Chapter 6: Understanding Ethereum

While Bitcoin introduced the world to the concept of decentralized digital currencies, Ethereum took this concept and expanded upon it. Created by a team led by a then-19-year-old Vitalik Buterin, Ethereum aimed to be more than just a cryptocurrency. The vision was to build a decentralized platform that could run applications exactly as programmed without any chance of fraud, censorship, or third-party interference.

Ethereum cryptocurrencies and background graph statistics

Launched in 2015, Ethereum’s native cryptocurrency, Ether (ETH), is used to power these applications, but Ethereum itself is much more than a medium for digital transactions. The Ethereum blockchain is often referred to as a “world computer,” with its ability to execute scripts using an international network of public nodes. This marks a significant departure from the primary purpose of the Bitcoin blockchain, which is to track ownership of its cryptocurrency (bitcoin).

Ethereum’s broader utility lies in its ability to automate agreements and facilitate decentralized applications through smart contracts, which we’ll discuss in greater detail in the following sections. Its technology has paved the way for a flurry of new cryptocurrencies, many of which have been initiated using the Ethereum platform via Initial Coin Offerings (ICOs). It has opened the doors to decentralized finance (DeFi), NFTs (Non-fungible tokens), and more, effectively revolutionizing various industries.

Understanding Ethereum and its implications requires a deeper dive into its central mechanism – smart contracts. They are the backbone of Ethereum’s functionality and the factor that distinguishes it as more than just another cryptocurrency. In the following sections, we’ll dissect what smart contracts are and explore their role in creating a new paradigm of decentralized applications (dApps).

Smart Contracts

Smart contracts, at their most basic, are self-executing contracts where the terms of the agreement are directly written into lines of code. They are called ‘smart’ because they carry out and enforce these terms automatically without needing a third party, like a lawyer or a bank. If certain conditions encoded in the contract are met, then certain actions are automatically carried out.

Let’s take a simple example. Imagine Alice wants to rent Bob’s apartment. In the traditional way, they would need to sign a contract, and Alice would give Bob a security deposit. Bob holds onto the deposit and returns it when Alice leaves, assuming no damage to the apartment. However, there are risks. What if Bob refuses to give back the deposit? Or what if Alice causes damage but disputes it?

A smart contract could handle this process much more fairly and transparently. Alice and Bob would agree to the terms: the rent amount, the conditions under which the deposit is retained, etc. These terms are coded into a smart contract on the Ethereum blockchain. Alice sends her deposit to the smart contract. Now, neither Alice nor Bob has control of the deposit. Instead, the contract itself controls the deposit. If Alice fulfills the terms (for example, leaving the apartment without any damage), the contract automatically sends the deposit back to Alice. If not, the contract sends it to Bob. Since everything is encoded into the contract and the Ethereum blockchain is transparent, there’s no dispute about what the terms were or whether they were met.

But that’s a simple example. Smart contracts can be programmed to perform complex functions, and several smart contracts can work together, forming a so-called “Decentralized App,” or dApp, which operates completely on the blockchain. Ethereum’s smart contracts have allowed the creation of decentralized exchanges, lending platforms, prediction markets, and much more, which we will explore in the following section.

Ethereum as a Platform for dApps

As mentioned before, Ethereum is not just a cryptocurrency; it’s a whole platform that enables the development of dApps, or decentralized applications. These are applications that run on the Ethereum blockchain, using smart contracts to perform their functions.

One major advantage of dApps over traditional apps is that they are decentralized, meaning they are not owned or controlled by a single entity. Instead, control is distributed among the users of the dApp. This can increase transparency and reduce the risk of censorship or manipulation.

For instance, consider a hypothetical dApp for a decentralized version of Airbnb, let’s call it “dAirbnb.” In this platform, anyone can offer their homes for rent and anyone can book them. All these transactions are handled by smart contracts on the Ethereum blockchain, which means no central authority like a company has control. If a user meets the conditions to rent a home (like paying the agreed amount), the smart contract automatically processes the transaction. If a dispute arises, it could be handled by the smart contract or by a consensus mechanism within the dApp’s user community.

Ethereum’s platform has given birth to a wide variety of dApps. Decentralized finance (DeFi) apps, for instance, allow people to borrow, lend, and earn interest on cryptocurrencies. Games have been developed where assets like characters and items exist as tokens on the Ethereum blockchain, giving them provable ownership and scarcity.

But while Ethereum has made many advances in the blockchain space, it’s not without its challenges. The network has faced issues with scaling and high transaction fees, which have led to efforts for upgrades and also to the development of competing blockchains. Still, Ethereum remains one of the most important and influential projects in the cryptocurrency world.

In the next chapter, we’ll take a look at some other significant cryptocurrencies and how they differ from or build upon the ideas of Bitcoin and Ethereum.