Ethereum Explained - What is it And How Does it Work?

When the Ethereum network launched in 2015, it became the first decentralised project that expanded the use of blockchains. It made headlines due to the fact that allowed users to create their own digital tokens and self-sustaining decentralised apps.

All these novelties introduced a wide range of new features and markets including decentralised finance, initial coin offerings, NFTs, as well as GameFi.

So, what is Ethereum and why did it have such a big impact in the crypto world? Let’s dive deeper into the specifics.

A Short Ethereum History

Let’s start with a little trip back in time. Vitalik Buterin is the name behind the creation of Ethereum and he developed the project to answer for all the Bitcoin shortcomings and problems. Buterin published a white paper explaining Ethereum in 2013 – detailing smart contracts that would enable the development of decentralised apps.

Decentralised apps already existed in the blockchain space, but their platforms couldn’t work together. As such, Buterin intended the Ethereum project to unify them, so that is how Ethereum 1.0  was born!

Of course, building such a network was never going to be cheap, so Buterin and his co-founders held a token pre-sale to raise about $18,000,000 in Ether which helped enormously with developing the project.

Apart from that, Buterin and the rest of the group founded the Ethereum Foundation in Switzerland which was in charge of developing and maintaining the network. Shortly after that, Buterin decided that the Foundation would run as a non-profit, so some of the co-founding members left the project.

Over time, the Ethereum network developed even further. Just in 2016, the users came up with the DAO idea – a decentralised autonomous organization without an address. The DAO had a mission to provide new decentralised business models for organizing commercial and non-profit enterprises for the Ethereum blockchain.

Nonetheless, this good idea lasted shortly as an unknown hacker stole $40 million from The DAO holdings. To make sure this kind of attack never happens again, the DAO decided to ‘hard fork’ Ethereum and update it to a new protocol that kept the name Ethereum.

So, How Does Ethereum Work?

In a nutshell, Ethereum is a global and completely decentralised platform that is used for money and new kinds of applications. Thousands of games and financial apps run on the Ethereum blockchain, and its popularity is further cemented by the fact that other crypto coins run on its network.

A central feature of Ethereum is the blockchain network. We can define blockchain as a decentralised, distributed public ledger where each transaction is recorded and then verified. The ‘distribution’ factor of the network comes as a result of every user participating in the Ethereum network.

By doing so, they have a copy of this ledger, allowing them to see all transactions made previously. The decentralised aspect of the network comes as a result of it not being controlled or operated by any entity – the distributed ledger holders mentioned previously are in charge of that!

As for security, blockchain transactions use cryptography to ensure that the network is 100% safe at all times. To make transactions on the network, you can use Ether – the native token of Ethereum.

A unique feature of the Ethereum network is that you can build apps that run on the blockchain and those apps can store and transfer data or handle complex transactions.

Ethereum’s Key Components

Ethereum consists of a few main elements that ensure it operates at a very high and secure level:

1. Smart Contracts
2. Blockchain
3. Consensus Mechanism
4. Ethereum Virtual Machine
5. Ether

Let’s dissolve them further, so you know all the details about the network itself.

Smart Contracts

We start with the cornerstone of the Ethereum network – smart contracts. We can define it as a programmable agreement on the blockchain network.

As such, it allows users to completely digitise conditions about their interactions and transactions. Since conditions are programmed and then launched on the blockchain as smart contracts, they will self-execute – as long as the predefined conditions are met, transactions will be completed.

Ethereum is the first project to implement smart contracts as a key component of how blockchains function. Since they were such a big success, more decentralised apps hit the market that ran the same way.

Blockchain

The blockchain that Ethereum uses to store and secure transactions makes it a bit similar to Bitcoin. A Blockchain is a chain of blocks that accommodate the data of confirmed transactions. You can think of it as a ledger where activities on the network are recorded, so this ledger is publicly available.

Furthermore, copies of the ledger are shared to a global network of computers that are known as ‘nodes’. Nodes verify and record transactions as well as smart contract data.

That way, all participants have a copy of the blockchain and verify the validity of the content inside it. Nonetheless, this is where the main difference between Ethereum and Bitcoin lies.

Nodes here don’t have to verify and record data of transactions only – they are also in charge of keeping track of how the network operates – i.e. its state. The state refers to the information about each user’s balance and activity.

Consensus Mechanism

Both Ethereum and Bitcoin had the same consensus mechanism for validating data and then adding it to the blockchain – the PoW or proof-of-work. That protocol runs on mining nodes that compete against each other to win the right to the next block on the blockchain.

All this changed in 2022 when Ethereum shifted to the so-called ‘Merge’ and moved to a proof-of-state blockchain (PoS). This system requires all network participants to deposit and lock away 32 ETH to be eligible for network validators.

The Ethereum Virtual Machine

Moving on, The Ethereum Virtual Machine or just EVM is the processing system of the network that allows all developers to create smart contracts and make nodes interact with them. Developers use Solidity, a programming language to write smart contracts.

Solidity’s smart contracts can be read by humans only, so they have to be converted into low-level machine instructions or opcodes. That way, the EVM can easily understand and execute.

So, when you make a transaction to a smart contract, every node will run it through its own EVM. That way, each node will be able to see the end result and whether the transaction will be valid or not.

Ether

Finally, we have Ether, the native cryptocurrency of the Ethereum network, so don’t get these two terms confused!

Ether is needed for doing anything on the Ethereum network. When users use it to execute smart contracts, we refer to it as ‘gas’. The amount of gas you need to pay is determined by the type of transaction you make. Of course, the more complex the transaction, the higher the gas fee users will need to pay.

Advantages and Disadvantages of Ethereum

As is the case with all aspects of life, cryptocurrencies are subject to some advantages and drawbacks. So, for you to make a better-informed decision about potentially investing in Ethereum, you need to see all its pros and cons.

Buying Ether – The Available Options

So, now that you know how the Ethereum network works, you might be itching to get your hands on its native cryptocurrency – Ether! You will be happy to know that you have a few options to choose from to buy Ether, so let’s see how they work.

A crypto exchange is arguably the most common method of buying Ether. It is a business that allows registered users to trade cryptocurrencies or other assets – often conventional fiat money, but some crypto exchanges work with digital currencies only.

Crypto exchange platforms are ideal for all novices in the crypto world, as they offer a simple process of buying ETH or other coins, and the process roughly goes as follows.

Choose a Crypto Exchange

First things first, you need to find and choose a crypto exchange platform. There is no shortage of that, as Coinbase, Binance, Kraken and eToro are just some options you have at your disposal. All of those support the biggest cryptocurrencies such as ETH, so you can start trading in no time!

Register & Verify Your Account

A negative aspect of top-class crypto exchanges is that they require their users to sign up and complete KYC procedures. This eliminates the decentralised nature of trading cryptocurrencies.

Deposit Fiat Money

Each crypto exchange platform has its own set of payment methods that you can use for your transactions. So, take a look at which options you have and deposit in a currency that you prefer. The most common methods include linking your bank account or debit card.

Buy Ether

Now, you are ready to buy your first set of Ether assets. See what the current price of the ETH is, and decide how much you want to buy.

When they eventually reach your account, you can decide to sell them, trade them or keep them for the future. Note that some countries impose taxes on crypto transactions, so make sure to double-check the legislation in your country!

Use a Wallet

We emphasize the importance of ETH wallets as they are very important methods of storing your digital assets. All crypto exchange platforms have a native wallet that is known as a non-custodial one (due to the fact that you don’t directly control your private key – the exchange keeps it safe for you).

On the other hand, you can choose self-custodial software wallets that you can use as apps or web extensions. As such, you will be completely in control over your assets, so you must make sure never to lose access to your private key. MetaMask is a great Ether wallet.

Finally, if you want to further enhance your security, or you have large amounts of ETH, we suggest you use hardware wallets. They are physical devices where you store your private key and their biggest advantage is that they work offline – making them immune to hacking attempts.

Any hardware wallet from the Ledger and Trezor series is a good option, but note that they come with a price of up to $200.

P2P Platforms

If you are not a big fan of the centralised crypto exchange platforms, then you will be happy to know that you can utilize the perks of Peer-to-Peer platforms instead.

They have gained a lot of popularity among ETH holders as they allow users to negotiate the terms of the trade deal without any intermediaries in between. Therefore, this is how you can buy ETH from a P2P platform:

1. Choose a platform – LocalCoinSwap, OKX, and ByBit are always good options for any trader.
2. Sign up – unlike crypto exchange platforms, P2P platforms don’t require much a personal information when signing up.
3. Filter through advertisers – Choose the Buy option, enter your desired cryptocurrency, as well as your preferred payment method to filter through the offers.
4. Place an order – when you eventually find the right offer for you, place an order.
5. Make a payment – you will have to make a payment before the order expires.
6. Receive ETH – once the seller confirms the payment, the P2P platform will release the ETH assets from escrow and send them over to you.

Crypto ATMs

Another conventional method of buying ETH is through a crypto ATM. However, be aware that crypto ATMs are not allowed in every country in the world, so once again, be sure to check the current laws before you proceed. Here is how the process of using such an ATM would go:

1. Find a nearby crypto ATM – there are various apps in the world that have the exact locations of crypto ATMs, so be sure to download and use one.
2. Enter your phone number – usually, crypto ATMs ask for your mobile number where you will receive a code that you can use for verification.
3. Scan your wallet’s QR code – we suppose you already have an ETH wallet, so here, you can scan your QR code and let the ATM send over the ETH assets.
4. Insert your fiat currency – decide on how much ETH you want to buy and enter the fiat amount.
5. Complete the transaction – review the details and confirm the transaction, after which the ATM will send ETH directly to your wallet.

Should You Buy Ether?

All of the above-mentioned now leads us to the million-dollar question – should you invest in Ether? Well, there are arguments for both sides of the story.

It goes without saying that ETH has value and it can lead to large chunks of profit in a short time. Moreover, the Ethereum blockchain is more and more attractive since it migrated to a new protocol, and people nowadays tend to use Ethereum’s decentralised apps more frequently.

As a result, the demand for Ether can rise in the coming years, so there might be plenty of benefits you can reap.

However, before making any significant investment in Ethereum be aware that there are some risks associated with it. Most notably, ETH is highly volatile as there is no government regulation that will guarantee its stability.

A general rule of thumb is that if you are to invest in cryptocurrencies, only invest what you can afford to lose, not a cent more!

What Does the Future Hold?

Well, no one can predict how the future of Ether and other cryptocurrencies will pan out. The emergence of decentralised apps and NFTs have surely added to the excitement about blockchain projects, so we are likely to see them develop further over time.

Hopefully, this guide has all the relevant information you need about the Ethereum network and the ETH cryptocurrency. Now, you can make a better-informed decision whether investing in it is worth it!