What is Ethereum and how does it work? Explained by Digimagg
Ethereum is a decentralized blockchain platform enabling smart contracts and decentralized applications (DApps) to run without third-party interference.
Understanding Ethereum: A brief explanation
Ethereum, a globally decentralized software platform utilizing blockchain technology, is renowned for its native cryptocurrency, ether (ETH). It empowers users to develop secure digital solutions, leveraging a token for blockchain support and transactions. Ethereum boasts scalability, programmability, security, and decentralization, attracting developers and enterprises to revolutionize various industries. With native support for smart contracts, Ethereum serves as the backbone for decentralized applications (DApps), including many in decentralized finance (DeFi) and other sectors. Explore Ethereum's role in non-fungible tokens, DeFi, decentralized autonomous organizations, and the metaverse.
What is the functioning mechanism of Ethereum?
In 2014, Vitalik Buterin, recognized for originating Ethereum, presented a white paper outlining its concept. In 2015, Buterin and Joe Lubin, founder of ConsenSys, officially launched the Ethereum platform. These innovators were pioneers in realizing blockchain's broader applications beyond secure virtual payments. Following Ethereum's inception, its native cryptocurrency, ether, surged to become the second-largest cryptocurrency globally, trailing only Bitcoin in market value.
Wallets
Ethereum holders utilize wallets to safeguard their ether. A wallet acts as a digital portal for accessing ether stored on the blockchain. Each wallet possesses an address, akin to an email address, where users send and receive ether. However, ether itself isn't physically stored in wallets. Instead, wallets contain private keys, similar to passwords, used to authorize transactions. Each ether owner receives a unique private key crucial for accessing their assets, emphasizing the importance of securely managing keys through various storage methods.
Blockchain Technology
Ethereum and similar cryptocurrencies operate on blockchain technology, which can be visualized as an extensive chain of blocks. Each block contains data, and this information is continuously added to new blocks as the chain progresses. Across the network, an identical copy of the blockchain is distributed.
The integrity of this blockchain is ensured by a network of automated programs that collectively agree on the validity of transaction data. Any alterations to the blockchain require a consensus among the network participants, making it highly secure.
Consensus is achieved through an algorithm known as a consensus mechanism. Ethereum employs the proof-of-stake algorithm, where a group of participants called validators generates new blocks and collaborates to authenticate the information they contain. These blocks include details about the blockchain's state, a roster of attestations (consisting of a validator's signature and vote on the block's validity), transactions, and more.
Historic Split
One significant event in Ethereum's history is the hard fork, or division, between Ethereum and Ethereum Classic.
In 2016, a group of participants in the Ethereum network gained control and exploited a vulnerability, resulting in the theft of over $50 million worth of ether allocated for The DAO project.
This successful theft was facilitated by the involvement of a third-party developer in the new project. Following the incident, the majority of the Ethereum community decided to reverse the theft by invalidating the existing Ethereum blockchain and adopting a new blockchain with altered history.
However, a minority faction within the community opted to retain the original Ethereum blockchain. This unchanged version ultimately evolved into the cryptocurrency known as Ethereum Classic (ETC).
Proof-of-Stake Mechanism
Proof-of-stake, unlike proof-of-work, eliminates the need for energy-intensive mining to validate blocks. It employs a finalization protocol named Casper-FFG and the LMD Ghost algorithm, amalgamated into a consensus mechanism known as Gasper. Gasper oversees consensus and outlines how validators are rewarded for their work or penalized for dishonest behavior.
Individual validators are required to stake 32 ETH to activate their validation capability. While smaller amounts of ETH can be staked, individuals must join a validation pool and share rewards. Validators create new blocks and verify their validity through a process called attestation, where the block is disseminated to a committee of validators who validate it and vote on its legitimacy.
Under proof-of-stake, dishonest validators face repercussions. Gasper identifies attempts to attack the network by discerning which blocks to accept or reject based on validator votes. Dishonest validators face penalties such as having their staked ETH burned and being expelled from the network. Burning involves sending crypto to a wallet without keys, effectively removing it from circulation.
Ethereum's outlook ahead
Ethereum underwent a significant upgrade with its transition to the proof-of-stake protocol, allowing users to validate transactions and generate new ETH based on their ether holdings. Initially known as Eth2, this upgrade is now simply referred to as Ethereum. However, Ethereum now consists of two layers: the execution layer for transactions and validations, and the consensus layer for maintaining attestations and the consensus chain.
This upgrade enhanced Ethereum's capacity to support its expansion, ultimately tackling persistent network congestion issues that have led to elevated gas fees.
In pursuit of scalability, Ethereum is actively developing "sharding," a technique that partitions the Ethereum database across its network. Analogous to cloud computing, sharding distributes the workload among numerous computers to reduce computational time. These segmented database sections, called shards, will be managed by individuals who have staked ETH. Sharding will enable more validators to operate concurrently, thereby reducing the time required to achieve consensus.
Furthermore, Ethereum has outlined a roadmap for forthcoming developments. As of March 2024, the roadmap focuses on four primary categories for network enhancement.
- Lower transaction costs: Ethereum acknowledges that rollups are currently costly and require users to rely excessively on their operators.
- Enhanced security readiness: Ethereum aims to be equipped for potential future attack scenarios.
- Improved user interactions: Ethereum seeks to enhance support for smart contracts and lightweight nodes to enhance user experiences.
- Future resilience: Ethereum intends to proactively address emerging issues that may not have arisen yet.
| The evolution of Decentralized Autonomous Organizations |
Decentralized Autonomous Organizations (DAOs) are emerging as a collaborative decision-making approach across distributed networks. For instance, consider setting up a venture capital fund where decision-making is decentralized and distributions are transparent and automated. Using smart contracts and applications, a DAO could collect votes from fund members to make investment decisions based on the majority vote, then automatically distribute returns. All transactions would be transparent, with no third-party involvement in fund handling. While the exact role of cryptocurrency in the future remains uncertain, Ethereum seems poised to play a significant role in personal and corporate finance, as well as various aspects of modern life. |
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Use in Gaming |
Ethereum is expanding its presence in gaming and virtual reality applications. Decentraland, a virtual world, utilizes the Ethereum blockchain to ensure the security of in-world items such as land, avatars, wearables, buildings, and environments, all of which are tokenized for ownership. Similarly, Axie Infinity, another game leveraging blockchain technology, features its cryptocurrency called Smooth Love Potion (SLP), utilized for in-game rewards and transactions. |
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Non-Fungible Tokens |
In 2021, non-fungible tokens (NFTs) surged in popularity. These are digital items tokenized using Ethereum, allowing for unique identification and storage on the blockchain. Tokenization assigns a specific digital token to a digital asset, linking it to an owner's wallet address encrypted in the data. This establishes ownership, enabling the trading or selling of the NFT, with each transaction recorded on the blockchain and verified by the network to transfer ownership. NFTs are being developed for various assets. For instance, sports enthusiasts can acquire fan tokens representing their favorite athletes, akin to trading cards. These NFTs may feature images resembling trading cards or videos capturing memorable moments from an athlete's career. |
Comparing Ethereum and Bitcoin
Ethereum and Bitcoin are frequently compared, yet they exhibit notable distinctions. Ethereum is dubbed "the world's programmable blockchain," emphasizing its versatility for diverse applications. In contrast, Bitcoin's blockchain solely supports the bitcoin cryptocurrency, capped at 21 million coins.
Unlike Bitcoin's finite supply, Ethereum's supply is theoretically unlimited, though block processing time constrains annual ether minting. As of March 2024, over 120 million Ethereum coins are in circulation.
Transaction processing fees differ between Ethereum and Bitcoin. Ethereum participants pay gas fees for transactions, whereas Bitcoin transaction fees are absorbed by the broader network.
Ethereum, as of March 2024, operates on a proof-of-stake consensus mechanism, while Bitcoin relies on energy-intensive proof-of-work, where miners compete for rewards. Ethereum transitioned from proof-of-work to proof-of-stake in 2022.
Is Ethereum considered a cryptocurrency?
The Ethereum platform features its own digital currency called ether, often referred to as ETH. Ethereum serves as a blockchain technology platform supporting various decentralized applications (dApps), including cryptocurrencies. While the ETH coin is commonly known as Ethereum, it's important to differentiate between Ethereum as a blockchain-powered platform and ether as its cryptocurrency.
How does Ethereum generate revenue?
Ethereum doesn't operate as a centralized entity for profit. Instead, validators involved in the Ethereum network receive ETH rewards for their active participation.
What is the process for purchasing Ethereum?
Investors have the option to utilize top cryptocurrency exchange platforms for purchasing and selling ether. Ethereum is backed by specialized crypto exchanges such as Coinbase, Kraken, Gemini, Binance, as well as brokerage services like Robinhood.
Is Ethereum a viable investment option?
Whether Ethereum constitutes a favorable investment hinges on your financial objectives, goals, and risk appetite. Given the volatility of the cryptocurrency ETH, there's a potential for capital exposure. Nonetheless, it's worth exploring as an investment due to the myriad of existing and evolving innovative technologies built on Ethereum, which could play significant roles in future societal developments. Consider enrolling in a cryptocurrency trading course to devise suitable investment strategies.
Is it possible to exchange Ethereum for cash?
Certainly. Investors in possession of the cryptocurrency ETH have the option to utilize online exchanges like Coinbase, Kraken, and Gemini to facilitate this conversion. The process involves creating an account on the chosen exchange, connecting a bank account, and transferring ETH from an Ethereum wallet to the exchange account. Subsequently, place a sell order for ETH on the exchange. Once the sale is executed, transfer the resulting U.S. dollar funds to the linked bank account.
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