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What is Ethereum and How Does it Work?

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Ethereum is the world’s second-largest cryptocurrency after Bitcoin. However, unlike Bitcoin, Ethereum exists to be more than just a store of value or medium of exchange. Ethereum is a decentralized computing platform built on its own blockchain. This piece will cover everything you need to know about Ethereum and how it works.

What is Ethereum? 

Ethereum is a platform that allows the execution of decentralized smart contracts and also works as a platform for numerous other cryptocurrencies. Ethereum was founded by eight co-founders, with Vitalik Buterin being the best known of the bunch. Ethereum’s goal is to become a global network for decentralized applications which allows people from all corners of the planet to run fraud-resistant software.

What is blockchain technology?

A blockchain is essentially a public ledger that duplicates and distributes information across multiple computers or nodes. It creates new blocks when the previous one is verified. These nodes work together and use each other to ensure that whatever is running on the blockchain is doing so correctly, rather than having one main entity to refer back to. 

How is Ethereum different from Bitcoin? 

In several ways, Ethereum and Bitcoin are similar. They are both digital currencies that are exchanged online and held in different forms of cryptocurrency wallets. Both are autonomous, which means they aren’t distributed or supervised by a central bank or other governing body. And both make use of blockchain, a modern, digital distributed ledger system.

But there are a number of key differences between Ethereum and Bitcoin as well. The Ethereum network’s transactions may include executable code, while the data attached to Bitcoin network transactions is mostly only used for note keeping. Other variations between ETH and BTC include block time (an Ether transaction is validated in seconds, while a Bitcoin transaction takes minutes) and the algorithms used (Ethereum uses Ethash while Bitcoin uses SHA-256). 

In terms of their general goals, the Bitcoin and Ethereum networks are distinct. Bitcoin was developed as a substitute for national currencies and hence aspires to be a medium of exchange and a store of value. Ethereum was designed as a forum for irreversible, programmatic contracts and applications using its own currency.

Key Takeaway

Ethereum is a decentralized platform for smart contracts and decentralized applications, whereas Bitcoin is primarily a store of value and medium of exchange.

How does Ethereum work?

Smart contracts

Smart contracts are similar to regular contracts, however the conditions and rules in the contract are automatically enforced via code. A smart contract is different from a conventional contract because it is intended to run on its own instead of depending on a third party. Smart contracts are generally written in the Ethereum programming language called Solidity.


Figure 1 – How smart contracts work

Decentralized apps (dApps)

Decentralized applications (dApps) are similar to the apps on your phone, except they are decentralized, rather than running through a central server. dApps are able to run on the Ethereum network using smart contracts. Once a developer has created a smart contract for the dApp, they can then put it on the Ethereum network where it is distributed throughout the nodes. These nodes then use Proof of Work (PoW) to verify the transactions and ensure the contract is following the rules. 

ERC-20 tokens

The Ethereum network functions as a foundation layer for other cryptocurrencies to build on top of. These cryptocurrencies that are built on top of the Ethereum protocol are known as ERC-20 tokens.

Gas fees

Each transaction or smart contract execution requires a fee in order for it to be processed. On the Ethereum network, this cost is known as a gas fee.

Examples of dApps running on the Ethereum network

Art and collectibles

Rarible: an online platform to buy and sell physical and digital artwork or NFTs.

Gaming

Decentraland: a virtual world you can explore and can hold online events. Connect with your peers and collect and trade land.

Decentralised Finance (DeFi)

Uniswap: Easily exchange tokens or provide tokens for interest.

Decentralised Technology

Brave Browser: Earn tokens for browsing and supporting creators with earned tokens.

Did You Know?

In order for a dApp to run on the Ethereum network, there must be gas or fuel to pay for the nodes – this gas is paid with the Ethereum network’s native token, Ether.

What is Ether?

Ether (ETH) is the digital currency that nodes on the Ethereum network are paid as a reward for verifying transactions, executing smart contracts, and running dApps. It also incentivises developers to create dApps that are as efficient and simple as possible. ETH is the second-largest cryptocurrency behind Bitcoin, by market cap.

How to buy Ether (ETH)

You can buy Ether (ETH) from most big cryptocurrency exchanges. Swyftx is a popular crypto exchange in Australia and New Zealand where users can buy Ether with low fees and store it in their personal crypto wallet.

What’s next for Ethereum?

Ethereum has a team of skilled developers who are working behind the technology to constantly make it run more efficiently. With more dApps and smart contracts running on the network, more upgrades need to be made for it to handle the capacity. The Ethereum 2.0 upgrade began in December 2020 and aims to solve ongoing problems and set the network up for the future. Some of the problems it will solve are: 

  • Scalability: Ethereum will introduce shard chains to spread the network’s load across 64 new chains. This makes it easier to run a node while keeping the hardware requirements low
  • Security: Moving to the new sharding system and using proof-of-stake will require new security measures to avoid coordinated attacks. Ethereum 2.0 will solve this
  • Sustainability: A noted problem by many is how much electricity Proof of Work uses to verify the transactions. Ethereum 2.0 will transfer the system to use Proof of Stake, which will significantly reduce energy consumption.

Did You Know?

Moving from a Proof of Work consensus mechanism to Proof of Stake will reduce the Ethereum network’s energy usage by a whopping 99.95%!

Summary

Ethereum is a versatile and powerful platform for executing smart contracts and running decentralized applications. It distinguishes itself from Bitcoin, which is primarily a medium of exchange and store of value. If you’d like to learn more about Ethereum, smart contracts, and dApps, there are heaps of great resources on Swyftx Learn!

Disclaimer: The information on Swyftx Learn is for general educational purposes only and should not be taken as investment advice, personal recommendation, or an offer of, or solicitation to, buy or sell any assets. It has been prepared without regard to any particular investment objectives or financial situation and does not purport to cover any legal or regulatory requirements. Customers are encouraged to do their own independent research and seek professional advice. Swyftx makes no representation and assumes no liability as to the accuracy or completeness of the content. Any references to past performance are not, and should not be taken as a reliable indicator of future results. Make sure you understand the risks involved in trading before committing any capital. Never risk more than you are prepared to lose. Consider our Terms of Use and Risk Disclosure Statement for more details.

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What are Smart Contracts?