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Ethereum has taken the world by storm…but how does it work and why is it becoming so popular? This guide will teach you everything you need to know about Ethereum. Due to increased length, this post is split into multiple pages. The split is performed as follows:
1. What is Ethereum?
Ethereum can be thought of as a virtual supercomputer. It’s designed as a platform to host applications that can run without the need for human interference. These applications are called ‘Decentralized Apps’, and I’ll explain how they work later in this guide. The cryptocurrency, Ether (usually referred to as Ethereum) is the currency or “utility token” that you pay to use this virtual network.
2. How Ethereum Works
2.1. Ethereum Blockchain.
Like Bitcoin and other cryptocurrencies, Ethereum has it’s own blockchain. This is like a record of all transactions on the Ethereum network. It’s stored on nodes (computers, miners, etc.) across the world. However, while Bitcoin’s blockchain just stores transaction records, Ethereum’s blockchain also hosts smart contracts and decentralized applications (DApps).
Smart contracts are contracts programmed to run by themselves. In simple terms, this means: If x happens, y results.
(I’ll explain Smart Contracts in more detail below).
The Ethereum blockchain keeps a record of the latest execution of each smart contract.
2.2. How Do Transactions Work?
Transactions, whether they are simple money transfers or executions of smart contracts or DApps, require “gas”. Gas can be thought of as transaction fees. You pay for gas using Ether. Transaction fees go to miners (explained below).
2.3. What Is Ethereum Used For?
Since you can program different smart contracts and DApps on the Ethereum blockchain, Ethereum use cases are only limited by the imagination. This potentially makes Ethereum more useful than single use cryptocurrencies, such as Bitcoin (payments). It’s also led to the coining of the term “Blockchain 2.0” (programmable transactions).
Ethereum’s innovation in this regard has even led to copycats trying to mimic Ethereum’s popularity and success.
Note: Want to see how Ethereum works in the ‘real world’?
Check out section 7 of this guide for some examples.
2.4. Smart Contracts.
As mentioned, smart contracts are contracts that are programmed to run by themselves. So why is this helpful? Smart contracts can eliminate the inefficiencies often caused by middlemen.
Smart contracts get rid of middlemen like banks and even service providers like Airbnb and Uber. For example, banks are usually the ones that give people loans. Instead of having a bank, smart contracts could be written so that loans are disbursed once certain conditions are fulfilled. For instance, once you pay your loan amount, funds could be disbursed into your account automatically without the need for a loan collector.
For something like Airbnb, instead of having Airbnb connect renters and landlords, smart contracts could grant a renter access to an apartment once he or she makes a payment. The examples are endless. Smart contracts could be revolutionary and have the potential to upend many industries and business models.
2.5. Mining Ethereum.
When you make a transaction, this transaction is broadcast to the Ethereum network. Miners verify transactions and group them into blocks (groups of transactions), which are added to the blockchain (groups of blocks or all Ethereum transactions). The way that miners verify Ethereum transactions is via “proof of work”. However, they are planning to move towards “proof of stake”.
Miners, using their mining devices, such as computers or specialized mining devices, perform computationally difficult work. Whoever finishes this work first gets to add a new block to the blockchain. For their efforts, miners are paid in transaction fees (gas paid for in Ether) and newly created Ether (if they finish the work first).