Blockchain Ethereum

What is Ethereum? Understanding How Does Ethereum Work

Explaining what is Ethereum

What is Ethereum? Let’s talk!

Welcome, friends! You’re probably here because you woke up this morning and thought to yourself, “what is Ethereum and how does Ethereum work?”

You weren’t sure, so you asked your neighbor and they didn’t know either! It’s okay, though — this guide is going to tell you everything you need to know about one of the world’s most exciting cryptocurrencies, Ethereum. Shall we begin?

Let’s start at the very beginning, a very good place to start…

A Brief History of Ethereum

What is EthereumIn 2012, aged 17, Vitalik Buterin was introduced to Bitcoin by his father and became very interested in its technology. Vitalik began writing for Bitcoin Magazine and suggested improvements to the Bitcoin platform. When these improvements weren’t made, he decided to make his own cryptocurrency instead.

His idea was Ethereum, and it went live in 2015. Since it started, Ethereum’s price has gone up a lot and it now has a ‘market cap’ of $48.7bn (that’s the total value of all Ethereum currency in the world today). So, why is Ethereum going up?

Ethereum market cap charts
Note: Ethereum’s ‘market cap’ is the total value of all Ether combined. Ether is Ethereum’s currency, whereas Ethereum itself is a platform.

Ethereum technology has real potential to change the world. What is Ethereum tech and what makes it so special, you ask? Let’s find out…

Ethereum For Dummies

Note: If you’re not a dummy, you should probably still read this, just in case!

It’s easier to answer, “what is Ethereum?” if we first ask, “what is Ethereum trying to replace?” Let’s see an example;

Matthew writes tutorials using Google Docs. He can edit his work and share it with whoever he wants. One day Google Docs is hacked, or the government bans it, so Matthew loses all his work.

Now Matthew decides that he will only use the word processor on his computer, so his work will be safe. But it isn’t safe, is it? Matthew’s computer can be lost, broken or hacked into.

Matthew is desperate now, so he decides to sell his laptop and buy a pencil, a notepad, and some stamps instead. Job is done!

Matthew’s problem here is that he wants the convenience and speed of the internet but with the control and safety of his pencil and paper. But what is Ethereum going to do about it?

Ethereum offers a way to use the power of the internet without trusting apps like Facebook, Google or your online bank with your personal information.

Apps like Facebook and Google collect and store the information of their millions of users in servers. This means that user data is kept at a very small number of locations (this is called centralization). If one of these locations is hacked into, we’re all in big trouble!

How Ethereum works is by removing the need to trust lots of apps with private information. It does this with decentralization using ‘blockchain’ technology.

Blockchain Basics

Ethereum’s version of the internet is one where servers and clouds are replaced with a network of systems called nodes. The nodes store and maintain a shared database called a blockchain.

There are thousands of nodes in the network all storing the entire blockchain. The more nodes there are, the safer the network and its data become. The information that you enter into this record can only be controlled by you. It isn’t stored on your computer, or in a central server — it is stored across the entire network of nodes.

The information held on the blockchain is verified by ‘consensus’. This means that more than half of the nodes must agree that information is correct before it is allowed onto the blockchain.

Hacking this kind of system is near impossible as you would need to control more than half of the network to force a consensus. Even if you did control more than half of the network, it would cost you so much money to complete the attack that it wouldn’t be worth it.

As I mentioned earlier, Ethereum didn’t invent blockchain technology, Bitcoin did, but it is using and improving it in some incredible ways. So, what is Ethereum blockchain?

Note: Read our Blockchain Explained guide for more on blockchain technology.

Ethereum Explained: Blockchain 2.0 and its Uses

The Ethereum blockchain (or ‘Blockchain 2.0,’ as it is sometimes called) uses similar technology to Bitcoin, but it is more advanced. It can do much more than the Bitcoin blockchain. It does this in two main ways;

Ethereum platform

Smart Contracts

The Ethereum blockchain is designed so that transactions can only take place when certain conditions are met. The rules deciding these conditions are called ‘smart contracts’. It’s an essential part of the what is Ethereum question.

For example, imagine a vending machine. If Peter wants a candy bar from a vending machine, he needs enough money to pay for it. If he doesn’t have enough money, he won’t get his candy bar. A smart contract for this transaction might look like this;

IF Peter puts $1 in the vending machine THEN the vending machine will give Peter a candy bar.

Once one of these contracts is written, it can’t be changed. That’s why they are called ‘trustless’ transactions. You don’t need to trust individuals on the network — if the conditions of the contract aren’t met, then it won’t happen.

Imagine that! A trustless global network that never goes offline!

To learn more about smart contracts, see our What is a Smart Contract guide.

DApps

Centralized and decentralized applications

Decentralized applications or ‘dApps’ are simply applications that do not run on a traditional central server. Instead, they run on a blockchain — using it to decentralize their server.

DApps are at the core of Ethereum’s design and its beliefs. Ethereum’s founders want users to learn Ethereum and build on it. So another part of what is the Ethereum question is definitely dApps.

Ethereum has its own coding language called Solidity. Solidity is used to build dApps. Because Solidity is like JavaScript (one of the most common programming languages), it encourages developers to create new and exciting dApps.

These dApps could soon be competing with (or replacing) centralized apps, in industries like social media, e-commerce, email, and online banking. There are endless possibilities for building dApps on Ethereum’s blockchain.

A Quick Recap

Let’s quickly revisit the first part of that question we asked earlier: what is Ethereum?

What have we learned so far…?

Put simply, we’ve learned that Ethereum is a blockchain that allows the user to build smart contracts and dApps — it has the potential to change the internet forever.

Happy? Yes? Are you sure? Great! Without any further delay and having a pretty clear idea of what is Ethereum, let’s have a look at the second part of that question: how does Ethereum work?

A Little More Detail: What is Ether and How Does Ethereum Work?

Ether is the currency of Ethereum. Sometimes the two are confused but it’s simpler if you try to remember that Ethereum is the system and Ether is its currency.

What is EthereumIf you want to get anything done on the system, you’ll need some Ether. Ether fuels the Ethereum system, and it’s often referred to as ‘gas’ for this reason. Each transaction on Ethereum needs a certain amount of ‘gas’ to get the job done. The bigger the job, the more gas you need.

The question of what is Ethereum and how does it work is often accompanied by the Ethereum vs Bitcoin question. As people often compare Ether to Bitcoin, so we’ll take a moment to explain the main differences.

Bitcoin

  • Bitcoin is a digital money. Its blockchain allows manual peer-to-peer transfers of digital money. If Peter wants to pay Paul 10BTC (Bitcoin) to paint his house, without using a bank, he can use Bitcoin. It looks like this; Peter sends 10BTC (Bitcoin) to Paul.

    Nice and simple! That’s Bitcoin’s one function, and it does it very well!
  • There is a cap on how many Bitcoin can exist (21 million), so it could become a reliable store of value, like gold or diamonds.
  • The average time for a confirmed Bitcoin transaction is, although they can be as quick as 10 minutes.

Ether

  • Going back to what is Ethereum and its currency: Ether is digital fuel for the automated smart contracts of the Ethereum network. If Peter wants to pay Paul 10ETH to paint his house, he can use an Ethereum smart contract. The transaction would look like this; IF Paul paints Peter’s house THEN 10 ETH will be sent to Paul. So, as you can see, Ether can be used very similarly to Bitcoin. The only difference is that with smart contract technology, Peter won’t pay Paul until Paul has painted Peter’s house. Paul won’t get paid if he doesn’t paint Peter’s house, so he can’t cheat! This same system can be used to guide transactions of all kinds, from emails to how a company pays its staff.
  • There is no cap on how much Ether can exist. Although, the amount of Ether probably won’t go above 100,000,000 for a very, very long time.
  •  The Ethereum transaction time is very quick — Ether-fueled smart transactions just take seconds.

What is Ethereum Mining?

In both Bitcoin and Ethereum, new currency (Bitcoin or Ether) is created by a process called ‘mining’. Nodes on a blockchain must verify transactions; the nodes are rewarded with a new currency. For example, an Ethereum node (known as a miner) is rewarded with a new Ether.

This is called mining because it is similar to gold or diamond mining. Instead of digging in the ground, though, the miners are verifying transactions.

Mining Ether in this way is called ‘Proof of Work’ mining. It is called PoW (Proof of Work) because the node has to show that it has done the ‘work’ (verified the transactions) to receive its Ether reward. The bad thing about PoW mining is that it uses a lot of computing power and therefore a lot of electricity, making it expensive and bad for the planet. So, now you have a pretty clear idea about what is Ethereum mining.

Soon, Ethereum developers hope to start using a different method, called PoS (Proof of Stake). This method uses much less electricity, so it’s a lot better for energy costs and the planet!

In PoS, users with a lot of Ether are selected at random to verify transactions. This form of mining will be rewarded with fees rather than a new currency and will use a lot less power and electricity.

A quick tip: the users that are selected in PoS to verify transactions are called ‘Stakers’ or ‘Stakeholders’.

What is Ethereum Storage?

Ether doesn’t leave the Ethereum blockchain, so it isn’t physically stored anywhere. If you want to use Ethereum, you’ll need a ‘wallet’ (sometimes called an Ethereum ‘address’).

Your Ethereum wallet won’t contain any Ether, but it will contain the codes needed to access it. These codes are called private keys. If you lose your private keys, you lose your Ether. So choosing a good wallet is very important! There are four main types;

Hardware wallets

These are physical storage devices like USB sticks. Ledger Nano S is one of the more expensive hardware wallets and it offers safe offline key storage. However, just like a real set of keys, a hardware wallet can get lost. So be careful where you put it!

What is Ethereum Ledger Nano S Wallet

Desktop Wallets

Store your public and private keys directly onto your computer. This option uses a password which you mustn’t lose. It also takes up a lot of space on your device. We recommend using the Exodus desktop wallet.

What is Ethereum Exodus Wallet

Mobile Wallets

Similar to desktop wallets, but use much less space — they are ideal for storing your public and private keys on your smartphone. Jaxx offers its users key storage for up to 13 different cryptocurrencies.

What is Ethereum Jaxx Wallet

Web Wallets

Store your private keys online — an example of this is the Coinbase wallet. These are the least safe type of wallet and we do not recommend using them to store any amounts of Ether that you cannot afford to lose.

What is Ethereum Coinbase wallet

Paper Wallets

What is Ethereum Paper WalletThese are the most old-fashioned storage option — they are just pieces of paper with your access codes written on them. They can’t be hacked but you need to remember where you put them!

If a wallet is connected to the internet, it is called ‘hot storage’. If it isn’t connected to the internet, it’s called ‘cold storage’. When storing private keys, it’s recommended that you use a combination of both hot and cold wallets for maximum security. Now you have a pretty clear idea of what is Ethereum storage and which wallet to choose.

Where to Buy Ethereum

You can buy Ether from three main sources;

Brokerages are coin exchanges like Coinmama which buy and sell Ether for a fee. They are simple to use but also quite expensive. You can use them to buy Ether with your fiat currency (USD, EUR, etc.) using a credit/debit card or with a bank transfer.

Trading platforms like Bitfinex connect the buyer and the seller in exchange by using a middleman (Bitfinex). This is what traders use to trade one cryptocurrency for another. E.g. buying Ether with Bitcoin, or selling NEO for Litecoin.

Peer-to-peer platforms like LocalEthereum allow buyers and sellers to contact each other directly to negotiate prices. This option is riskier than the other two as you are trading directly with someone you don’t know. There is no middleman, so you don’t pay any fees, and you can pay using cash too.

For more information on how and where to buy Ether, you can follow our How to buy Ethereum guide.

What is Ethereum Doing Now?

A lot of dApps are being created on Ethereum’s blockchain and a kind of fundraising called an ICO is being used to pay for them. So knowing what is Ethereum doing now is pretty useful.

Initial coin offerings (ICOs) allow developers to sell the idea of their product to pay for its creation — it’s like Kickstarter but for dApps.

Check out some of the dApps being developed (or that have already been developed) on Ethereum with ICOs;

Golem is a dApp which allows users to rent the idle power of their computers to each other. It’s like being able to rent your car to other drivers when you’re not using it!

What is Ethereum Golem

EtherTweet is a communications platform that is very similar to a famous social media app except it’s on the blockchain so there is no central authority. That’s right, it’s a dApp version of Twitter and it is completely uncensored!

Etheroll is an online casino that uses Ethereum’s blockchain to create fair online dice games. Although, all this new technology might already be enough of a gamble for most people!

With all this good stuff going on, it’s easy to forget that Ethereum is still very new and still has a few issues.

Some critics think that the platform is too complicated for most users. This complexity could mean that experienced users might be able to scam newbies if they wanted to. Ethereum has been compared to DOS because DOS needs Windows to make it user-friendly. So, maybe there will be something released later on that will make Ethereum more user-friendly!

Having a pretty clear idea about what is Ethereum doing now, we can talk about one more issue – the Ethereum ‘fork’. Put simply this was a disagreement in the Ethereum community which split the platform in two. This is a possible flaw in how its community operates. When you run something with voting, not everyone will agree — it’s normal!

What is Ethereum Going to be Doing In the Future?

Imagine all the different transactions that occur in everyday life. Buying or selling a car, renting an apartment, placing a bet on the World Cup Final. They all involve trusting strangers with your money and your information. Ethereum solves this issue, which means it has lots of potential for the future. So now you not only know what is Ethereum but also how it works.

More and more real technology is connected to the internet every day — we call it the ‘Internet of Things.’ Door locks, refrigerators, ovens, light bulbs, boilers, and TVs are all connected to the internet and they all need to be run safely and with clear instructions.

Now, imagine a world where smart contracts and dApps automatically guide those transactions and technologies, whilst an unbreakable record of it all is kept online forever. Pretty cool, don’t you think?

We asked a question at the beginning of this guide, what is Ethereum? Well, the real answer is, Ethereum is anything you want it to be. So, get started, learn Ethereum and think big. The future starts now!

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