- What is Ethereum?
- How Ethereum works
- Ethereum ecosystem
- Investing in Ethereum
- Ethereum mining
- The history of Ethereum
- Pros and cons of Ethereum
- What’s next for Ethereum?
If you are keen on cryptocurrencies and are particularly interested in Ethereum, this ultimate guide can be a good source of knowledge for you. Here you will learn not only what Ethereum is, how it works and how it can be used in practice, but also get insights about interesting milestones in its history and the possible scenario of its future development and implementation.
Note that the guide implies that the reader already has some basic understanding of the blockchain. If you are a total newbie, check our articles in the glossary about the blockchain technology and Bitcoin first.
1. What is Ethereum?
Ethereum is a blockchain-based platform with an open source code that serves as a tool to develop decentralized apps and conduct transactions based on smart contracts. These contracts represent pieces of code that execute operations such as transfer of value precisely the way they are programmed, with no fraud, possibility of downtime or third-party interference.
Some think that Ethereum is very much alike to the first cryptocurrency Bitcoin. It is true to some extent at least when considering Ethereum as a mere means of payment. However, the point is that the smart contracts make the “crypto silver” a much more powerful tool than its “golden” predecessor.
Automating the transactions with the help of smart contracts opens numerous possibilities to eliminate third-parties in many industries, from online gaming to real estate. Without having to rely on notaries, lawyers and other middlemen, the transactions can be processed faster and with no excessive paperwork. Also, the costs associated with intermediaries can be significantly reduced.
2. How Ethereum works
2.1. The Ethereum blockchain
On the surface, the Ethereum blockchain is indeed very similar to Bitcoin. It represents the public ledger that stores information about transactions between users. Every node in the network stores the history of all transactions that have ever been made between all the users and a set of consensus rules that make these transactions valid.
What makes Ethereum different is that apart from this data, it also stores the most recent state of all smart contracts running on it. Sounds complicated, doesn’t it? In reality, it is even more complicated than that, but we’ll try to explain it more clearly.
When you send funds to someone in bitcoins, no physical money is transferred anywhere. It’s only the balances on your BTC wallets that really change, as the new line is added to the public ledger.
With Ethereum, the logic is the same but comes with some additional components. According to “Mastering Ethereum” (the book by Andreas Antonopoulos is available on GitHub), it represents a decentralized computing infrastructure that executes programs called smart contracts. The blockchain is used not only for exchanging cryptocurrency called ether but also for synchronizing and storing the system’s state changes.
2.2. What are smart contracts?
Simply put, a smart contract is a piece of a computer code that sets the rules for exchanging money, property, content or anything else between users.
For example, Alice orders a pizza from Bob. When the juicy meal is eventually delivered to the hungry recipient, a smart contract triggers the payment that is forwarded to Bob’s wallet according to their arrangements.
Launching such programmes on the blockchain makes them a really powerful tool since they run exactly the way they are set up, without any downtime, censorship or third-party intervention.
2.3. What is Ethereum Virtual Machine?
Ethereum Virtual Machine or EVM is the main innovation offered by the platform. This is the software that allows any developer to create and run any application using any of the supported programming languages. It is Turing complete, which means that developers with the necessary set of skills can create programs that can resolve any computational problem and perform any command.
In theory, EVM is capable of hosting thousands of decentralized applications, all on one platform.
2.4. What is gas?
On the Ethereum network, gas is a special unit that is used for paying transaction fees. Whenever you send funds in Ether, you also have to pay the fee – not to a third-party to process the transaction, but to the network.
To process your payments, network resources are used. Transaction fees come as a payment for using these resources.
The fee is fixed and doesn’t depend on the amount of funds you send. However, it is affected by the current level of network overload and the complexity of each given transaction. Typically, ETH wallets calculate and display the fee right within the app.
Ethereum can process only 19 transactions per second at the maximum. So when too many people try to send ethers at once, the fees are calculated on an auction basis. The higher the fees you pay, the faster your transaction will be confirmed.
To check how much the Ethereum network is currently overloaded and how much fees you need to pay, there is a tool called EthGasStation.
2.5 What is ERC20?
ERC20 is a developers’ standard that underlies the Ethereum network and is used for creating new tokens. The abbreviation “ERC” stands for Ethereum Request for Comments. All ICOs (Initial Coin Offering) based on Ethereum issued ERC20 tokens.
Previously, ERC20 was just an unofficial recommendation for developers. It achieved the status of the official guidelines in late 2015 when it was published on the Ethereum GitHub page.
The primary goal of this standard is to make sure that Ethereum-based tokens work predictably, are less prone to security vulnerabilities and consistent with the whole environment of dApps and smart contracts.
3. Ethereum ecosystem
3.1. What are decentralized apps?
On the surface, decentralized apps or dApps are similar to traditional apps that we are all used to: Google, YouTube, Skype, Amazon, etc. The core difference is that dApps can function without intermediaries, i.e. users can connect with providers directly. Here’s what it means in practice.
First, decentralized apps are censorship-resistant. Imagine there was a decentralized version of Facebook. Whatever you posted there, your message would never be banned or erased, not even by the company that created this app.
Also, decentralized apps that utilize smart contracts to conduct payments between users guarantee that the payment will be settled right after the conditions of the contract are met.
Other non-financial dApps such as online voting and decentralized governance provide all the interested parties with transparency since all transactions are verified on the public blockchain.
3.2. What dApps are developed on Ethereum?
According to Dappradar stats, currently, there are more than 1,300 dApps on Ethereum. But don’t let such big numbers fool you. The main problem with all these projects is lack of funding and therefore, little to no audience. As of February 2019, only 24 apps have more than 100 users in 24 hours and a sustainable amount of transactions.
We are going to review the reasons behind such a poor state of Ethereum-based dApps and the problems associated with their development later in this article. Meanwhile, let’s take a look at some of the most popular applications.
- My Crypto Heroes: an online game where users can collect and train historical heroes, get special items and challenge other players to battles.
- Idex: a decentralized exchange where you can switch crypto tokens between your own wallets without having to rely upon a centralized party.
- ForkDelta: one more decentralized exchange based on the same principles.
- HyperDragons: a strategy game powered by the blockchain.
- Lordless: one more RPG.
- Blockchain Cuties: a blockchain collectible game with adventures.
As you may have noticed, most of the dApps fall under the Games or Gambling category. The gaming industry was the first one to grasp the benefits of the blockchain. When ruled by the code, with no third party to rely upon, games become a much fairer place to make or lose money. Games and online casinos are the pioneers of the blockchain mass adoption, and other industries with new use cases will follow after.
4. Investing in Ethereum
4.1. How to store Ethereum?
If you’ve decided to invest in Ethereum and buy some Ether coins, you should first decide on how you’re going to store them.
Since digital coins such as ethers, bitcoins, litecoins or any other cryptocurrencies, are just a piece of code, they are not stored anywhere. An ETH address represents a combination of a public address that you share with your opponent and a private key that only you have the access to. And an ETH wallet is a piece of software that stores these keys in one place.
There are numerous cryptocurrency wallets that support Ether. They differ in the level of security and the ease of use. Below, we are going to briefly review them and give some guidance on when each type of wallets should be used.
4.1.1. Online and mobile wallets
These are Ethereum wallets that come in the form of browser extensions or mobile applications. They are considered to be most convenient, especially for non-tech-savvy users and newbies in the digital currency. Their developers strive to make them as handy and sexy as possible.
At the same time, these wallets are considered to be least secure since they have direct access to the internet and can easily get hacked.
- Metamask: a Chrome extension that supports Ether and all ERC20-compatible tokens. It can be used to authorize some decentralized apps.
- Jaxx: another user-friendly Chrome extension.
- MyEtherWallet (MEW): an online service for generating ETH wallets and sending funds
- Coinbase: an ETH wallet from a reputable platform for purchasing cryptocurrencies.
4.1.2. Desktop wallets
These are the wallets to store digital currency right on your desktop. Typically, they are also quite user-friendly but require to follow safety rules while browsing the internet. If you catch a crypto-stealing virus, password or no password, the funds can easily be lost.
- Exodus: a user-friendly multicurrency wallet that supports Ether tokens.
- Atomic: this desktop wallet comes with the atomic swap support, i.e. it allows exchanging cryptocurrencies that are based on different platforms right within the app. It supports more than 300 tokens, including Zcash, Monero, and EOS. Also, it is integrated with Simplex and allows purchasing ETH, BTC, BCH and a few other altcoins with a bank card.
4.1.3. Hardware wallets
If you are a long-term investor and have a tidy sum of ethers that need to be stored with the top-notch level of security, consider getting yourself a hardware wallet. There are two main providers, both supporting ETH. They differ in production materials and overall design, but the core features are the same:
- Ledger Nano S: 60-270 USD per device.
- Trezor: 95-680 USD per device.
4.2. Where to buy ETH?
Now that you have got yourself an ETH wallet together with your wallet address, it’s high time to fill it with some digital coins. Here are some reputable platforms where you can buy this crypto:
- Coinbase: reasonable fees, additional services, doesn’t work in some regions
- Binance: the biggest platform by daily trading volumes, supports fiat (you can pay with a bank card through Simplex), available worldwide
- Coinmama: supports fiat (a bank card and a bank account), available worldwide
- Bitfinex: not available in the US, low fees, an extensive set of tools for traders
- CEX.io: available worldwide, low fees, supports fiat, strict verification
- Kraken: fiat support, available worldwide, low fees
5. Ethereum mining
5.1. ETH mining explained
Ethereum mining is based on the algorithm called the Proof-of-Work. Many machines (“miners”) around the world try to resolve complex computational problems. Whenever any of them finds a solution, a new block is created. Then it gets verified by all other participants of the network and added to the chain of blocks that have been found before. At this moment, all miners stop solving this particular block and get to the next one. The miner who found the block gets a reward for the efforts.
All these blocks store information about transactions that are made by the users of the network on a peer-to-peer basis. Such a system makes it possible to eliminate a third-party to verify the transaction.
5.2. How to mine ETH?
There are three main ways to mine ETH:
- Pool mining: Join the pool of miners, rent your computing power and get the passive income. This is the easiest and the most profitable way of mining for an end-user.
- Standalone mining: You can get yourself the needed equipment and mine digital coins all by yourself as well. But get ready to pay astronomic sums for the electricity and cope with the overheating problem. Of all mining methods, standalone mining is considered to be the least profitable.
- Cloud mining: Rent the computing power for mining from a cloud storage provider such as Genesis or Hashflare.
6. The history of Ethereum
6.1. Who created Ethereum?
Unlike Bitcoin that was created by an anonymous developer or a group of developers under the nickname of Satoshi Nakamoto, Ethereum has a real person standing behind its creation. A young programmer Vitalik Buterin first described his idea of the future platform in a white paper in late 2013.
Buterin introduced the idea to his friends who spread the word further into the world. Eventually, he managed to get around 30 responses from different people who wanted to discuss his concept with him. He was expecting them to notice some critical mistakes and was ready for a negative reaction, but the feedback turned out to be only positive.
The project was announced to the broad public in January 2014 with the crowdsale following in a few months after that. Vitalik managed to raise 18 million USD to make his dream a reality. And those investors who managed to hold their tokens until 2017 have made really good profits.
6.2. DAO hack
Although Ethereum itself is pretty secure, the smart contracts that are created on its basis may contain bugs and different vulnerabilities. Developers are mere people, and people make mistakes, especially when working with complex programming languages. Any bug in the code is an opportunity for a skilled hacker to make profits.
This is exactly what happened to an Ethereum-based decentralized venture capital fund in June 2016.
The purpose behind creating a Decentralized Autonomous Organization (DAO) was to provide crypto startups with funding in a decentralized way basing solely on smart contracts. People would have got an opportunity not only to invest in startups but also vote for the projects to get money.
Launched in May 2016, the platform managed to raise 150 million USD worth of Ether which was the biggest crowdfunding campaign ever at that time.
However, the platform creators didn’t have a chance to rest on their laurels. In a little bit more than a month after the launch, hackers found a vulnerability in the system and withdrew 3.6 million ETH (worth 70 million USD at that time).
6.3. Hard fork and Ethereum Classic
The Ethereum community wasn’t particularly enthusiastic about the DAO theft and voted for something that comes against the core idea of cryptocurrencies: to undo the transaction and refund the stolen money.
There were those that stood against this proposal justifying their point by the main principles of the blockchain technology: the irreversibility and the lack of governance.
The split in the community resulted in the split of the network via the hard fork into two different cryptocurrencies. Those who voted for reversing the network to the point before the hack occurred went on with Ethereum the way we know it nowadays. And those who let hackers get away with the stolen funds founded Ethereum Classic.
7. Pros and cons of Ethereum
7.1. Ethereum advantages
Vitalik Buterin is a true genius for having invented a system that lets developers create decentralized applications. Combining the principles of the blockchain with the traditional approach provides numerous advantages such as:
- Reducing costs on middle-men: this is one of the biggest advantages that end-users may get with the help of smart contracts. Turning the conditions of any deal into code can significantly reduce costs needed for notaries, real estate agents and all other types of third parties that control the process.
- Security / Tamper-proof: decentralized apps don’t have a central control point that can be hacked. All users’ data are stored in a decentralized way on the blockchain, which makes the whole system pretty secure.
- Immutability: once the data is sent to the blockchain and remains there for some time, it cannot be changed.
- 100% uptime: the decentralized system and smart contracts can never experience a minute of downtime. There is no place for a human error either, dApps always run the way they are programmed.
7.2. Ethereum disadvantages
When you are a pioneer in a new complex area, it is difficult to create a perfect system at the first attempt. Mistakes and numerous deficiencies are simply inevitable.
Ethereum was working just fine with a small number of early adopters in 2014. But when the success of ICOs in 2017 drew the attention of other IT startups and numerous investors, the influx of new users revealed the system’s flaws.
- Low capacity: Ethereum can only process 19 transactions per second at the maximum (just to compare: VISA handles several thousand). The more people try to send funds in a given moment, the more time is needed to confirm each transaction.
- Transaction fees: the commission is calculated at the auction basis. The higher is the level of the network congestion, the higher fees one needs to pay in order to send funds. This problem proved to be especially acute in December 2017, when the blockchain game CryptoKitties was launched. As the game quickly gained popularity, the fees increased from ~0.3 USD to ~1.5 USD per transaction in a matter of a few days.
- Bugs in the dApps’ code: the Ethereum network is pretty secure, but one can’t say the same thing about the decentralized apps that are created on its basis. One small mistake in the code makes an application vulnerable to hackers’ attacks and money losses. This was the main reason for the DAO hack, which we’ve already mentioned above.
- Irreversible transactions: if a user loses the money because of a hack or a typo in the recipient’s address, there is no way to get a refund.
8. What’s next for Ethereum?
All the issues that we’ve mentioned above are serious obstacles that prevent big companies from making use of the Ethereum’s advantages. Buterin and his team work hard on developing new solutions that would let the Ethereum platform get over its technical restrictions.
Ethereum’s global roadmap set in 2014 includes 4 main stages of development:
- Frontier: beta-stage – completed.
- Homestead: stabilizing the network – completed.
- Metropolis consists of two substages:
- Byzantium: security updates – completed.
- Constantinople: reduce block reward and delay the so-called “difficulty bomb”, the mechanism designed to make mining more difficult – now in progress.
- Serenity: switch to the Proof-of-Stake algorithm to avoid problems related to cryptocurrency mining.
The current stage Constantinople is the most difficult and it has already been delayed several times. Will Buterin and Co manage to resolve all the issues and deliver a scalable solution that will boost the growth of blockchain technologies? Only time will tell.
Skeptics say that it is impossible for Ethereum to regain its position as the number one solution for dApps’ development, especially since there are already several alternatives such as TRON and EOS that offer much better indices in terms of scalability and transaction fees.
But Ethereum community is big, and Ethereum Foundation that stands behind the project’s promotion and deployment has a solid team of experts. So, we may yet live to see its best days to come.
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