How does Ethereum work?

Ethereum is a blockchain on which anyone can build blockchain applications. Ether (ETH), however, is the name of the cryptocurrency that facilitates many functionalities on the Ethereum platform. Ether is the second largest cryptocurrency worldwide based on market capitalisation. Ethereum was originally conceived by then 19-year-old Vitalik Buterin and has opened the door to many new applications of blockchain using smart contracts. In this article, we delve deeper into Ethereum and how it distinguishes itself from Bitcoin.

Proof-of-Stake

The Ethereum network reaches consensus through the Proof-of-Stake (PoS) algorithm. Until September 15, 2022, Ethereum was using Proof-of-Work (PoW) just like Bitcoin. The decision to switch consensus protocols was made because of the high energy usage of Proof-of-Work and to improve the scalability of the platform.

Proof-of-Stake (PoS) is a consensus algorithm where the chance to add the next block to the blockchain and earn transaction fees depends on the amount of cryptocurrency (in this case, Ether) a person owns and has 'staked'. The more you stake, the greater the chance you are chosen. This process is called staking and it encourages participants to follow the network's rules as they can lose their stake if they act dishonestly.

Ether and Gas

Ether acts as the fuel of Ethereum. It is the name of the cryptocurrency that enables the Ethereum blockchain. Ethereum is therefore often used as a common name for the cryptocurrency, even though technically it is not the same.

To perform transactions or actions on the Ethereum blockchain, you have to pay a small amount of Ether. These transaction costs are therefore also called gas. These transaction fees are then used to pay the stakers for maintaining and securing the network. Without this income, stakers would have little reason to contribute to the security and stability of the network.

A multi-functional blockchain

Ethereum is a platform where anyone can run applications, which are then executed in a decentralised manner. This can be used for a wide range of applications, including wallets, tokens, and decentralised exchanges. Indispensable for this are smart contracts: digital agreements on the blockchain that can automatically execute actions when certain conditions are met.

ERC-20 Tokens

Smart contracts can be used to create new tokens using the ERC-20 standard. Tokens are often also considered cryptocurrencies, but they do not have their own blockchain. Instead, the logic for transactions and balances is recorded in these smart contracts, meaning ERC-20 tokens rely on Ethereum as the underlying blockchain. Well-known examples include Chainlink and Polygon, as well as stable coins such as USDT and USDC.

dApps

Decentralised applications, also known as dApps, are one of the key innovations that Ethereum enables. These applications run on the Ethereum blockchain and are not managed by a single entity, meaning they are completely transparent and immutable. dApps use smart contracts to manage transactions and can be used for many purposes, including decentralised exchanges, games, and even decentralised finance (DeFi).

NFT’s

NFT's, or Non-Fungible Tokens, are another important aspect of Ethereum. Unlike cryptocurrencies like Ether or Bitcoin, which are interchangeable and can be freely exchanged on a one-to-one basis, NFTs are unique and cannot be exchanged on an equivalent basis. This makes them ideal for recording proof of ownership on the blockchain, making the history of this proof of ownership transparent and unchangeable.

Conclusion

In conclusion, Ethereum is much more than just a cryptocurrency. It is a multifunctional platform that enables a wide range of applications through the innovative use of smart contracts and the Proof-of-Stake consensus algorithm. From creating unique tokens to facilitating dApps, Ethereum continues to be a pioneer in the field and opens the door to countless possibilities in blockchain technology.

The information provided in our articles is intended solely for general informational purposes and does not constitute (financial) advice.