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How Does Ethereum Work?

Since its release, Bitcoin has been the leading cryptocurrency in terms of value and market cap. However, of all the other cryptocurrencies, Ethereum has kept the pace as the best alternative. Ethereum has kept its place as the second most valuable digital currency with a massive market and user base.

The success of Ethereum both as a cryptocurrency and a programmable currency has led it to attract various big names in the financial industry. It’s thus important that you understand everything about the crypto project and how to use it.

Here is all you need to know about the distinctive features and real-life applications.

What is Ethereum?

Ethereum is a blockchain-based cryptocurrency and computing platform that allows developers to create and implement decentralised applications (dApps). For the longest time, application developers relied on centralised platforms like the Play Store and App Store to develop and deploy their applications. These platforms, however, come with challenges like limited control and earning abilities. That is where Ethereum comes in. It allows the specific application participants full decision-making authority.

Ethereum was created in 2013 by Vitalik Buterin. The developer, who was 19 at the time, had an idea of expanding the blockchain technology behind Bitcoin. He was looking to make it applicable in various options more than just for transactions.

While Ethereum has several similarities with Bitcoin in terms of development based on blockchain technology, it comes with massive use cases, way beyond money.

How Does Ethereum Work?

To understand how Ethereum works, you need to detail the various aspects of the crypto project. Some of its main components are;

  • Ether – Ethereum’s cryptocurrency
  • Smart contracts – rules governing the interactions within the Ethereum network.
  • Ethereum Virtual Machine (EVM) – the part of the network that applies the Ethereum rules. It provides the underlying technology that supports smart contracts and allows you to use them.
  • Decentralised applications – the consolidated applications created on the Ethereum platform.
  • Decentralised Autonomous Organisation (DAO) – the democratic decision-making functionalities of the Ethereum blockchain.

By looking at these Ethereum features in detail, you will understand how Ethereum works. Let’s get to it.

1. Ether

Ether (ETH) is the Ethereum platform’s native token. Running smart contracts and other aspects in the Ethereum network require money, which comes in the form of Ether. It is used to pay for the transaction fees and the computational resources used in the network. You can also use it in executing smart contracts. However, at this point, it is called “gas”.

Ether can be used for various functions like making regular peer-to-peer transactions, building smart contracts, and building decentralised applications.

2. Smart contracts

Smart contracts are the revolutionary Ethereum network concept. It is impacting how transactions occur among various parties.

 A smart contract is a set of guidelines that determines the conditions under which assets move between two parties. The system works such that any exchange will only happen if certain conditions are met, thus negating the need for trust between the parties involved or to look for an intermediary. The asset in this case can be anything from shares, property, money to any other digital product.

 Both parties involved in a transaction agree to a set of terms and conditions under which a transaction can take place. Ethereum allows anyone participating in the network to create smart contracts. After which, once a transaction is launched you can alter, cancel or introduce another transaction on top of the existing one.

 Ethereum looks to expand smart contracts by supporting more than just simple transactions. It allows users to introduce additional terms and rules of ownership for an agreement to take place. For example, a network user can offer decentralised financial services at specific conditions like repayment plans or the use of the money.

 The flexibility of the smart contracts on the Ethereum network has led to concerns about the possibility of security vulnerabilities. However, all transactions happen transparently for both parties’ security.

3. Ethereum Virtual Machine (EVM)

EVM is what executes smart contracts in the Ethereum network. To deploy a smart contract, the creators write the agreement in human-readable language. However, this language is not understandable to the computer. It’s EVM that translates it into a byte code that the computer understands.

EVM can translate all coding languages into a byte code that the computer understands. For example, the Ethereum network uses Solidity language to create a smart contract. The EVN then translates it to byte code for execution.

The EVN works by confirming transactions in the network through a proof-of-work consensus algorithm. Ethereum mining operates almost similarly to Bitcoin mining. The Ethereum network has a wide range of nodes that access the entire blockchain for the records of transactions. The miner validates transactions before they become part of the blockchain. They in turn get rewarded for every successfully added block in the form of ETH and transaction fee from the various transactions verified.

The proof-of-work has had various challenges like costly resources used in mining. As such, Ethereum is looking for proof-of-stake as an alternative. So, how will Ethereum proof of stake work? It involves nodes approving transactions based on the ETH tokens they hold in their accounts. An account holding more tokens has a higher chance of mining the block.

4. Decentralised applications

Ethereum is transforming how applications run. The existing applications work such that anytime you log in, it deploys an API to access your data from a centralised database. However, for the Dapps, when you access the application, it uses a smart contract to fetch your information from a blockchain network.

The blockchain is a decentralised network that allows all participants access to all the actions in the network. The Ethereum network provides for every Dapp a backing code that allows it to run on a distributed peer-to-peer network. As such, any issue or glitches that occur on a single Dapp does not affect the other platform users.

5. Decentralised Autonomous Organisations (DAO)

Most of the current organisations run based on decisions by select leadership. The Ethereum network, however, introduces decentralised decision-making. Instead of decisions by a single person impacting the whole organisation, the DAO lets decision-making be a broad endeavour for various entities within the organisation.

DAO provides for a voting system in the blockchain for various organisational decisions. The voting rights depend on the number of tokens one has on their accounts.

Real-World Ethereum Use Cases

Ethereum has a wide range of real-world use cases like;

Digital Identity

The world has relied on the same identification protocols for years. People are always required to move around with passports for identity. This can be an issue due to loss or theft as it takes time to renew, and it can also lead to identity theft.

Ethereum looks to impact identification by enhancing data verification. The network’s open and transparent data verification can be used in creating digital identification systems.

Banking systems

The banking system is another sector that can gain from the secure nature of Ethereum. It protects against hacking as all transactions in the Ethereum network must be approved by the nodes. Banks can also use the platform as a payment method.

Payments

The world economy runs on transactions. People all the time exchange products, services for money, or other products and services. Ethereum intends to revolutionise how payments operate through smart contracts.

The smart contracts eliminate the risk of either part not honouring their end of the agreement. It ensures transactions go through when the laid guidelines are met. This enhances more trust and secure payment systems.

Voting systems

Ethereum network can be the needed solution to transparency in voting systems. Like with the DAO, the network provides an elaborate platform with voting rights. Various entities can use it to conduct polls with transparent results. Using the blockchain network voting system eliminates any possibility of voting malpractices.

Storing data

Cloud storage like Microsoft and Dropbox are some of the most popular storage options. They operate server farms that contain multiple servers located in a single location. The central location means higher risk in case of breach of security.

The blockchain network looks to improve storage by decentralising the servers. It provides for multiple servers spread all over the world.

FAQs

What is the future of Ethereum?

Ethereum is in a growth process. Its developers are looking for ways to alleviate the existing challenges on scalability and secret storage. As a developing network, the Ethereum platform is looking to try out various use cases, like the massive storage capabilities.

What is Ethereum 2.0?

Ethereum 2.0 is an upgrade of the existing Ethereum network to improve the network’s scalability and security. The major shift of the network is on mining. Unlike the current proof-of-work algorithm consensus, the ETH 2.O will rely on proof-of-stake for mining.

What is an ERC20 token?

An ERC20 is a digital currency that operates similarly to other cryptocurrencies. However, while the other cryptocurrencies are the native tokens of their projects, ERC20 is created and hosted on the Ethereum network. USDC, Aave and Uniswap are popular ERC20 tokens that can be purchased on exchanges such as Coinspot.

ERC20 operates using Ethereum addresses and uses gas for transaction fees.

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