What Is Ethereum And How It Works – The Short Version

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Disclaimer: Crypto is a fast-paced economy and things change quickly. Information on this post might be outdated even if written today. Do your own due diligence and stay safe. I might get affiliate commissions for purchases made through links in this post. Read the disclosure.

Ethereum is currently the second biggest crypto asset by market cap. Ethereum however isn’t the second cryptocurrency invented, that place goes to Litecoin (LTC). Ethereum is a decentralized and open-source blockchain with smart contract functionality to pass data inside the network.

Birth Of The Ethereum Blockchain

Ethereum was invented by Vitalik Buterin and the blockchain went live 30th of July 2015. Ethereum is currently the most used blockchain in the world. One of the reasons for that is that developers are able to develop many kinds of dapp’s (decentralized applications) and smart contracts to the platform and for example DeFi’s (UniSwap, SushiSwap) and NFT applications (OpenSea, Rarible, Axie Infinity) through its EVM (Ethereum Virtual Machine).

ETH is used to pay for the processing power of the EVM for you to be able to run smart contracts or dapps on the platform. This is also called gas in the Ethereum network. When the network is in high use, the gas fees get higher and the network starts to get congested (meaning the network will slow down).

EVM is not a cloud, but one single entity maintained by thousands of connected computers running an Ethereum client/software. The computers running this software are called nodes and the nodes are the ones that can verify blocks and transaction data.

When the network gets busy the network becomes unusable and also very expensive, making ETH as a layer 1 solution a bit unusable. Therefore, layer 2 (L2) solutions were invented like Polygon (MATIC), Optimism and Parastate, to boost ETH so that it could be used more efficiently.

Polygon (MATIC) layer 2 scaling solution for the Ethereum network

Polygon for example is an extremely used L2 scaling solution for Ethereum-compatible blockchain networks that enables fast, inexpensive, and secure off-chain transactions for payments and other kinds of interactions with off-chain smart contracts.

Sidenote:

OpenSea for example is one of the platforms that have used and built on Ethereum but is now developing a way to use the Polygon network for a gas-free way to collect, mint, and play with NFT’s. The NFT space is growing rapidly and to keep up with the costs and make sure its user friendly from a monetary perspective, a more efficient solution is needed.

Kind of the same thing that you saw with the Bitcoin and Lightning network. ETH and BTC were some of the first blockchains invented and thus they have somewhat old consensus mechanisms behind them. Something that Ethereum is trying to now fix with ETH 2.0, by bringing the Proof Of Stake mechanism to its blockchain.

ethereum_ecosystem
Ethereum Ecosystem (small part of it)

ETH 2.0

ETH 2.0 concept was developed to make Ethereum more scalable. Currently, Ethereum is growing at a very fast pace and the nodes running the network can’t handle all the activity that is thrown against the nodes. There are roughly 7,000 nodes currently operating the Ethereum network.

In a summary, ETH 2.0 is meant to be a massive improvement to the existing ETH network. ETH 2.0 is not a new blockchain but a set of upgrades currently in progress. The development started already back in 2014 but has made huge steps forward in 2020. It is expected that by 2022 Ethereum will rollout the sharding technique which will complete the ETH 2.0 upgrades.

Proof Of Stake

Proof of stake was the first phase that kicked the ETH 2.0 improvement into gear. Beacon chain that went live in December 2020, introduced the PoS concept that moves away from the mining principle (effective on Bitcoin blockchain) to a staking principle. While you can already stake ETH, it’s not yet fully implemented to the blockchain.

In staking, users store a certain amount of ETH in their crypto wallet (32 tokens are needed minimum to become a full validator) and then use those ETH tokens/coins to validate and forge new ETH tokens.

This process makes ETH blockchain extremely energy efficient as it is not anymore reliant on electricity consumption the same way as Bitcoin. Making Bitcoin look like old technology and an old coin, not worth owning?

Sharding

Sharding is another way to speed up the chain and the processing of transactions. Sharding creates 64 new chains on the Ethereum network and enables database partitioning techniques for further scaling of the blockchain.

The sharding technique also makes the network more secure and sustainable and will eventually allow ordinary users to operate Ethereum on a personal device, increasing network users and thus making the Ethereum blockchain more decentralized than before.

When a blockchain has more users, it means more nodes, and that means more work for hackers to take hold of a large part of the network.

EIP-1559 – ETH burning

Ethereum Improved Protocol (EIP) – Every transaction burns ETH. Making ETH deflationary, less and less ETH available. However, we need to keep in mind that this does not make Ethereum inflation-protected as ETH can be created as much as is needed.

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Written By Juha Ekman

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