What is Ethereum? A step-by-step guide
Learn all about the Ethereum network, including how to use it and where it might be headed.
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Ethereum is a public blockchain and cryptocurrency. In this guide, we'll look at why this is such a big deal, learn about the Ethereum native currency, Ether (ETH), and see what you can do with Ethereum.
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What is Ethereum?
The word "Ethereum" refers to the platform itself, which can be thought of as a decentralised "world computer". The coin itself is more correctly called Ether (ETH). However, these terms are often used interchangeably.
When you buy Ether, you're buying ETH coins, which are used by the Ethereum platform – the world computer itself.
The world computer
Blockchains can be thought of as computers that can run scripts (scripts are lines of code that tell computers what to do). The Bitcoin blockchain, for example, can run scripts that let people send Bitcoin coins to each other.
The Ethereum blockchain, though, is designed to be programmed to run a much wider range of more complex scripts. These kinds of scripts are what people are talking about when they discuss "smart contracts".
These smart contract scripts can then be assembled to create decentralised applications, or "dapps". Dapps are basically computer programs that run on a blockchain.
Right now, the Ethereum world computer is home to hundreds of dapps. Among the most popular are games, gambling platforms, marketplaces and exchanges. There are also social networks, media outlets, identity services, cloud storage platforms and financial services. The idea is that almost any type of program that can be run on a regular computer can be built and run on Ethereum.
It's also home to many other tokens, which are also built to run across the Ethereum blockchain, creating an entire ecosystem of many different tokens. Ethereum-compatible tokens are those which use a standard called ERC20. When you see a reference to an ERC20 token, it basically means that it's a token which lives on the main Ethereum blockchain.
The thing that makes smart contracts so different to regular scripts, and dapps so different to apps, is decentralisation.
Back to topThe Ethereum network and decentralisation
Centralised systems
A centralised system is one that's under the control of a single entity. So when you use a centralised system, you're putting a lot of trust in that entity.
For example, if you're playing online poker, you'll usually just have to trust that the owner of the site isn't cheating. You have to hope that they aren't playing against you and looking at your cards or that they aren't accepting bribes from your opponents or picking and choosing who gets which cards. And you just have to hope that they actually pay out any winnings you're due.
This is the way most systems, whether it's an online poker site or an entire bank, operate these days. You just have to trust them to do the right thing, while accepting that there's always some chance of being cheated.
Ethereum as a decentralised system
A decentralised system like Ethereum is not under the control of any one entity. Like most blockchains, it's operated by thousands of different entities all around the world, none of which has any actual control over it.
And unlike many centralised systems, Ethereum's programming is open source and laid bare for the whole world to see. Anyone with the right know-how can see exactly how it works and even make suggestions on how to improve Ethereum itself.
The programs that run on Ethereum are similarly transparent. So if you're playing on an Ethereum-based online poker website, for example, you can see exactly how it's programmed and be 100% certain that it's fair for all players, that no one can see anyone else's hand and that winnings are automatically paid out as appropriate.
The idea is that on an appropriately decentralised blockchain, there is not a single entity in the world that can prevent that script from executing exactly as programmed.
What can decentralised applications be used for?
Decentralised applications have a lot of important use cases beyond just online gambling, although gambling dapps are very popular on Ethereum. For example, you might use a decentralised marketplace where complete strangers can trade cryptocurrencies via escrow smart contracts, without needing to create accounts, pay fees or place any trust in third parties. These are also very popular on Ethereum.
Some people also use Ethereum to embed messages into transactions, to essentially use it as a censorship-immune publishing platform.
Beyond cryptocurrency, an insurance company might use smart contracts to automatically create a system that customers can trust and that can automatically pay claims in certain situations. Or someone might use smart contracts to automatically verify payments and create an auditable record.
"Whereas most technologies tend to automate workers on the periphery doing menial tasks, blockchains automate away the center. Instead of putting the taxi driver out of a job, blockchain puts Uber out of a job and lets the taxi drivers work with the customer directly."
– Vitalik Buterin, co-founder of Ethereum
The limitations and downsides of Ethereum
One of the first problems with this kind of blockchain world computer is that it's slower, more expensive and more difficult to use than a centralised system.
- Slower: Their decentralised nature means that blockchains will often be much slower than equivalent centralised systems. This is because data, including the data being carried by smart contracts and dapps, needs to be squeezed into blocks, which generally means joining a queue, putting up a fee and then waiting for a blockchain miner to process your transaction. Centralised systems typically send and receive data much faster than decentralised blockchains, although the gap is tightening.
- More expensive: Performing operations on the Ethereum blockchain involves fees paid in very small amounts of Ether. These fees are known as gas and their cost will vary depending on factors like how busy the network is and how complex the script being run is. More complex computing operations are bigger (as measured in bytes, megabytes, etc), which means that they take up more space on the blockchain and will be more expensive.
- More difficult: On the world computer, costs can be unpredictable, programs generally can't be too complex and there are no do-overs if you get something wrong. As a decentralised system, Ethereum has no help desk or customer service and if you make a mistake, you risk losing funds permanently. Ethereum programming and user errors have resulted in the loss of hundreds of millions of dollars worth of Ether so far.
- Other problems: Other problems also limit the current usefulness of smart contracts and dapps. One of the main problems is that even the best smart contract is still only as good as its data sources. For example, you might want to design a smart contract that's only usable by people over the age of 18, but then you still need to think of a way for the world computer to actually check that someone is over 18 in a way that's 100% reliable. And if your solution isn't 100% reliable, then it's probably not worth using a decentralised system for it.
"The thing that I often ask startups on top of Ethereum is, 'Can you please tell me why using the Ethereum blockchain is better than using Excel?' And if they can come up with a good answer, that's when you know you've got something really interesting."
– Vitalik Buterin, co-founder of Ethereum
These kinds of problems are found across most smart contract blockchains and they mean that there's still a huge gap between the theoretical potential of smart contracts and blockchain technology, and how they can actually be deployed in the real world.
Programming on decentralised systems is also quite different to using a centralised system and developers have to be extremely careful because even minor bugs can have devastating consequences, as evidenced by incidents such as the DAO Hack.
How can I use ETH?
ETH is the native cryptocurrency of the Ethereum computer. Its primary function is to pay network fees, called "gas".
Gas is the fuel that runs the network. It's used for transactions and computing functions on the Ethereum world computer, so people who want to build dapps on Ethereum or make full use of the system will generally need to hold some Ethereum.
There are also lots of stores that accept it as a currency. Websites using cart software like WooCommerce and OpenCart can be set up to accept ETH payments. And bill payment services such as Paid By Coins and BitTrade allow users to pay their bills with cryptocurrencies such as ETH.
Many people are also buying Ethereum to hold it as a speculative digital asset in the hope that its price will increase over time. The theory is that if Ethereum becomes an extremely widely used platform, there will be a lot more demand for the Ether token, which might increase its value.
It can also be used as a straightforward cryptocurrency for peer-to-peer payments.
How to send Ether
Transferring ETH works just as it does with any other cryptocurrency:
- Have some ETH in your wallet. The official Ethereum wallet can be downloaded either from GitHub or from the official website.
- Scan or enter the recipient's address. Whether they provide you with the hashed wallet address or a QR code, just follow the simple instructions on your wallet of choice and you'll be done in no time.
- Enter the amount and send. The transaction should be verified in a few seconds and you're done.
How do I store my Ether safely?
If you're looking for an Ether wallet, there's no shortage of options. You can look forward to a high degree of compatibility and plenty of choices for holding your ETH, any other Ethereum-based (ERC20) token and other popular cryptocurrencies such as Bitcoin and XRP, all in one place.
The trick to finding the best Ethereum wallet for your needs is to know what you want. If you're looking for an easy way to spend and send ETH through your web browser, that might be MetaMask. If you're looking for high security, that would be a hardware wallet. If you want to hold it as part of an investment portfolio, that might be something like Uphold.
Learn about wallets and keeping your ETH secure
Best ways to store your ETH
Ethereum tokenomics
What gives Ether its value? How many Ethers are there? How fast are they created? How often do they leave the system?
Asking these kinds of questions might help you work out whether Ether is currently overvalued, undervalued or just right.
What gives Ether its value?
The core function of Ether is to serve as gas for the Ethereum world computer. This is what gives it at least some "real" value, as long as there's anyone in the world who wants to use the Ethereum world computer in any way.
This means that the value of Ether increases based on how many people want to use Ethereum.
But it can also be used as a currency of sorts within Ethereum. When people want to send money, place a bet, fund a project or otherwise transmit monetary value through Ethereum, Ether will generally be the currency of choice. In this way, more dapps generally means more ways to spend Ether, which might increase demand for it and increase its price.
This is counterbalanced in some ways by the fact that Ethereum also hosts many other tokens which can have lots of value themselves. If a gambling dapp uses its own token instead of Ether, then people won't necessarily need to actually buy Ether to use the dapp, except as it might be required for gas or other network costs.
ERC20 and Ethereum explained
ERC20 is the name given to a set of standards for Ethereum-based tokens. It's a standard for the Ethereum ecosystem.
What it basically means is that all ERC20 tokens can enjoy a certain level of interoperability and more easily interface with the full range of Ethereum applications and smart contracts. For example, it's easier to trade ERC20 tokens for each other on Ethereum-based decentralised exchanges.
Ether (ETH) itself is not an ERC20 token though. It was created before the ERC20 standard existed, so doesn't actually comply with the rules of its own ecosystem.
Wrapped Ether and Wrapped Bitcoin
To let Ether itself be more seamlessly used as a currency or token within the Ethereum ecosystem, developers created the Wrapped Ethereum (wETH) token. This is essentially Ether that's been wrapped in ERC20 standards, so it can be used on the network.
wETH is created by locking Ether into a smart contract, which then issues wETH. The original ETH can then be unlocked by redeeming the wETH back in. A similar thing exists for Bitcoin. Called wBTC, it's an ERC20 standard Bitcoin token.
For the end user, this process is exactly the same as trading ETH for wETH or wBTC, or vice versa, on a decentralised exchange such as Kyber Network.
You can think of it as Bitcoin or Ether putting on a spacesuit to go for a spacewalk on the Ethereum network. It puts on its "wrapped" spacesuit to enter Ethereum, and can easily take off its spacesuit and return to normal when it leaves the network.
What to watch out for
Ethereum is trying to be bigger and better than simple currencies like Bitcoin, but this might also be its downfall.
- Not just a coin. Ethereum wants to be something more than a cryptocurrency and this might cause problems. A platform is harder to maintain, harder to develop and harder to see adoption. A cryptocurrency is simple: buy and sell things using that currency. Bitcoin, for example, is nothing more than a currency and people, especially businesses and merchants, like simple things that just work.
- Big things in the future. With a roadmap as ambitious as Ethereum's, the road is bound to be a little rocky. After all, platforms have failed for introducing far smaller and far simpler new features that have had unforeseen, fatal side-effects. This is obviously not a certainty, but it's good to be mindful of big changes coming in the future of Ethereum.
The DAO hack
The decentralised autonomous organisation (DAO) was to be the crown jewel of the Ethereum smart contract and virtual machine ecosystem: a smart contract that was going to build a decentralised venture capital fund with the aim of providing funding for all future dapp development. People would invest in the DAO and they would be allowed to vote on which dapps got funding and which did not.
The DAO launched on 30 April 2016 and within 28 days, it had accumulated more than US$150 million worth of ETH. The attack happened on 17 June 2016 and it worked by exploiting a loophole in the way traders left the DAO. If you wanted to leave the DAO (as a trader), you were allowed to take all the ETH you had purchased after you returned the DAO tokens you had been given when trading (a sort of stakeholder system).
The problem was that the contract had two steps:
- Take DAO tokens from the user and give back ETH from DAO to the user.
- Register the transaction in the blockchain and update the DAO token count.
The hack was simple in hindsight: inject a step between step 1 and step 2 where, before the transaction gets registered, the DAO would give the same user more ETH for the same tokens.
This hack cost the DAO US$50 million worth of ETH and caused the value of ETH to plummet from US$20.17 to US$11.52 in 48 hours.
Following the DAO hack, the Ethereum community was faced with a difficult choice. It needed to collectively decide to either:
- Vote to modify the Ethereum world computer itself and essentially reprogram it in such a way that it was like the entire thing never happened, to restore lost funds to the rightful owners.
- Vote to leave it as is and accept that what's done is done, in the belief that decentralisation and immutability is the primary purpose of Ethereum and that it should never be compromised.
But an agreement was never reached. Neither side was willing to back down and instead, they just started mining different versions of Ethereum, one where the DAO hack was reversed and another where it wasn't.
As a result, the blockchain split into two. Ethereum, as it's known today, was built by the side that voted to undo the DAO hack. And Ethereum Classic is built on a blockchain where the DAO hack occurred and was never reversed.
It would be the last time Ethereum ever seriously considered that kind of rollback. Since then, Ethereum has maintained the principles of decentralisation above all, even at the cost of hundreds of millions of dollars.
What's next for Ethereum?
Ethereum's roadmap is sprawling and ambitious. Apart from a strong drive to have ETH accepted by more merchants, there are some promising things in Ethereum's future.
- More dapps. Ethereum is a platform for building decentralised apps. From smart contracts to crowdfunding projects to autonomous organisations, just as a computer is only as effective as the software written for it, Ethereum is only as successful as the dapps running on it. This is definitely an exciting time for everyone, from simple users of Ethereum to investors, developers and the cryptocurrency community as a whole.
- Proof-of-stake. Similar to the proof-of-importance system used on NEM, Ethereum is working on shifting from a proof-of-work (POW) mining method to a proof-of-stake (POS) generation of ETH instead.
Frequently asked questions
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