What Is Ethereum (ETH)? A Simple Explanation

What Is Ethereum (ETH)?

Ethereum is a public and decentralized blockchain network where developers can build applications and digital assets. So Ethereum is not just for sending value. The network can also run programs.

Ethereum's native cryptocurrency is called ether. Its ticker is ETH.

ETH has several functions within the network. You use ETH to pay transaction fees when you, for example, send ETH or use an application on Ethereum. ETH is also staked to help secure the network. Validators lock up ETH and can receive rewards in return.

An important part of Ethereum is smart contracts. These are programs that run on the blockchain and can automatically carry out rules that were set in the code ahead of time. That lets developers build applications that use the blockchain without one central party having to process all the transactions.

Ethereum Mainnet went live on July 30, 2015, with the network's first block, the genesis block.

Key Takeaways

• Ethereum is a programmable blockchain platform for applications and digital assets.
• ETH is Ethereum's native crypto and is used, among other things, for fees and staking.
• Validators secure Ethereum through Proof of Stake.
• Smart contracts automatically carry out rules and application logic.
• High network demand, complex smart contracts, and differences between Layer 2 networks are important things to keep in mind.

How Does Ethereum Work?

Ethereum works like a shared digital ledger. Many independent computers, also called nodes, store and check the same information about transactions, accounts, and smart contracts. That means there is no single central party deciding what happens on the network.

When you send ETH or use a smart contract, you send a transaction to the network. Nodes then check whether that transaction follows Ethereum's rules. If it does, the transaction can be included in a block and the network's new state is updated.

Transactions and smart contracts are executed in the Ethereum Virtual Machine, usually shortened to EVM. You can think of the EVM as the environment where programs run on Ethereum. Because all nodes follow the same rules, they can check whether a program produces the same result.

Ethereum uses Proof of Stake to secure the network. In this system, validators lock up ETH. A validator can be chosen to propose a new block. Other validators check that block and vote on whether it is valid.

That is how the network reaches consensus. In other words, validators together agree on which transactions and blocks are valid.

Validators can receive rewards when they participate correctly and stay online. If someone is temporarily offline, they can receive a small financial penalty. In more serious cases, part of the staked ETH can be lost. That is called slashing.

Ethereum is made up of two important layers:

• The execution layer processes transactions and smart contracts.
• The consensus layer handles Proof of Stake and coordinates the validators.

Ethereum (ETH) Overview

What Are Smart Contracts on Ethereum?

Smart contracts are programs that run on the Ethereum blockchain. So they are not legal contracts, but pieces of software with rules that are executed when someone calls a function in the contract.

A smart contract has its own address on Ethereum. It contains code and can also store data. For example, a smart contract can issue tokens, carry out a swap, or manage the rules of an application.

Say a smart contract is programmed to send tokens when certain conditions are met. As soon as someone calls the right function and meets those conditions, the contract carries out the preprogrammed rules. The nodes on Ethereum all check the outcome using the same rules.

Smart contracts can also call other smart contracts. That lets developers combine existing pieces to build new applications. This is called composability. Simply put, it means different blockchain applications and smart contracts can build on each other.

A transaction carried out through a smart contract cannot just be reversed. Also, the code of a smart contract at an existing address cannot simply be changed. Developers can, however, build a system in advance that lets certain parts be replaced or updated later. Those upgrade setups come with their own management and trust risks.

A smart contract also cannot pull data from outside Ethereum on its own, such as a market price, sports result, or weather data. For that, an oracle can be used. An oracle provides outside data to the blockchain, but it also adds an extra dependency.

How Does Staking Work on Ethereum?

Staking means locking up ETH to help secure Ethereum through Proof of Stake. Validators put ETH at stake and can receive rewards when they participate correctly in the network.

To activate a validator on your own, you need at least 32 ETH. You also need to run validator software and make sure it stays reliably online.

A validator can be chosen to propose a new block. Other validators then submit attestations. An attestation is a kind of vote in which a validator says which block and which blockchain state they believe are valid.

Since the Pectra upgrade, a validator with so-called compounding withdrawal credentials can have an effective stake of 32 to a maximum of 2,048 ETH. For these validators, staking rewards can be automatically added to the effective stake. Older validators have an effective balance capped at 32 ETH.

Validators receive rewards when they participate correctly and stay available. If a validator is temporarily offline, small penalties can apply. In certain serious cases, part of the staked ETH can be lost. This is called slashing.

You do not have to run your own validator to take part in staking. Through staking pools and other providers, it is possible to participate with less than 32 ETH. In that case, though, you depend on the operation of that service or those smart contracts. That can create extra risks, such as smart contract risk and counterparty risk.

How Do Gas Fees Work on Ethereum?

Transactions and smart contract execution require computing power. Ethereum measures this work in gas. Gas is not the same as the transaction fee. Gas shows how much computing work an action requires, while the gas fee is the amount in ETH you pay for it.

The final gas fee is determined by the number of gas units used and the price per gas unit. That price is usually expressed in gwei. One gwei is one billionth of an ETH, or 0.000000001 ETH.

The price per gas unit consists of a base fee and usually a priority fee. The base fee is set automatically by the Ethereum protocol and changes based on demand for block space. When a transaction is executed, this base fee is burned and removed from circulation.

The priority fee is an extra payment for the validator proposing the block. You can think of it as a tip that makes your transaction more attractive for inclusion in a block. When demand for block space is high, a higher priority fee can help get a transaction included sooner.

The amount of gas needed depends on the action. A simple ETH transfer, for example, uses 21,000 gas units. Interacting with a complex smart contract can use much more gas.

Every transaction also has a gas limit. This is the maximum number of gas units the transaction is allowed to use. If you set the limit higher than needed, you do not automatically pay for all the unused gas. Only the gas actually used is charged.

If the gas limit is too low during execution, the transaction can fail. Changes are then rolled back, but you still lose the gas used for the failed execution.

What Is the Difference Between Ethereum and Bitcoin?

Ethereum and Bitcoin are both public blockchain networks, but they were built with different main goals. Ethereum was designed as a programmable platform for smart contracts and applications. Bitcoin was originally designed as a peer-to-peer system for electronic money.

One important technical difference is how the two networks reach consensus. Ethereum uses Proof of Stake. Validators lock up ETH and help decide which blocks are valid. Bitcoin uses Proof of Work, where miners use computing power to produce new blocks and secure the network.

Through the EVM, Ethereum can run general smart contract code. That lets developers build a wide range of applications on the network. Bitcoin also has programmable features through Bitcoin Script, but it was not designed as a general smart contract platform like Ethereum.

The issuance of the two cryptocurrencies is different too. ETH does not have a fixed protocol maximum. New ETH is issued, among other things, as a reward to validators, while part of the transaction fees is burned. These two mechanisms together determine how the total amount of ETH changes.

For bitcoin, the maximum supply is fixed at 21 million BTC. New bitcoin enters circulation through mining, and the amount of new BTC per block decreases periodically through halvings.

Transaction fees also work differently. On Ethereum, you pay gas fees for transactions and smart contract execution. On Bitcoin, users pay transaction fees to get transactions included in a block.

Who Founded Ethereum?

Vitalik Buterin came up with Ethereum in 2013 and wrote the original Ethereum white paper that same year. The project was publicly announced in early 2014.

Along with Buterin, seven other people are generally considered co-founders of Ethereum: Gavin Wood, Joseph Lubin, Jeffrey Wilcke, Mihai Alisie, Anthony Di Iorio, Amir Chetrit, and Charles Hoskinson.

Gavin Wood wrote the Ethereum Yellow Paper, which described how Ethereum works technically. He also played an important role in developing Solidity, a programming language widely used for smart contracts on Ethereum.

Ethereum Mainnet launched on July 30, 2015, with the genesis block, the network's first block.

Ethereum does not have a CEO, a board, or one party that controls the network. The Ethereum Foundation supports research, development, and the broader Ethereum ecosystem, among other things, but it does not control the network on its own.

What Are the Benefits of Ethereum?

Ethereum has several features that make it a good fit as a programmable blockchain:

• Smart contracts and applications: Developers can deploy smart contracts and applications on Ethereum without needing prior permission.
• Shared execution: The EVM makes sure nodes run the same smart contract code under the same rules and can verify the result.
• Composability: Smart contracts can call other public smart contracts. That lets developers combine existing functions into new applications.
• Proof of Stake: Validators lock up ETH to help secure the network and can receive rewards for doing so.
• Layer 2 rollups: Rollups process many transactions outside Ethereum Mainnet and publish data or proofs back to Ethereum. That can increase capacity and lower transaction costs for users.
• Public data: Transactions and smart contract data on Ethereum are public and can be checked through the blockchain.

Ethereum is permissionless. That means the protocol itself does not require permission from a central party to send transactions or use smart contracts. In practice, access can still depend on things like an internet connection, a crypto wallet, local regulations, or third-party services.

What Are the Downsides of Ethereum?

Ethereum also has limitations and risks.

• Limited block space on Ethereum Mainnet: When demand is high, users compete for block space. That can push gas fees up.
• Proof of Stake does not automatically make transactions cheaper: Gas fees mainly depend on demand for block space and Ethereum's fee market.
• Smart contract risks: Programming mistakes and vulnerabilities can lead to lost crypto or unwanted transactions. Once transactions are executed, recovery can be difficult or impossible.
• Dependence on oracles: Smart contracts cannot independently fetch or verify data outside the blockchain. For things like prices or other external information, oracles are often needed.
• Running your own validator takes technical knowledge and capital: To activate a validator on your own, you need at least 32 ETH. You also need to run validator software and stay reliably online.
• Layer 2 networks differ from each other: Rollups can make transactions cheaper and faster, but they differ in design, bridges, fraud proofs or validity proofs, and the role of sequencers. So the risks are not the same on every Layer 2 network.

Conclusion

Ethereum is a public blockchain network where developers can build smart contracts, digital assets, and applications. The native cryptocurrency ETH is used for transaction fees and staking.

The network works with nodes that check the same rules and data. The execution layer processes transactions and smart contracts, while the consensus layer uses Proof of Stake to make sure validators agree on the valid state of the blockchain.

Smart contracts make many different uses possible, but they also come with risks. Mistakes in code and executed transactions are often hard to reverse. In addition, users may deal with high gas fees, staking risks, and extra dependencies on Layer 2 networks.

Ethereum stands out mainly because it is a programmable blockchain where different applications and smart contracts can work together, while ETH plays a central role in transaction fees and securing the network.