Ethereum Explained - A Beginner's Guide
By Romanon N , Updated on: Apr 07 2023.
Ethereum is a decentralised computer network that uses Ether (ETH) cryptocurrency in order to conduct transfers and execute smart contracts. It's an entire ecosystem where people can build pretty much anything, from custom tokens (ERC-20 tokens), non fungible tokens (NFTs) and complicated decentralised applications (Dapps) that work seamlessly using smart contracts. It sounds very technical, but it's actually very easy to understand.
Once you fully realize what Ethereum can do for you, it will open the floodgates of innovation for your business, personal life and other entrepreneurial endeavours. Let's take a dive into the decentralised universe.
Table of Contents:
- What is Ethereum?
- How is Bitcoin different from Ethereum?
- Why is Ethereum valuable?
- History of Ethereum
- How does Ethereum work?
- What the hell is a smart contract?
- But wait, what's an ERC-20 token?
- NFTs - Non fungible tokens
- What are ICOs?
- Decentralised finance on Ethereum
- How is DEFI different from the traditional financial system?
- How to buy and store ETH
- Why is Ethereum important?
What is Ethereum?
In the beginning there was Bitcoin. A network with a friendly orange coin that ended up conquering the hearts and minds of millions of people worldwide. We finally have the chance to use an alternative payment system that works without borders, permissions and governmental gatekeepers.
As good as the orange coin is, it can only allow us to do 2 things:
- Transfer value from point A to point B
- Accumulate BTC in order to profit from its rising value over time
This wasn't an option for Vitalik Buterin. This young programmer wanted more functionality from the new blockchain technology, so he and his team went out to design something that can do more than what Bitcoin alone isn't capable of and in 2014 Ethereum was born. So, what exactly is Ethereum?
It's a decentralised network that allows anyone to use it and BUILD on it. It's a digital set of Lego blocks given to the world in order to live out all our digital dreams and possibilities. Tokens, artwork, decentralised applications, digital documents, you name it! Everything is possible on this network and just like Bitcoin, it's open to anyone with an internet connection.
The Ethereum network is made from millions of individual computers that are connected into one single entity (a giant supercomputer). We can use this computer for any imaginable task and we can “hire” that massive computational power by paying “gas” in the form of the native Ethereum token called Ether (ETH).
How is Bitcoin different from Ethereum?
|21 million coins total supply||Total supply is unlimited (with recent EIP1559 upgrade, Ethereum will become deflationary over time)|
|1 block every 10 minutes||1 block every 10 seconds|
|7 transactions per second||20 transactions per second|
|SHA-256 mining algorithm||Ethash mining algorithm|
|Programming language; C++||Programming language: Solidity|
|Digital store of value||Decentralised computer with almost infinite use cases and a digital store of value|
As you can see, Ethereum goes beyond the classic capabilities of Bitcoin. It's meant to be used and built upon. If we could compare Ethereum to something classic, we can see it as the original TCP IP (the original protocol used by the internet as we know it today).
If you think you are late to the party, here's a newsflash. When it comes to Ethereum, we are in the 1990's and you have the front row seat to learning about this amazing new tech. Exciting isn't it? Knowing that, we can tackle the following question:
Why is Ethereum valuable?
Take a second and think about how you found this article? Chances are that you used Google or some social media platform to find this information. The inventor of TPC IP (the core protocol layer of the entire internet) was NOT paid by Google or social media platforms for providing this valuable service.
The value in this case got hijacked and syphoned off by Silicon Valley tech giants. The inventor of the core layer of the internet received absolutely no financial compensation for his hard work.
In the case of Ethereum, the value is evenly spread across the network, as well as all the stuff BUILT on this network. Here's how:
- Chainlink (LINK) builds decentralised oracle solutions on the Ethereum network. The more people (and programs) use Chainlink, the more ETH is needed to power all these transactions.
- USDC is a dollar backed “stable coin” built on the Ethereum network.The more people buy and use USDC, the more ETH is needed for these transactions.
- Basic Attention Token (BAT) is levelling the playing field in the business of advertising. The more their product is used, the more ETH is needed to power this machine.
- Silvio is an artist from Brazil who sells his digital art on the blockchain to happy customers all over the world. The more art he creates (and sells), the more ETH is needed to facilitate his transactions.
- Agroworld is an international company that imports fruits from all over the world. They use bills of lading (identifying the ownership of their containers) that are built on the Ethereum network in the form of a non fungible token (NFT). The more containers of fruits and vegetables they transport, the more ETH is needed to work with these documents online.
As you can see, the more people USE the Ethereum network, the more ETH coins they need to pay for all this computational power. This is exactly where the value of ETH is hidden in plain sight. Now you understand.
When it comes to active development, the Ethereum community is one of the most beefed up and hairy chested bunch of programmers out there. Although plagued with constant delays, they can still pull off massive stunts and improve the network on the fly.
The recent release of the London Hard Fork and the EIP1559 upgrade (explained later), is similar to flying a plane and building extra jet engines on the wings in mid flight. Not many people can pull it off yet somehow, they will manage, since they have pulled off even more impressive stunts in the past.
It wasn't always like this however. In the beginning things worked much more differently.
History of Ethereum
It's no secret that Vitalik Buterin (one of the founders of Ethereum) has been active in the Bitcoin community almost since the beginning. He understood Bitcoin very well and helped to spread the gospel of Satoshi far and wide.
Naturally curious, he wanted to tinker and experiment with the new blockchain tech to see what it can do. Pushing this agenda literally means going against the entire Bitcoin community and breaking all of their rules. If you think about it, something that was developed as a digital wealth preservation tool (Bitcoin) MUST remain rigid and “tamper proof” in the same way that gold cannot be altered by any chemical process.
Vitalik said “Screw it!” and went to develop his own blockchain technology with all the bells whistles and smart contract functionality built right into it.
In November 2013 the Ethereum whitepaper was published and in January of 2014 came the public announcement that the Ethereum project had been conceived. The people behind it all were Vitalik Buterin, Mihai Alisie, Anthony Di Iorio, and Charles Hoskinson.
From July to August 2014 the Ethereum crowdsale was alive and kicking. The people who participated in it most likely don't have to worry about money these days. A respectable 11.8 million usd was raised and it allowed the team of hungry developers to kickstart their dreams in peace.
The very first testnet of Ethereum was already live in may 2015. This long lasting tradition of using test nets has allowed the Ethereum team to work out all the bugs and faults before the updates get deployed on the main net. Not bad at all!
Finally in march 2016 the long awaited mainnet of Ethereum went live. The mainnet used “Solidity” as the programming language that allowed thousands of programmers to use this amazing network to their fullest advantage. And so they did!
As expected, not everything was smooth sailing when Ethereum was unleashed to the world. The infamous DAO hack has highlighted vulnerabilities in the Ethereum ecosystem that eventually lead to the splitting of the network into Ethereum mainnet (ETH) and Ethereum classic (ETC).
Even with the setbacks the Ethereum network continued to function with many upgrades and improvements along the way. Here are the most important ones:
- Tangerine Whistle hard fork: Fixed the issue with gas fees that were too low. This ecosystem attracted too many DDOS (Denial of service) attackers who tried to exploit the network.
- Spurious Dragon hard fork: This update has eliminated empty Ethereum accounts (public addresses) that deliberately bloated the network. This was again the handy work of online attackers.
- Byzantium and Constantinople updates have brought even more order in the chaos. After all, Ethereum is a huge sandbox and all the programmers in the world are welcome to play there (and occasionally leave broken toys and trash behind)
- The latest EIP (Ethereum Improvement Proposal) was implemented in August 2021. It led towards even more improvements to the network and a much more transparent gas fee structure that remains to be proven useful with time.
Again don't let yourself be fooled by the complex sounding lingo. We are here to break things down to bite sized pieces. Let's start by analysing how Ethereum actually works.
How does Ethereum work?
If you've read our Bitcoin guide, by now you are familiar with proof of work, private keys and similar terms.
Ethereum (for now at least) uses a similar method. The huge decentralised network of computers working 24/7 to keep the network nice and secure, performs in a very similar manner to Bitcoin. Both networks have the same “blocks” of data that are being processed every 10 seconds and both use cryptography to append data to their respective blockchains.
Let's take the time to analyse the main differences of Ethereum and Bitcoin.
First of all, Ethereum has its own programming language called “Solidity”. It's been co-developed by none other than Dr. Gavin Wood (who later gave us the Polkadot ecosystem). Thanks to these smart contracts we can now use the Ethereum network for much more than just sending value from A to B.
But wait a second...
What the hell is a smart contract?
Smart Contracts are simply agreements transformed into code. Here's a small example:
- Bob and Tim are long time friends, but they seem to like completely opposite football teams.
- One day their teams are playing head to head in the same arena, so the boys decide to make a bet. If Bob's team wins, Tim has to pay up. Same goes for Tim.
- Since our 2 heroes are also pretty damn good programmers, they decide to use a smart contract. This is simply a software program that will perform a certain action based on the input it receives; Bob's team wins - Bob gets paid. Tim's team wins - Tim gets paid. That's all there is!
- They both lock up $50 of cryptocurrency into this smart contract and head off to the game.
- During the playoffs, the smart contract receives data that Tim's football team has won.
- The smart contract automatically sends all the locked up funds to Tim's wallet and erases itself (since it has no more reason to exist). Now the 2 amigos head down to the bar for a few cold ones. Done deal!
As you can see this is just a simple example of what's possible with these types of smart contracts, but their implementation goes way beyond the sports dabbling of our 2 friends. Nowadays there are smart contracts for business, education, trading, data management and much much more!
We are all just prehistoric humans who have just discovered fire. We are yet to discover all its applications to their fullest extent. Moving on, what else can we do with the Solidity programming language?
How about creating our very own cryptocurrency? Enter the ERC-20 tokens!
But wait, what's an ERC-20 token?
Now that we know that Ethereum is not just a “coin” or ordinary crypto but rather a super powerful decentralised computer that operates by consuming GAS in the form of ETH to perform transactions, we know that this computer also has the ability to pretty much do whatever we tell it to do, such as creating our own little tokens inside the system.
ERC-20 means “Ethereum Requests for Comments 20” and is nothing more than a standard set of rules for creating a particular type of token.
According to Ethereum.org, A token is a virtual representation of pretty much anything we can think off, for example:
- A fiat currency like EUR
- A barrel of oil
- Reputation points
Tokens can be anything we want them to be. What's particularly interesting about ERC-20 tokens is that the specific set of rules that they're built upon ensures fungibility, all tokens are equal between each other when it comes to a specific token created, for example: If we create TTBCOIN (TheTradingBible's coin) then 1 COIN has the same value as any other TTBCOIN, they're not unique.
There are thousands of these ERC-20 tokens in existence. Most famous are:
And there are thousands more out there. What's cool about the ERC-20 tokens, is that all of them need ETH (Ether) in order to work. You need the Ethereum network to make all of these transactions possible, hence again the value goes right back to ETH.
Aside from ERC20 tokens, there's a new kid on the block: the Non fungible token (NFT). Let's take a look:
NFTs - Non fungible tokens
According to Merriam-Webster dictionary, the term “Fungible” means:
- Capable of being substituted in place of one another
So basically, when we say non-fungible, we're simply saying “unique” but using fancy terminology.
Here's an example:
When Bob pays Alice 20 usd in cash, that crisp 20 usd note can originate from literally anywhere and anyone.It holds its value and it can be used by Alice for all her financial transactions. This 20 usd note is “fungible”.
When we're talking about rare items such as:
- Rare gaming items
- Legal documents
- Contracts between individuals
We're dealing with “unique” items that are very different from things like mass produced banknotes (and even other types of cryptocurrency). This is the core principle of non-fungibility. When you think non-fungible, think: unique.
The Ethereum network allows us the freedom to use ERC721 and ERC1155 standards to create unique tokens that represent a totally new concept of value: scarcity and proof of ownership of these scarce assets!
Back in 2017 the Crypto kitties and in-game items were the beginning of a complete new phenomenon. In 2021 NFTs are taking over the world. Here are just a few examples:
- Crypto punks (pixelated art)
- Music (many artists are releasing new songs in NFT format)
- Alchemist Crucibles (Investments wrapped into an NFT format)
- Film merchandise (Hollywood is capitalising on the new trend)
- Physical items tokenized on the blockchain (wine, homes, cars, ...)
There are many types of NFTs out there. It's difficult to keep up with all the trends. The Ethereum network makes it all possible and this causes another important part of value to flow towards ETH. If we truly want to understand NFTs, we need to keep in mind the concept of immutable and unfalsifiable digital ownership.
Anyone who used a dial-up modem and a Nokia phone is certainly scratching their head and trying to figure out why the hell someone would actually pay for digital ownership. The whole concept of digital ownership sounds very foreign to us, traditional people.
However the young generation (and the innovators who are coding on the next killer app) actually SEE the value in this digital proposition. They are showing off their NFTs in online galleries, exchanging rare in-game items and even collecting the next rare digital artwork released by their favourite actor or athlete.
To you as an investor, trader and speculator, it's important to keep in mind that this trend is growing and picking up speed. In 5 years time NFTs will be everywhere and in every industry. Deeds to homes, insurance contracts, concert tickets, gift cards, stocks, bonds etc. The list is almost endless and so are the applications.
It helps to dig into the topic of NFTs in your free time. Remember this is the future and you have the front row ticket while everyone is still picking their noses. Keep in mind that EVERY aspect related to NFTs requires Ether to make it all happen. Ether is burned when NFTs are minted (created), transferred, sold or destroyed.
Now what else can we do with Ethereum? Well…. Ever wanted to launch your own cryptocurrency? Enter ICOs!
What are ICOs?
An ICO stands for “Initial coin offering” and it's a method used by cryptocurrency projects to seek capital for growth and development.
- A team of talented developers gathers to build a new cryptocurrency
- The team proceeds to auction a big percentage of their new coins at a discount price
- Investors and regular people buy the coins at whatever price was set
- The team receives the money and the investors have their coins
Before we dive deeper into this topic, be sure to put on a decent raincoat and grab your umbrella, because the topic of ICOs is filled with controversy and mud slinging. Why?
Well, ICOs are so much different compared to IPOs (initial public offering) which occur under controlled and regulated environments. The year was 2017 and ICOs were on everyone's lips.
Hundreds of ambitious crypto projects were releasing their own ERC20 tokens on the Ethereum network and gathering a boat load of capital (in ETH of course), while promising their investors the moon, stars and the rings of Saturn.
If a traditional company wants to launch their Initial public offering on the stock market, they have to jump through endless bureaucratic hoops and kiss the rings of many financial popes and gatekeepers. In crypto things work a bit differently, here's an example:
Mika is a programmer from Vantaa (Finland). Aside from the traditional activities of car racing, visiting the sauna and “Kalsarikännit” (sitting at home alone in his underwear and drinking alcohol), he loves to program new and exciting decentralised apps on the blockchain and mainly on the Ethereum network (using the Solidity programming language of course).
His new decentralised application is now ready. It looks amazing and it's ready to take the world by storm. Mika releases his ERC20 governance token and starts to build a company around his creation. It only takes a few weeks to launch an ICO and rake in a few millions of investment capital from normal crypto people like you and me. There are no rules, regulations and certainly no hoops to jump through at the office of the financial regulators.
Naturally not every ICO has had good intentions like our friend Mika. There were countless scams that robbed millions of people from their Ether and vanished into the thin air. This is why eventually the regulators have descended upon the ICO space in order to bring the needed peace into the simmering cauldron of madness. Many crypto projects ended up paying sizable penalties, because of the violation of the securities laws.
These days ICOs are not that common, mainly because Decentralised Finance has taken the center stage. But how can finance be decentralised?
Decentralised finance on Ethereum
Finance became decentralised from the moment that we broke all entry barriers and allowed people from all over the world to interact with computer code instead of financial institutions. Forget the concept of an “accredited investor”! With Ethereum, the doors to ALL financial applications are now open to the public and no one can stop it (unless they remove your internet connection or send you to jail).
Here people are using their cryptocurrencies and interacting with code on the blockchain. This is what makes finance decentralised!
Again we won't cover everything DeFi here. The topic is simply too vast, yet some important aspects are definitely worth mentioning.
How is DEFI different from the traditional financial system?
|Built and operated by large institutions||Built by programmers|
|Laws and regulations apply||No laws, no regulations and no barrier to entry (in 2021)|
|Limited by country and nationality||Open participation world wide|
|Small investors are excluded||Small investors are welcome|
|Identity verification is needed||Only a Web 3.0 wallet is needed|
|Large starting capital is needed||No requirements regarding starting capital|
Have you ever wanted to set up your own hedge fund? Perhaps a lending and borrowing platform? How about a full scale crypto exchange or even your own bank?
Good luck setting these businesses up in the real world! The rigid financial system that's owned by the global elites will promptly show you to the door, or even to a jail cell.
In DEFI things are much different. Remember we are dealing with code and not with the physical financial system. Yes, decentralised finance is just the use of decentralised applications that allow us to do more with our cryptocurrency.
The door to unrestricted services is wide open and all we need to join is a web 3.0 wallet (such as Metamask or Trust Wallet) to use this system. Here's what you can do with decentralised finance today:
- Lend and borrow crypto assets (and get handsome returns)
- Set up your own hedge fund
- Use exchanges without identity verification
- Created, buy and sell NFTs
- Provide liquidity to decentralised exchanges and get rewarded for your risk
- Gamble and use predictive markets
- Provide insurance services and use decentralised insurance policies
- Make your own index of crypto assets
- Borrow huge amounts of money for arbitrage
Human creativity is the only limiting factor here. Rest assured that the DEFI space will grow into a huge industry in just a few short years. No wonder the regulators are biting at the heels of this innovation. What takes decades to implement in the finance 1.0 system, takes weeks to achieve in DEFI. At this moment, some brilliant programmer is coding the next “Goldman Sachs on steroids”, while sitting in his basement with a dangling cigarette and a can of Red Bull. Anything is possible in crypto!
Nowadays millions of people worldwide armed with nothing more than a Web 3.0 wallet and an internet connection are changing the world. They literally have the access to ALL the financial tools that exclude the “little guy” in the traditional financial system. A Namibian desert nomad with a smartphone can now do more than the most privileged stockbroker on Wall Street. This is how important DEFI is.
Currently the biggest players in DEFI are:
Every single day more and more projects are joining the party. Again it's important to mention that literally EVERY interaction with the DEFI infrastructure requires Ether for paying the gas fees. Again Ethereum profits from this innovation firsthand.
Before you jump out of your shoes with excitement and hunger to learn, here's a word of caution! DEFI is a Wild West. Anything goes here! This means that the risk is off the scale. Hence it's a very good idea to study and explore DEFI at your own pace.
There are countless scams, rug pulls (whereby people lose all of their coins) and hacking attacks happening on a weekly basis. Therefore it's vital that you learn at your own pace.
Do not dive into this digital cesspool with nothing more than enthusiasm and your naked ass. Stop, think and learn one step at a time. You're very early. When you use logic and common sense, the knowledge of DEFI will be one of the best investments of your time.
And yet again in order to even dabble in the space of decentralised finance, we need Ether to play around with. How do we get it and where?
How to buy and store ETH
You might be surprised to discover this, but Ether can be bought at literally ALL the same places as Bitcoin. Currently your best bet would be registering at any reputable centralised exchange such as Kraken, Binance, ByBit and presto! The ETH coins are now yours.
Again in case your geographic location excludes you from the biggest cryptocurrency exchanges, other options of obtaining ETH are:
- Working in the crypto industry and getting paid in ETH
- Buying ETH from regular people (P2P exchange)
- Buying ETH from miners
- Mining ETH yourself (still possible in 2021)
- Accepting donations in ETH
- Selling goods or services for ETH
As you can see, just like DEFI, human creativity allows anyone to obtain ETH relatively easily. Where there's a will, there's a way. Now how do we store your coins in the best way possible?
Depending on your strategy, there are several amazing storage options. Let's look at all of them.
From a trading perspective
If you love to use your ETH and trade it regularly, there's no harm using centralised exchanges that utilise several fail-safe mechanisms in order to protect their clients. Binance for example uses a special fund in order to compensate traders should the platform experience a hacking attack and yes that's a possibility and you should definitely be aware of it.
That being said, any prudent trader MUST use 2 factor authentication, difficult passwords and several backups of important data on offline carriers or even on a simple piece of paper.
For long-term investors
If time is on your side and you can afford to forget about your investment for months and even years, you definitely need to consider a decent hardware wallet (such as a Ledger or Trezor). These wallets allow you to safely store your ETH without having to worry about security because your private keys (your proof of ownership over your ETH) is permanently stored on a physical device. Your private key never interacts with the hacker-infested internet and is being used only to “sign” (meaning: to authorise) any transactions.
Again safe storage of your passwords, recovery phrases and the lot MUST be done properly. If you aren't sure if something is important, write it down on a piece of paper and store it in a safe place. Remember: If you lose this piece of paper, you will lose your ETH permanently!
For DEFI and NFT investors
In case you're bitten by the DEFI or NFT bug and you want to actively USE your ETH in this amazing ecosystem, there are several excellent options out there for example:
More will come in the future of course! Having your ETH working in the decentralised finance space is risky, therefore a prudent crypto investor NEVER stores all of their coins in a web 3.0 wallet. Neither should you. Caution and paranoia are the best friends of any crypto investor.
Therefore, just like with the example above, please write down all the important details (such as passwords, recovery phrases and even private keys) on several pieces of paper. This is your only proof of ownership over your cryptocurrency.
As you can see, the purchase and storage of your ETH is solely depending on your own risk and investment profile. The more you learn about Ethereum (and about yourself), the better trader/investor you will become.
There's much more to be said about Ethereum and all the amazing tech built (and to be built) on this network. Knowing what we know so far, the next question is:
Why is Ethereum important?
Ethereum is not only a network powered by the ETH coin, it's much more than that. We're literally talking about a box full of financial Lego blocks, waiting to be explored by programmers across the globe. It's a virtual sandbox inviting anyone to play and explore it using nothing more than their imagination, programming skills and vision for a better tomorrow.
Perhaps this is why the institutional demand for ETH is off the scale in 2021.
In order to understand Ethereum better, we must look beyond price action. Remember, we are all just Neanderthals who started to explore the applications of fire. We don't yet understand how Ethereum will change and shape our world.
For all of us it's impossible to imagine the future. As dystopian as the current events may be, Ethereum can grant us the much needed financial freedom and endless possibilities to do much more with our money than we have ever imagined.
Currently the Ethereum team is busy with the gargantuan task of moving the network to a proof of stake model. This will take time and mistakes will be made along the way. This is perfectly ok and we will be watching with great anticipation. Some day we will look at the Ethereum programmers in the same way we look at Steve Jobs.
As for us mere mortals, Ethereum presents a truly unique opportunity. Not only as an investment, but also as a tool for freedom and self expression. Your time spent on learning about how Ethereum ticks, will be worth its weight in gold after a few short years.