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What is Ethereum?

In the previous article, we introduced you to the largest and most well-known cryptocurrency Bitcoin. In this article, we will take a look at his “partner in crime”, which is the second-largest cryptocurrency. How does Ethereum work?

What is Ethereum?

Ethereum, like bitcoin, is a cryptocurrency based on a decentralized database that stores and protects an ever-increasing number of records. In computer science, this special database type is referred to by the English word blockchain. At the same time, however, it is a decentralized virtual machine for running so-called "smart contracts".

“For Bitcoin, Blockchain is the same as the Internet for email - a large electronic system on which you can build applications. Cryptocurrency is just one of those apps” Sally Davies

The Russian-Canadian programmer and cryptocurrency developer, Vitalik Buterin, is the one responsible for creating Ethereum. He also took part in the early adoption of Bitcoin. However, rather than creating a new cryptocurrency, developers wanted to create a shared computing platform that allows them to use blockchain to run decentralized applications.

The entire development was financed by crowdfunding with almost 18 million euros collected. The Ethereum network was subsequently launched on July 30, 2015, approximately two years after the whole concept behind Ethereum had been introduced. By its nature, Ethereum belongs to the category of cryptocurrencies of the second generation. These are often referred to as Bitcoin 2.0.

Ethereum - ideal environment for smart contracts

The primary purpose behind Ethereum’s inception is to improve intelligent contracts and extend them to a wide range of practices, where they could replace and in a way decentralize, for example, all classic contracts and agreements. Their functioning is absolutely essential for the operation of the entire network, and this is why Ethereum differs significantly from bitcoin.

By definition, a smart contract is any protocol or software that secures, verifies, or enforces the agreement or conclusion of a contract . While a standard contract describes the terms of a relationship (usually enforceable by law), smart contracts enforce these terms using a cryptographic code.

Bitcoin was the first technology to support basic smart contracts in the sense that the network can transfer something valuable from one person to another. The entire network of nodes confirms and approves the transaction only if all specified conditions are met. However, Bitcoin is exclusively limited to currency only. In contrast, Ethereum has replaced the very limited Bitcoin scripting language (which contains only about 100 scripts) with a language that allows developers to write their own programs, and consequently also intelligent contracts.

Different functions of Ethereum blockchain Figure 1: Smart Contracts scheme

Smart contracts are actually programs that act according to their inventors’ bidding. This could be helping you to exchange money, property, stocks, or simply anything valuable in a transparent and non-conflicting process. All this in a way that avoids contact with third parties (lawyer, notary). A very popular example of how to explain smart contracts is comparing them to a digital vending machine. Computer scientist and cryptologist, Nick Szabo, described how users can enter data or something valuable into a vending machine and then get a final item from the same machine (for example a drink or a house).

Ether serves as a fuel for the Ethereum network

Each action sequence in the Ethereum network costs a certain amount of "fuel", which is based on the required computing power and overall duration of the sequence. Instead of functioning as a classic virtual currency, ether is used as the digital fuel of the entire network.

Ethereum Fuel station Figure 2: Ether could be perceived as a "fuel" in the Ethereum blockchain

At the instigation of smart contract administrators, miners request a certain action to take place (change, deletion, modification of the program). For this, they are rewarded in ethers. For example, a normal transaction costs 500 units of fuel. This amount is then converted to ethers and the resulting amount acts as a transaction fee, similar to bitcoins.

Difference between Bitcoin and Ethereum

As already mentioned, Bitcoin and Ethereum are networks based on a public and decentralized blockchain database. Although there are significant technical differences between these networks, the most significant one is the fact that Bitcoin and Ethereum are completely different regarding their purpose and capabilities . While Bitcoin’s blockchain is used to track transactions with Bitcoin virtual currency, Ethereum’s blockchain focuses on running the source code of any decentralized application (smart contracts).

Bitcoin versus Ethereum Figure 3: There are many key differences between Bitcoin and Ethereum

Another difference is the average time to extract one block. It takes about 10 minutes to complete it in the Bitcoin database, while in the case of Ether it is only 12 seconds. As a result, transaction confirmation is faster . Ether does not have to solve the same scaling problems that have long accompanied Bitcoin. More than two-thirds of all bitcoins have already been mined, and most of them are now owned by the first bitcoin miners. On the contrary, Ethereum has decided to offer the first Ethers in advance, and presumably by 2020 half of all Ethers will be mined.

Ethereum Hard Fork - not only Bitcoin was divided into two branches

Practically from the day of its creation, Ethereum attracted a lot of attention. The turning point came in 2016 when the DAO (Distributed Autonomous Organization) was established. The goal of DAO was to provide a decentralized business model to commercial as well as non-profit companies through intelligent contracts on the Ethereum network. In less than a month, $ 150 million was raised for this ambitious project. The problem came a month later when hackers took this organization by storm, resulting in $ 50 million worth of Ether in losses.

Jakub is a crypto trader and founder of Trader 2.0 project, which helps hundreds of traders from central Europe to understand cryptocurrency trading and its challenges. Jakub not o...

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