Ethereum

First proposed by Vitalik Buterin in 2013, Ethereum is a blockchain-based computing platform that enables users to create applications and transfer value around the globe. The project was conceived as a solution to flaws that have dogged the internet since its inception.

It may not seem like it, but the worldwide web is centralized. The cloud lets people collaborate across distances, but their work, emails, and family photos are stored on servers, which have physical locations and are administered by governments or private companies. Administrators can censor users, and if a hacker cracks a server, they have access to all the data housed therein.

Ethereum, which refers to itself as a world computer, seeks to improve on this design by replacing centralized control with a decentralized network of nodes. Each node, or network participant, has an updated version of the blockchain on which the network runs. If an outsider tries to censor or adulterate an entry, the other nodes will notice and reject the change.

Decentralization brings impressive benefits, but it also presents a problem. Each version of the blockchain must first be agreed to by actors who neither know nor trust one another. Users of cloud-based applications can place their trust in the central administrator. With decentralized apps, agreement must be reached in other ways.

To reach agreement, Ethereum uses a consensus mechanism known as Proof-of-Work (PoW), which pays participants to solve complex mathematical puzzles to validate blocks of transactions. Once a puzzle is solved, the associated block is added to the chain. Each node is updated more or less instantly, and the finder of the solution is rewarded in Ether (ETH), the token that buys goods and services on the Ethereum network.

PoW is energy-intensive and ill-suited to scaling to millions of users. As of this writing, Ethereum is planning on switching to Proof-of-Stake, a modern mechanism that is more efficient.

Participants in the Ethereum network who validate transactions are known as miners. The name is a nod to the 19th century Gold Rush during which miners used shovels and brute strength to extract gold from the western U.S. and Canada. ETH mining relies on a different kind of brute force, raw computing power, to repeatedly guess at answers to mathematical puzzles.

Specifically, ETH miners attempt to match transaction metadata to a string of letters and numbers known as a hash. Once a match is found, it is shared across the network, and the underlying transactions are added to the blockchain. Though it’s hard work to find the right hash, it’s easy for nodes to verify that an answer is correct.

In exchange for correct answers, miners are paid in ETH. This is referred to as the block reward. In addition, successful miners receive a fee related to the amount of gas attached to each transaction. Developers who want their programs to run smoothly must allot an appropriate amount. To do otherwise risks being ignored by miners, who are up against equipment and electricity costs.

In 2008, Satoshi Nakamoto introduced Bitcoin as a “a peer-to-peer electronic cash system.” Ethereum is often referred to as a second-generation blockchain because it adds a second layer that enables developers to write blockchain-based computer programs. As transactions occur on Ethereum, nodes are updated with a network-wide accounting of ETH along with the most recent state of each decentralized application, or Dapp. Dapps run on smart contracts, programs that facilitate the transfer of value on blockchain.

Smart contracts automatically execute when certain conditions are met. For example, cryptocurrency could be released to a player once they beat the dealer in virtual blackjack or advance to a particular level in an online game. Smart contracts can be programmed to handle real-world situations, too. Dapps are already disrupting industries like finance, insurance, real estate, and the law.

Thanks to decentralization, these applications are more resistant to censorship, outages, and industrial espionage than their cloud-based counterparts. That said, a Dapp or smart contract is only as good as the developer who writes it.

Ethereum’s most infamous programming failure occurred in June 2016 when a hacker exploited a vulnerability in the code for the DAO, an organization envisioned as a decentralized venture capital firm that would democratically fund the creation of new Dapps. The hacker stole 3.6 million ETH, worth more than $60 million at the time and equal to a third of the amount initially raised by the organization. The loophole the hacker exploited was not in the blockchain but in the code written by DAO developers.

Ethereum Classic (ETC) began as a reaction to the DAO hack. In response to the security breach, the Ethereum community opted to retrieve their stolen ETH by executing a hard fork. This was akin to traveling back in time, erasing every transaction that occurred after the hack, then proceeding forward along a new, clean branch.

If Ethereum didn’t retrieve the money, participants and future investors might have lost confidence in the project. By retrieving it, the community violated first principles, namely that blockchain should be immutable, or unchangeable, and free from interference by a central authority.

Approximately 10% of the community felt strongly enough about those principles to remain on the original hacked branch. They took the name Ethereum Classic to distinguish themselves from the new branch, which kept the name Ethereum.

Since the split, Ethereum and ETC have proceeded along different tracks. Ethereum, which retained the lion’s share of the community’s developers, has held its ground as the world’s largest ecosystem for Dapps and is working towards swapping its Proof-of-Work (PoW) consensus mechanism for Proof-of-Stake (PoS). ETC will stick with PoW.

ETC views PoW as core to decentralized governance. There is merit to the claim. PoW only rewards miners who put in the work. By contrast, PoS reaches consensus by paying participants who already control large chunks of the network. This smacks of corporations, which are centrally managed and pay dividends according to the number of shares each investor holds.

The PoW-PoS debate is complicated. Time will tell which approach succeeds.

The Ethereum blockchain isn’t for sale, but anyone can purchase ETH, the token that powers the network. There are several ways to buy in, but most people make their first purchase on an exchange.

An exchange is a marketplace where parties trade financial instruments. Certain cryptocurrency exchanges, known as fiat on-ramps, allow customers to buy ETH for fiat currencies like dollars, euros, and yen.

To register with an exchange, a prospective customer must provide personal details including address history, a photo, and banking information. This is for regulatory compliance and to secure the login process. Once these requirements are squared away, buying can begin.

For those who balk at government oversight, ETH can be purchased peer-to-peer on a decentralized exchange or even in-person. These methods have few to zero compliance requirements, which makes them faster than centralized exchanges, but transacting peer-to-peer brings security risks that should not be discounted.

Whether ETH is purchased through an exchange or at a coffee shop, a buyer must have a way to store it. Exchanges provide wallets where customers can keep their coins. Unfortunately, exchange-based “hot wallets” are tempting targets for hackers, and not every exchange will be able or willing to compensate a customer for a loss.

It’s safer to use a desktop or web-based wallet. Going off-exchange shifts some responsibility from exchange to customer, but this is a small price to pay for peace of mind. Those who hold large amounts of ETH should store their coins offline in a hardware wallet.

ETH can be sold for fiat currencies like dollars, euros, and yen or traded for other cryptocurrencies. Many ETH holders transact through centralized exchanges. Others feel more comfortable operating in decentralized, peer-to-peer settings. Generally, there are two classes of people who have ETH to sell, HODLers and active traders.

HODLers, or investors who buy and hold cryptocurrency, keep ETH because they believe in Ethereum and expect the value of their tokens to rise. Their perspective steels them through negative news events like the DAO hack, which sent ETH tumbling by nearly 50%. The following year, the token set highs at levels beyond anything seen before the breach.

Active traders keep ETH to sell for short-term gain. Some traders consider fundamentals like developer activity and rates of Dapp adoption, but most rely on technical analysis to time their transactions.

While ETH can be sold directly for fiat, not every exchange provides a fiat off-ramp. This can make it difficult to lock in profits. When there is no off-ramp, options include hopping exchanges or trading for a stablecoin that is pegged to fiat.

For holders who are neither bona fide HODLers nor active traders, there are brick-and-mortar businesses that accept ETH for physical goods and services. However, most opportunities to spend the token will be found on the Ethereum network, where it can be used to develop and engage with Dapps.

As the original second-generation blockchain, Ethereum pioneered concepts like smart contracts and Dapps. Though it’s now in competition with other platforms, Ethereum is dominant in the decentralized finance (DeFi) space. DeFi leverages blockchain and open source software to deliver financial services without the aid of trusted third-parties. Projects include lending protocols, decentralized exchanges, stablecoins, and more. If DeFi succeeds, demand for ETH will increase.

For DeFi to succeed, the network must first undergo a series of upgrades. At the time of this writing, Ethereum does not scale. It is unable to efficiently process high volumes of requests from its users. Developers are working on solutions, but these will take time to test and implement.

The two most promising solutions are Proof-of-Stake (PoS) and sharding. PoS is a modern consensus mechanism that is more efficient than Proof-of-Work, the mechanism on which the network currently relies. Sharding refers to a division of labor among nodes that relieves them of the burden to carry complete copies of the blockchain. Instead, nodes will maintain subsets of blocks and reach out to other nodes on an as-needed basis.

If Ethereum can’t solve scaling, it will lose its DeFi Dapps to a blockchain that can securely manage thousands of transactions per second. If it does scale, the applications will remain, and ETH could blast past all-time highs.

Ethereum started with a supply of 72 million ETH to power the network. Since then, mining has increased circulation by 10% annually, pushing the total number of tokens north of 100 million. The upcoming switch to Proof-of-Stake (PoS) is expected to curb inflation to a more modest rate of 2% per year.

It is difficult to predict how many ETH will be around in 5 or 10 years’ time. The transition to PoS could fail, permitting millions of new tokens. Alternatively, if PoS happens, it would effectively cap the supply. Regardless, Ethereum has already done more than any platform to increase the range of cryptocurrency options. Thousands of projects have launched from the network as ICOs, or initial coin offerings. Some have left for their own blockchains, but most have stayed put.

The ICO boom was made possible by Ethereum’s development of the ERC-20 standard, a protocol for token issuance that acts as readymade infrastructure for blockchain-based businesses. Projects that adhere to the standard enjoy interoperability with other ERC-20 tokens and are simpler to list on exchanges. The standard also ensures that tokens will be compatible with desktop, web-based, and hardware wallets.

The network has since created additional standards such as ERC-721 and ERC-1155. The former facilitates the ownership and transfer of digital collectibles. The latter allows a single smart contract to govern fungible tokens like ERC-20 cryptocurrencies and one-of-a-kind ERC-721 tokens. This flexibility could boost network efficiency as it enables transactions to include multiple data types.