Ethereum
What is Ethereum and how does it work? – Forbes Advisor
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Ethereum (ETH) is the second most popular cryptocurrency after Bitcoin. Founded by Vitalik Buterin and Gavin Wood in 2015, Ethereum’s market capitalization today represents approximately 20% of the global crypto market, estimated at $1.1 trillion.
There are distinct differences between Ethereum and the original crypto. Contrary to Bitcoin (BTC), Ethereum is intended to be much more than just a medium of exchange or a store of value. Instead, Ethereum is a decentralized computing network built on blockchain technology.
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What is Ethereum?
In crypto’s own words, Ethereum is “a global, decentralized platform for money and new types of applications”, with thousands of games and financial applications running on the Ethereum blockchain. The crypto is so popular that even other crypto coins operate on its network.
At the heart of Ethereum is its blockchain network. A blockchain is a decentralized and distributed public ledger where transactions are verified and recorded.
It is distributed in the sense that all participants in the Ethereum network hold an identical copy of this ledger, allowing them to see all past transactions. It is decentralized in the sense that the network is not operated or managed by any centralized entity, but rather by all distributed ledger holders.
Blockchain transactions use cryptography to provide network security and verify transactions.
Ether, the native token of Ethereum, can be used to buy and sell goods and services, just like Bitcoin. But what’s unique about Ethereum is that users can create applications that “run” on the blockchain like software “runs” on a computer. These apps may store and transfer personal data or manage complex financial transactions.
Ether and Ethereum: what is the difference?
You can use Ether as a digital currency in financial transactions, as an investment, or as a store of value. Ethereum is the blockchain network where Ether is held and traded. As mentioned above, this network offers various other functions apart from ETH.
“These can be simple movements of funds, but they can also be complex transactions ranging from the exchange of assets to taking out loans to acquiring a work of digital art” , explains Boaz Avital, product manager at Anchorage. Transactions are processed and stored on the Ethereum network.
The Ethereum network can also be used to store data and run decentralized applications. Rather than hosting software on a server owned and operated by Google (GOOGLE) or Amazon (AMZN), where a single company controls the data, users can host applications on the Ethereum blockchain. This gives users control of their data and allows them to freely use the app because no central authority manages everything.
One of the most intriguing use cases involving Ethereum is self-executing contracts, or smart contracts. Like any other contract, two parties agree to deliver goods or services in the future. Unlike conventional contracts, lawyers are not required: the parties encode the agreement on the Ethereum blockchain. Once the contract conditions are met, it self-executes and delivers Ether to the appropriate party.
Ethereum vs. Bitcoin
Bitcoin’s primary use is as a virtual currency and store of value. Ether also functions as a virtual currency and store of value. But the decentralized Ethereum network also allows applications, smart contracts and other transactions to be created and executed on the network. Bitcoin does not offer these functions.
Ethereum also processes transactions faster.
“New blocks are validated on the Bitcoin network every 10 minutes, while new blocks are validated on the Ethereum network every 12 seconds,” explains Gary DeWaal, president of Katten’s regulatory and financial markets group. And future developments could speed up Ethereum transactions even further, he notes.
Finally, there is no limit on the number of potential Ether tokens, while Bitcoin will release no more than 21 million coins. Currently, Bitcoin has 19 million coins in circulation.
Advantages of Ethereum
- Large existing network. The advantages of Ethereum are a proven network that has been tested over years of operation and billions in market value. It has a large and engaged global community and the largest blockchain and cryptocurrency ecosystem.
- Wide range of functions. In addition to being used as a digital currency, Ethereum can also process other financial transactions, execute smart contracts, and store data for third-party applications.
- Constant innovation. A large community of Ethereum developers are constantly looking for new ways to improve the network and develop new applications. “Due to Ethereum’s popularity, it tends to be the preferred blockchain network for new and exciting (and sometimes risky) decentralized applications,” says Avital.
- Avoid middlemen. Ethereum’s decentralized network promises to allow users to leave behind third-party intermediaries, such as lawyers who draft and interpret contracts, banks who are intermediaries in financial transactions, or third-party web hosting services.
Disadvantages of Ethereum
- Rising transaction costs. The growing popularity of Ethereum has led to an increase in transaction costs. Ethereum transaction fees, also known as “gas,” can fluctuate and be quite expensive. This is great if you’re making money as a miner, but less so if you’re trying to use the network. Unlike Bitcoin, where the network rewards transaction verifiers, Ethereum requires those participating in the transaction to cover the fees.
- Potential for crypto inflation. Although Ethereum has an annual release limit of 18 million Ether per year, there is no lifetime limit on the potential number of coins. This could mean that as an investment, Ethereum might function more like dollars and might not appreciate as much as Bitcoin, which has a hard lifetime limit on the number of coins.
- Steep learning curve for developers. Ethereum can be difficult for developers to master as they migrate from centralized processing to decentralized networks.
What is Ethereum 2.0?
In 2022, Ethereum 2.0 took the crypto blockchain from one proof of work consensus mechanism for proof of stake. This has gradually eliminated the need for miners, who perform validations on expensive and power-consuming crypto mining equipment.
Staking, which involves locking up a certain amount of cryptocurrency to participate in the transaction verification process, has replaced mining to verify Ethereum transactions. Ethereum 2.0 reduced the the carbon footprint of crypto up to 99.9%.
How to buy Ethereum
This is a common misconception among newcomers to the Ethereum network. You’re not buying Ethereum itself, you’re buying the network. Instead, you buy Ether and then use it on the Ethereum network. Given the popularity of Ethereum, it is very simple to buy Ether:
- Choose a Cryptocurrency Exchange. Cryptocurrency exchanges and trading platforms are used to buy and sell different cryptocurrencies. Coinbase, Binance.US And Kraken are some of the most important exchanges. If you just want to buy the most common coins like Ether and Bitcoin, you can also use a online brokerage like Robinhood or SoFi. Be prepared to pay some amount of trading or processing fees almost universally.
- Deposit fiat currency. You can deposit money, such as dollars, into your trading platform or link your bank account or debit card to fund Ether purchases.
- Buy ether. Once you have funded your account, you can use the money to buy Ether at the current Ethereum price as well as other assets. Once the coins are in your account, you will be able to hold them, sell them or exchange them for other cryptocurrencies in the future. Keep in mind that you may incur taxes every time you sell or trade cryptocurrencies.
- Use a wallet. Even though you can store Ether in your trading platform’s default digital wallet, this can pose a security risk. If someone hacks the exchange, they could easily steal your coins. Another option is to transfer coins that you don’t plan to sell or trade soon to another digital wallet or cold wallet that is not connected to the internet for security reasons.
Should you buy ether?
You might consider investing in the Ethereum network for several reasons, according to DeWaal. “First, it has value and is used as virtual currency. Second, the Ethereum blockchain could become more attractive when it migrates to the new protocol. And third, as more people use Ethereum distributed applications, the demand for ETH could increase,” he says.
In addition to buying Ether directly, you can also try investing in companies creating applications using the Ethereum network. If you would like help managing your investment, you can also subscribe to a professional investment fund like the Bitwise Ethereum Fund or the Grayscale Ethereum Trust.
Before making a large investment in Ether or other cryptocurrencies, consider speaking with a Financial Advisor first on the potential risks. Given the high risk and volatility of this market, make sure it’s money you can afford to lose, even if you believe in Ethereum’s potential.