Ethereum Basics: What Is Ethereum?

Ethereum itself is not a cryptocurrency but rather a programmable platform built using blockchain technology. Its native token, used to fuel operations on the blockchain, is the ether (ETH).

The Ethereum platform launched in 2015, and it’s now the second-largest form of crypto next to bitcoin (BTC), with a market capitalization of about $533 billion, as of December 2, 2021.

Keep reading to understand how Ethereum works, how it’s different than Bitcoin, and how to invest in ETH.

How Does Ethereum Work?

The concept for the Ethereum platform was first proposed in a white paper by Vitalik Buterin in 2013. In 2014, he and a team of developers raised about $18 million to establish the nonprofit Ethereum Foundation and fund its development. The Ethereum platform launched a year later in 2015.

From the beginning, the vision for Ethereum was quite different from Bitcoin or any other cryptocurrency at the time. Like Bitcoin, Ethereum is built on a blockchain and uses blockchain technology to run a decentralized payment system for ETH.

But the larger idea for Ethereum was to create a programmable blockchain that would enable a sort of free-market environment, where developers could create applications and programs without any control or interference from a third party.

How the Ethereum blockchain works

The Ethereum blockchain operates similarly to the bitcoin blockchain. It’s a distributed digital ledger that’s maintained by a global network of nodes or computers that verify all transactions on the blockchain.

The Ethereum blockchain also supports the mining of ether, Ethereum’s native token, which is mined using a proof of work (PoW) system. In proof-of-work mining, computers burn energy to solve complex mathematical puzzles needed to validate blocks of data or transactions. Miners batch transactions into new blocks roughly every 12 seconds versus the eight or nine minutes it takes to confirm blocks of data on the bitcoin blockchain.

On the Ethereum blockchain, users can create and store code used to build decentralized applications (dApps or dapps) and financial contracts, an innovation that has set Ethereum apart from Bitcoin and inspired other crypto platforms to attempt similar innovations.

Smart contracts and DeFi

Developers write programs (e.g. smart contracts) in the project’s main programming languages (Solidity or Vyper), and then deploy this code on the Ethereum blockchain. All nodes maintain a copy of the Ethereum Virtual Machine (EVM), which translates the smart contracts and executes their changes in transactions on the blockchain. Thus smart contracts are self-executing and don’t need a third party to be effective.

The development of these smart contracts is part of what has fueled the growth of decentralized finance or DeFi, with the Ethereum platform being a leading innovator in this new area.

Ethereum and ICOs

The flexibility and adaptability of the Ethereum blockchain have also allowed it to support the development of new forms of crypto, based on the Ethereum source code. Thus the Ethereum platform became foundational for several Initial Coin Offerings or ICOs.

What Is Ether?

Ether can be thought of as both a type of cryptocurrency that can be bought and sold and as the transactional currency that helps drive various operations on the Ethereum platform.

Ether as crypto

Ether is the second-largest type of cryptocurrency. You can buy and sell ether on crypto exchanges and other platforms that support crypto trading. As of Dec. 2, 2021, one ETH was worth about $4,500.

How ether is used on Ethereum

Like other cryptocurrencies, ether is a medium of exchange — but ether tokens can only be used on the Ethereum network. That’s because ether is designed to support the development of decentralized applications on the Ethereum platform.

Users can trade other cryptos for ether tokens (or they can use a fiat currency like the dollar to buy ether). But you cannot substitute another type of crypto for ether in order to provide computing power for Ethereum transactions.

What is gas vs ether?

Gas refers to the computational power required to complete various tasks on the platform. It’s essentially a unit of measurement. To pay for gas, developers can use fractions of ether tokens, sometimes called gwei.

What Is Ether Mining?

Currently, ether is mined in much the same way that bitcoin is, using a proof-of-work system. “Miners” use their computers to solve complicated mathematical problems, providing the “proof of work.” When they successfully solve the problem, they receive ether as a reward.

The annual supply of ether is finite. No more than 18 million ether are issued each year, a strategy that is designed to curb inflation. There is about 118.5 million ETH in circulation, as of Dec. 2, 2021.

Eventually, Ethereum will switch to ETH 2.0, which will involve a number of updates to the core Ethereum protocol. At this time, Ethereum will shift away from the proof-of-work system of mining to a proof-of-stake (PoS) system. This system relies on a set of algorithms that allow miners to mine ether in proportion to a stake, or amount of ether, that they already have.

Proof of stake addresses a number of problems inherent to PoW mining. First, a proof-of-stake system uses far less electricity and thus is considered a more sustainable option than PoW.

PoS also reduces centralization risks, because users with more computing power won’t be at a greater advantage. And it reduces the risk of 51% attack, in which a miner who controls 51% of a mining pool can create fraudulent blocks for themselves.

Bitcoin vs Ethereum: How Is Ether Different?

Ethereum shares similarities with other crypto projects, including bitcoin. They both make use of a decentralized, distributed blockchain ledger system and both are encrypted. Both bitcoin and ether can be traded on digital currency exchanges. Yet, the two differ in significant ways.

Bitcoin was designed to be an alternative to traditional fiat currencies and as a medium of exchange and store of value. By contrast, Ethereum is a programmable blockchain that supports decentralized applications, smart contracts, and NFTs.

And while the Bitcoin and Ethereum blockchains share some similarities (both are distributed networks that rely on consensus verification), there are some differences here as well. The block time for each is different: an ether transaction is confirmed in seconds compared to minutes for bitcoin, as well as the algorithms on which they run, SHA-256 for Bitcoin and Ethash for Ethereum.

The same amount of ether is produced every year.

BTC vs ETH

Bitcoin and ether are both digital currencies, but BTC was established as an alternative currency, whereas the aim of ETH is to monetize the operation of smart contracts and decentralized applications (dApp) on the Ethereum platform.

BTC is also limited: the number of bitcoin that can be mined is capped at 21 million. The number of ETH is unlimited, but the amount is capped at 18 million per year, as noted above.

Consensus mechanisms

Both Ethereum and Bitcoin rely on a Proof of Work (PoW) consensus mechanism, which allows the nodes of the respective networks to agree on the state of all information recorded on their blockchains and secure the networks against fraud and hacks. Right now, both ETH and BTC are mined using the PoW system.

But PoW is considered inefficient by many, and in 2022 the plan is for Ethereum to graduate to a proof of stake system (PoS) as part of the rollout of Ethereum 2.0 — a series of upgrades that will make the platform more scalable, secure, and sustainable.

A major criticism of PoW is that it is highly energy-intensive because of the computational power required. Proof of stake substitutes the energy-intensive process of PoW with staking, which lowers the energy required to run the network by replacing miners with so-called validators, who stake their cryptocurrency holdings to activate the ability to create new blocks.

How to Buy Ethereum: 5 Things to Know

Ether trades under the symbol ETH. Investors interested in adding it to their portfolios should first set up a crypto wallet, and identify a trading platform where they can carry out their trades.

1. Set up a crypto wallet

A crypto wallet isn’t a place to store your crypto, per se, but a type of software or hardware that protects the public and private keys that enable you to trade your ether and other types of crypto.

•   Software wallets. You can choose a mobile wallet or app, or a desktop wallet. These types of wallets, sometimes called hot wallets, are software based and you need a secure internet connection to access them.

•   Hardware wallets. A cold wallet uses hardware, like a thumb drive, to download and secure the keys to your crypto. This type of wallet can be more secure, but if you lose the device, you lose access to your crypto assets.

2. Understand public and private keys

Like most forms of crypto, all ether exists on the blockchain, the permanent digital ledger that records all Ethereum transactions. So when you buy, sell, or trade ether, you’re not really dealing in individual tokens, but a series of blockchain transactions.

That’s why you need both public and private keys: the public key is like an address used by the parties making the transaction. The private key is only for you, the owner of the crypto. If you lose, misplace, or forget that private key, you cannot access your crypto.

3. Decide where to trade

There are three main types of crypto exchanges: centralized, decentralized, and hybrid. Most crypto exchanges enable crypto-to-crypto trades, or fiat-to-crypto (meaning, you can use a traditional currency like dollars to buy and sell bitcoin and other cryptocurrencies).

5. Fund your account

You can fund your trading account using a bank account, debit card, credit card, wire transfer, or by using other forms of crypto. It depends on where you plan to trade, and what types of currency the platform accepts for trading. Although trading bitcoin in the U.S. is legal, some banks may flag or even bar deposits to crypto-related sites or exchanges, so be sure to check with your bank in advance.

Also be sure to research any fees associated with different payment options and on different exchanges. Credit cards, for example, charge a processing fee in addition to transaction costs and may treat crypto purchases as cash advances. Crypto exchanges typically charge transaction fees as well, which might come in the form of a flat fee or a percentage of the trade.

The Takeaway

As the second-largest form of crypto on the market, and one of the most ambitious blockchain projects, Ethereum and its native token ether (ETH) have been growing steadily since the platform launched in 2015. Unlike Bitcoin, Ethereum is more than just a blockchain-based cryptocurrency — it’s a programmable blockchain that has become the home of many dApps, helped to launch countless new coins, and is the leader in decentralized finance or DeFi. With the Ethereum platform poised to evolve in 2022 and possibly shift from a proof of work to a proof of stake consensus mechanism, investors may see yet more innovations.