PYMNTS Blockchain Series: What is Ethereum?
In this series of articles, we’re going to take a look at the major cryptocurrency blockchains, with the goal of helping you understand what they are, how they work, what they do, and what their benefits are. and their drawbacks.
You will come out of this series not only with a better idea of what cryptocurrency is; you’ll understand why how a token works – how its blockchain handles transactions – is key to its success or failure as a digital asset.
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So what is Ethereum?
Ethereum is where cryptocurrency ends and blockchain begins.
It might be a bit of a stretch, but the reality is that before Ethereum, blockchains were kind of a one-trick pony. These were decentralized digital ledgers that were very, very good at creating an unalterable, timestamped record of transactions that allows two parties to transact without trusting either third party or the other, and without risking to double the expenses.
In other words, from the launch of Bitcoin’s “genesis block” on January 3, 2009, crypto was all about currency – making peer-to-peer payments.
That changed on July 30, 2015, when Ethereum’s mainnet went live with its own zero block, turning blockchain technology from a digital ledger into what Ethereum’s main creator, Vitalik Buterin, loves. call it a “world computer”.
See also: PYMNTS Crypto Basics Series: What is a Blockchain and how does it work?
Indeed, Ethereum is much more than a store of value or a record of events.
Ethereum is a smart contract platform, which means it can be used to create self-executing agreements that are written on an immutable blockchain. When the conditions specified in a smart contract are met, it automatically executes, fulfilling the conditions without any outside human control or oversight.
See also: PYMNTS DeFi series: what is a smart contract?
Concretely, this means that Ethereum can be used to trade options and futures, sell a video or a car, track shipping containers around the world or heads of lettuce from farm to table, bet on football games, creating crop insurance plans that automatically pay out when the temperature drops below freezing – basically any form of commerce or anything that involves managing a supply chain can be done cheaper, more quickly and more accurately.
The if/then world
Smart contracts are written in what computer coders call “if/then” statements, which are at the heart of almost every business transaction or contract: “If John pays Mary $5,000, then Mary will give John a car or “If the National Weather Service reports that the temperature has fallen below freezing on Steve’s farm for three consecutive days, Acme Crop Insurance will pay him the value of the damaged produce.”
The thing is, almost all computer programming languages consist of if/then statements. This means that Ethereum’s if/then statements – if complex enough – can be used to create entire decentralized applications, called DApps. Thus, a cryptocurrency exchange, a video game, or even an entire metaverse virtual world can be built in Ethereum’s Solidity smart contract programming language.
This is why decentralized finance, or DeFi, is built on Ethereum or blockchains trying to be a better, faster, or more scalable version of Ethereum. Smart contract programming is sophisticated enough that DApps can be built complex enough to operate without any centralized human intervention of any kind – no owners, no managers, no governance staff at all.
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This is where Buterin’s “world computer” idea came from – Ethereum can be used as a decentralized computer.
A twist on this is that smart contracts don’t exactly run on the Ethereum blockchain. Ethereum has something called the Ethereum Virtual Machine, or EVM. It is a virtual environment separate from the central transaction-recording part of the blockchain where smart contracts live and can interact – where they execute.
Ethereum’s native token, ether, makes it the #2 blockchain by market capitalization. Which obviously means that a lot of people have invested in ETH, because ether is known on crypto exchanges.
That said, ether is one of only two cryptocurrency tokens that the United States Securities and Exchange Commission agrees are not securities, but “utility tokens” that serve a specific purpose within a crypto ecosystem. In other words, they give the holder the right or the ability to use a service or product on a blockchain.
In the case of ether, that goal is to create smart contracts.
To be self-executing, a contract must automatically pay out when specified conditions are met. The way it works is that when a smart contract is made, the buyer “locks” a certain amount of ether into the contract.
As smart contracts, like everything else on blockchains, are immutable – i.e. unchangeable – parties can be sure that payment will be made because it has already been made: if well-drafted, the contract only executes when the conditions are met or when it expires (if so), making the ether locked to the person who deposited it.
One of Ethereum’s greatest strengths is that you can build a DApp or protocol on it without having to use Ether tokens. Instead, developers can create their own tokens using a technical specification called ERC-20, and those tokens will work just as efficiently, but only for that DApp or protocol.
And in fact, there are many other technical specifications compatible with Ethereum, although ERC-20 tokens are by far the most common. Another that is gaining a lot of traction is ERC-721 – the standard for non-fungible tokens (NFTs).
Read also: PYMNTS NFT Series: What are NFTs and why are they the new “next big thing?” of Crypto?
It is worth mentioning that most of the best “Ethereum-killer” blockchains that attempt to be upgraded versions of Ethereum – which has several Achilles heels – use Ethereum token standards and are also EVM compatible.
The latter because it allows them to be written in the same Solidity programming language. This in turn makes it easier to entice DApp developers to bring a project to their blockchain.
See also: PYMNTS DeFi Series: What are the best DeFi blockchains?
Ethereum has two big issues: scalability and power consumption.
Scalability is why Ethereum killer blockchains like Polkadot, Solana, Cardano, and Polygon eat at least a bit of Ethereum’s lunch.
Read here: PYMNTS Blockchain Basics Series: What is Polygon? Ethereum killer hedges bets
Simply put, Ethereum is not fast enough. It can only handle 12-15 transactions per second, far too few to pose a threat to Visa’s maximum speed of 65,000 TPS.
And because it is by far the most popular blockchain platform, it is being crushed under the weight of its own success, with peak-hour transaction delays and skyrocketing transaction fees – at as of today they are averaging close to $11 and have reached $70.
Read more: PYMNTS Crypto Basics Series: What is a consensus mechanism and why is it destroying the planet?
Then there’s the power and the pollution – while not as bad as Bitcoin, Ethereum uses a proof-of-work consensus mechanism (see link above) to mine new ETH and write new transactions to the blockchain. – which requires an enormous amount of power. Again, as I write, about as much as the Netherlands.
However, there is a solution: Ethereum 2.0. But this is another story.
Another story: Can Proof of Stake Solve Crypto’s ESG Problem?