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What Is Ethereum?

by | Dec 18, 2017

If you are interested in understanding Ethereum, you probably have already heard of Bitcoin.

At the time of writing, Ethereum has the second largest market cap out of all cryptocurrencies. At its core, Ethereum is a programmable blockchain platform that supports smart contracts. It was created by Vitalik Buterin in 2013 with the goal of overcoming certain limitations of Bitcoin protocol, particularly as it relates to smart contracts, which we will explain below.

The Purpose of Ethereum

Part of what makes Ethereum so interesting is that it is more than a simple digital currency.  In fact, its underlying technology has the potential to change the way global industries do business. As stated in its white paper, “Ethereum intends to provide an ease of development as well as stronger light client properties while allowing applications to share an economic environment and blockchain security.” To be clear, technically Ethereum refers to Ethereum’s network, blockchain and its EVM (Ethereum Virtual Machine), however its native currency is officially called Ether (ETH). Ether’s original purpose was to function as utility coin for the use of the network. In a later stage it became increasingly used as a means of payment and store of value as well (similar to the use of Bitcoin).

In other words, Ethereum provides a decentralized world computer, the Ethereum Virtual Machine (EVM), which allows anyone to (1) build decentralized applications (known as Dapps) where they can create their own set of arbitrary rules and (2) write smart contracts. Let’s take a closer look at those two functions of the EVM.

Smart Contracts

One major hallmark of Ethereum is the ability to program smart contracts.  Smart contracts are computer scripts that automatically execute tasks when certain predetermined conditions are met, without requiring intermediaries. Smart contracts are digital contracts created with code which is stored and replicated on a network of computers that run and secure the blockchain.  When specific criteria are met by the relevant parties, the contract is automatically executed. The code in a smart contract is essentially an “if, then” statement: if conditions in the contract are met, then an event detailed in the contract is triggered. Here is a simple example:

If someone pays X amount to the smart contract, then the smart contract will send that person the desired concert tickets.

Benefits of Smart Contracts

Smart contracts are appealing because they are trustless and autonomous.  Because no single entity owns or controls the blockchain, smart contracts are able to transact and execute autonomously without a third party. You don’t have to rely on a lawyer, broker, or even the person you are transacting with to fulfill the other half of a contract (trustless). All the details are hosted on the blockchain, and because it is open source, the conditions can be reviewed by anyone on the network. The immutability of the blockchain means that the contract code cannot be changed, so all parties can be confident that the terms will be executed. It also means that whoever writes the contract needs to be very sure the code is 100% correct, because once it is on the blockchain it is there forever!

Smart contracts are secure.  Because of the cryptographic properties of blockchain technology, a properly coded smart contract is very secure and the assets it holds are safe against hacking. Plus, once a smart contract is submitted to the blockchain network it is distributed to all of the computers on that network, so it is backed up and cannot be lost.

Lastly, smart contracts are fast and cheap. Smart contracts auto-execute when criteria are met, so transactions are automated – which can save a lot of time. And because smart contracts don’t need to rely on a third-party, like a lawyer or broker, the parties can avoid associated fees.

Instead, running smart contracts on the blockchain requires the network to complete computer calculations, just like cryptocurrency transactions. Transaction fees are paid to miners in the blockchain’s native currency; for example, the Ethereum network uses Ether. And because smart contract transactions are more complicated than those for digital currency, the fee is usually a bit higher. Having said that, it will still be significantly less expensive than lawyers or brokers fees you would otherwise have to pay. And who doesn’t love that?

Smart Contract Use Cases

Still not sure how these smart contracts work? Here are some examples.

  1. Business Operations. There are many applications for smart contracts in business to business (B2B) transactions, such as supply chain and logistics. A common example is the use of self-executing smart contracts for companies to pay their suppliers when goods are delivered.
  2. Copyrighted Content. In creative industries, smart contracts allow content creators and musicians to retrain the rights to their work. With this system, they are able to collect royalty fees every time their content is used for commercial purposes because the smart contract ensures that a fee is charged for each use of the content.
  3. Property and Titles.  Using smart contracts to facilitate property ownership and sales can reduce auditing cost, time, and need for third-parties. For example, the title to a car can be sent to the new owner as soon as the price has been paid down. The smart contract is self-enforced and auto executes, and every payment is immutably recorded on the blockchain.

DAPPS

The second major utility of Ethereum is the ability for others to create decentralized applications, or Dapps, on the Ethereum blockchain. A Dapp is an application that can be built on the Ethereum network and consists of a (system of) smart contract(s) that should make the application run autonomously on the Ethereum Virtual Machine (Ethereum’s decentralized computer). Using the Ethereum platform is great for developers because they do not need to create an entirely new blockchain to get their project off the ground. Instead, developers can implement a standard technical protocol and pay transaction fees to use the Ethereum framework. Like Bitcoin, users must pay small transaction fees, called “gas,” to the network by using its crypto-fuel token called Ether. These fees are used to incentivize miners to mine blocks of transactions that power the network, as well as people under smart contract conditions to use the Ethereum platform.

As of July 2018, there were over 1700 Dapps built on the Ethereum network.

How Does the ERC20 Standard Work?

ERC20 defines guidelines for Ethereum tokens to follow within the larger Ethereum ecosystem, allowing developers to accurately predict the interaction between tokens. These guidelines are largely a set of functions (a smart contract!) the public can use in order to interact with that tokens. The functions include how the tokens are transferred between addresses and how data within each token is accessed. Because these functions can be identified by other smart contracts, the interaction between tokens is seamless.

Pop quiz! Do you know what ERC20 stands for? ERC stands for Ethereum Request for Comments, the the name for the proposed system within Ethereum, and 20 is the number of that proposal or request.

Before the ERC20 standard was created, anyone who wanted to build on the Ethereum platform had to “reinvent the wheel,” so to speak, which meant each token smart contract was slightly different.  Practically speaking, this meant that exchanges and wallets had to write custom code to support each token.

Today, with ERC20, exchanges and wallets only have to implement this code once in order to support the various tokens. This is why, MyEtherWallet, for example, can support any ERC20 compliant token without having to be updated.  In Exodus wallet, your ERC20 tokens share the same receiving address as your Ethereum address. That is because these tokens live on the Ethereum blockchain. They are not independent of Ethereum and rely on the platform.

That said, many of projects that initially start as ERC20 tokens eventually migrate to their own platform.  At that time, the ERC20 token needs to be swapped for the new token or coin on the project’s mainnet. Of course, some tokens are specifically used for DApps (decentralized applications) to be used on the Ethereum network in the future so those remain as ERC20 tokens.

Functions within an ERC20 token smart contract

Let’s take a look at the functions for ERC20 tokens.  First, there are three optional features one can include:

  • Name
  • Symbol
  • The number of decimals which indicates how divisible the token will be.  Most will have 18 decimals like Ether (the native token of the Ethereum network.)

The six mandatory functions of an ERC20 token are:

  • TotalSupply — when this limit is reached, the smart contract will refuse to create new tokens.
  • BalanceOf — indicates the number of tokens a given address has.
  • Transfer — takes a certain amount of tokens FROM the total supply and give them to a user.
  • Transferfrom — which can be used to transfer tokens from any 2 users who have them.
  • Approve — verifies that your contract can give a certain amount of tokens to a user taking the total supply into account.
  • Allowance  — checks whether one user has a sufficient amount of tokens to send to someone else.

Two events that are triggered when a contract takes a relevant action are:

  1. Transfer — broadcasts the details coins moving from one contract to another onto the network
  2. Approval — broadcasts the details of approvals of tokens from one address to another onto the network

An ERC20 token is generated by a set of smart contracts. Every transaction, therefore, goes through the smart contract. Outside of the ERC20 standards, developers can build more functions for the token in the smart contract. For example, token smart contracts can be programmed to have a lock-up period for the token before they become transferable. Or the smart contract can even be programmed to “mine” new tokens under certain conditions.  The creation of new ERC20 tokens — adding to the token supply — can be done by virtue of issuing the smart contract code. This is referred to as “minting” (a term applied to the same process on other platforms as well.)

As a crypto investor, you may come across various ERC20 tokens that are offered as “ICOs” or that people are promoting on internet. It is important to realize that because of the ERC20 standard it is relatively easy and cheap to create a token on Ethereum and it doesn’t require a lot of developer skills either. This is also the reason why many scammers issue a token and try to sell it in any shape or form to the general public. There is nothing inherently special about any ERC20 token; its specific use case for a Dapp or other implementation should define what value it could potentially bring.

Overview of Ether, Gas and ERC20 tokens eco-system

To use smart contracts on Ethereum and to transfer Ether and ERC20 tokens the required computer calculations cost “Gas” which you can compare as the fuel on which the whole Ethereum network runs. Users always pay for “Gas” in Ether (ETH); this is why Ether is primarily the utility coin of the network. Dapps on the other hand are smart contracts that may require the use of the dedicated ERC20 token that is designed for that specific Dapp. To use the token for the Dapp or to simply transfer it between accounts, you still need to pay for Gas in Ether as well. To read more about how Gas works on the Ethereum network please read this article.

Difference between Ethereum and Ethereum Classic

When you look in many price charts and on various exchanges you will also come across a cryptocurrency called Ethereum Classic (ETC). What is the difference between that cryptocurrency and the Ethereum (ETH) we discussed here. In short this is the result of a network split (fork) that was initiated as a result of a huge hack of a smart contract (the so-called DAO project) where millions worth of Ether were lost/stolen. Main Ethereum developers and leadership, the Ethereum Foundation, miners and users decided to split the network off of the original and rolled back the transactions so the stolen funds were recovered. Because a small group of users, developers and miners didn’t agree with this decision, these users continued on the old deprecated blockchain which was then rebranded Ethereum Classic. However, because the majority of users, miners, leadership and main developers (like Ethereum’s founder Vitalik Buterin) are developing on the “new” Ethereum, this is considered the official Ethereum (and its native coin Ether-ETH) that we have been discussing in this article.

Conclusion

Ethereum is considered a groundbreaking blockchain platform, offering faster and lower-cost transactions for the use of smart contracts, as well as a framework for Dapps to be built on. Although Ether was originally intended as a utility token for running the Ethereum network, and not a means of payment, Ether has had a lot of success that it is now also used as one of the major currencies! Also, at the time of publishing this article more than 90% of all tokens that are created on blockchain platforms are built on the Ethereum network. Despite the recent success of Ethereum as a cryptocurrency and “competitor” of Bitcoin on the territory of means of payment and store of value, investing in Ether comes with its own set of additional risks and the realization that the core use cases of both Bitcoin and Ethereum might be considered to be different. For that reason, we highly recommend doing thorough research yourself as well and having full understanding of the essential differences between both projects and their position in the whole cryptocurrency eco-system before committing considerable money in any other altcoins (like Ethereum) after Bitcoin. If you’d like to learn how to buy Ethereum or Bitcoin without any fees, check out our other article here.

Disclaimer:

This article was written to the best of our knowledge with the information available to us. We do not guarantee that every bit of information is completely accurate or up-to-date. Please use this information as a complement to your own research. Nothing we write in any of our articles is intended as investment advice nor as an endorsement to buy/sell/hold anything. Cryptocurrency investments are inherently risky so you should never invest more than you can afford to lose.

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