Ethereum represents a distributed computing platform that generates a cryptocurrency known as Ether. Programmers can create "smart contracts" on the Ethereum blockchain, which automatically execute based on their underlying code.
What Is Ethereum?
Ethereum is often compared to Bitcoin, but there are significant differences. While Bitcoin functions primarily as a cryptocurrency and a decentralized payment network enabling peer-to-peer transfers, Ethereum aims for broader applications.
As stated on the official Ethereum website, "Ethereum is a decentralized platform that runs smart contracts." These smart contracts operate on the Ethereum Virtual Machine (EVM), a distributed computing network formed by all devices running Ethereum nodes.
The term "decentralized platform" means that anyone can set up and operate an Ethereum node, similar to how Bitcoin nodes function. Those who wish to execute smart contracts on the network must pay node operators in Ether. In this way, node providers contribute computational resources and are compensated in Ether, mirroring how Bitcoin miners are rewarded with Bitcoin for their processing power.
In summary, while Bitcoin is mainly a blockchain-based payment system, Ethereum serves as a distributed computing network whose blockchain supports a wide range of functions beyond digital currency.
What Is Ether?
Ether is the digital token—or cryptocurrency—associated with the Ethereum blockchain. In technical terms, Ether is the token, and Ethereum is the platform. However, people often use these terms interchangeably. For instance, platforms like Coinbase allow users to "buy Ethereum," which refers to purchasing Ether tokens.
Ether is considered an "altcoin," meaning any cryptocurrency other than Bitcoin. Like Bitcoin, Ether operates on a distributed blockchain—the Ethereum blockchain.
Developers who build applications or smart contracts on the Ethereum network need Ether to pay for computational resources. Users might also require Ether to access services within these applications. Additionally, Ether can be traded on exchanges for fiat currency, similar to Bitcoin.
The Value of Decentralized Applications
Ethereum blockchain applications go beyond simple transactions. While the Bitcoin blockchain records a history of Bitcoin transactions, the Ethereum blockchain stores not only Ether transactions but also the most recent state and code of every smart contract.
Since the blockchain is a distributed ledger stored across multiple locations, smart contract data is maintained by all Ethereum nodes. When you create a smart contract—essentially an application—it is stored and executed in a decentralized manner.
Consider traditional applications like Gmail or Microsoft OneNote. These rely on centralized servers. If the company shuts down the service or bans your account, you could lose all your data unless you have a backup.
With Ethereum-based applications, the application code and user data are stored across the blockchain. Every time you interact with the application and modify data, all nodes update the smart contract's state. This eliminates single points of failure. Your data and the application itself remain accessible globally, with no central authority able to take it offline. Data on the blockchain is encrypted, ensuring privacy and security.
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How Do Smart Contracts Work?
Smart contracts are applications that run on the Ethereum Virtual Machine. The EVM acts as a distributed "world computer," where computational power is provided by node operators who are compensated in Ether.
These are called "smart contracts" because they can be programmed to execute automatically when specific conditions are met.
For example, imagine building a crowdfunding service similar to Kickstarter on Ethereum. A smart contract could be designed to pool funds until a specific goal is reached. If the goal is met, the funds are automatically released to the recipient. If not, contributions are returned to the donors. This would use Ether instead of traditional currency.
All of this occurs based on the contract's code, without requiring a trusted third party to hold funds or authorize transactions. Kickstarter, for instance, charges fees ranging from 5% to 8% per project. A smart contract could significantly reduce these costs.
Smart contracts have diverse applications. Developers can create contracts that provide functionality to other contracts, similar to software libraries. They can also serve as simple storage applications on the blockchain.
To execute a smart contract, users must pay a transaction fee in Ether, the amount of which depends on the computational resources required. This incentivizes node operators to support the network.
Real-World Example: CryptoKitties
One of the most well-known applications built on Ethereum using smart contracts is CryptoKitties, a game described as "the first blockchain-based game worldwide."
CryptoKitties are digital collectibles stored on the Ethereum blockchain. The game demonstrates how digital assets can be stored, traded, and generated on a decentralized network.
New CryptoKitties are created through "breeding," which involves selecting two existing kitties and spending Ether to run a smart contract. The contract generates a new unique kitty, with all breeding details stored publicly on the blockchain.
Users truly "own" their CryptoKitties, as ownership is recorded on the immutable ledger. They can sell, trade, or purchase these assets without fearing loss due to company shutdowns or account bans. This contrasts with traditional mobile apps where digital items are stored on centralized servers.
In December 2017, coinciding with Bitcoin's all-time high price, users spent over $12 million worth of Ether on CryptoKitties. The most expensive kitty sold for approximately $120,000.
Like Ether, Bitcoin, or valuable art, CryptoKitties derive their worth from what people are willing to pay for them.
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Frequently Asked Questions
What is the main difference between Ethereum and Bitcoin?
Bitcoin is primarily a decentralized digital currency and payment system. Ethereum is a broader platform that supports smart contracts and decentralized applications, using Ether as its native currency for transactions and computational services.
How are smart contracts secured?
Smart contracts are secured through cryptographic principles and the decentralized nature of the blockchain. Once deployed, the code cannot be altered, and execution is automatic and transparent across all network nodes.
Can smart contracts be used for real-world agreements?
Yes, smart contracts can automate various real-world agreements, such as insurance claims, supply chain management, and financial derivatives. However, legal and technical challenges remain regarding integration with existing systems.
What are the costs associated with using smart contracts?
Executing smart contracts requires paying transaction fees in Ether, known as "gas." Costs vary based on the complexity of the computation and network congestion at the time of execution.
Is Ethereum environmentally friendly?
Ethereum currently uses a proof-of-work consensus mechanism, which consumes significant energy. However, its ongoing upgrade to proof-of-stake (Ethereum 2.0) aims to drastically reduce energy consumption and improve scalability.
Can I create my own smart contract?
Yes, if you have programming skills in languages like Solidity, you can write and deploy smart contracts on the Ethereum network. Various development tools and frameworks are available to assist in the process.