrepreneurship and digital marketing. When he's not creating content online, he's spending time with his family.

Ilir Salihi

Related posts

What is Chainlink? An Introduction to LINK & DeFi

​Read More

Monero: A Crash Course in the Leading Privacy Coin

​Read More

Bitcoin 101: Beginner’s Guide to Bitcoin

​Read More

What is Ripple? A Beginner’s Guide to Ripple (XRP)

​Read More

Are You an Income Insider?

Insider Guide Reveals How to Supercharge Your IRA or 401(k) with Cryptocurrencies...

>