2021-03-20 13:30:00

What Is Ethereum and How Does It Work?

Ethereum continues to grab the attention of the masses. As cryptocurrency awareness increases, more people are getting active on the Ethereum blockchain, a decentralized application ecosystem.

So, what is Ethereum, and how does it work?

What Is Ethereum?

Ethereum is a blockchain network that makes it possible to use decentralized applications and cryptocurrencies on the same blockchain. Ethereum is often described as one of the key components of Web 3.0.

Ethereum was founded by Russian-Canadian programmer and writer Vitalik Buterin in 2013. In the Ethereum whitepaper, Buterin described the need for Bitcoin to have a scripting language to develop applications. He went on to raise funds to work on developing Ethereum.

The team behind Ethereum uses several key concepts to create and maintain the Ethereum blockchain.

Ethereum Components

  • P2P network: A P2P network comprises two or more connected computers that share resources. Ethereum runs on a set of network protocols that are known as devp2p.
  • Ethereum Virtual Machine: The Ethereum Virtual Machine (EVM) processes Ethereum transactions by executing machine-language instructions known as bytecode. Programming languages such as Solidity are used to create smart contracts that give instructions to the EVM.
  • Client and node: An Ethereum client is any node that is used to verify the blockchain. Geth is a type of node that acts as a gateway into the Ethereum network. It provides access to the main, test, and private networks.
  • Consensus algorithm: Consensus algorithms are sets of rules used to validate transactions on the blockchain and determine how nodes agree on the state of information stored on the blockchain. Proof of Work (PoW) and Proof of Stake (PoS) are popular consensus algorithms used on Ethereum.

You may be wondering how the different components of Ethereum work together to create the decentralized application ecosystem that we know today. Read on to find out how the Ethereum ecosystem works.

How Does Ethereum Work

Some of the most important concepts used to make Ethereum are based on economics, cryptography, and smart contracts.

Ethereum depends on various systems, including a governance protocol and automation on the blockchain made possible by smart contracts. The immutable nature of smart contracts means that the input of data on the blockchain cannot be changed or easily tampered with.

Decentralized Applications on Ethereum

Decentralized applications are bridges between the real world and the blockchain. Many decentralized applications function in very similar ways to regular apps, except that data flow and interactions are based on blockchain states. As new data is added to the blockchain, it becomes permanent.

Related: What Is a Blockchain and How Does It Work?

Normal web applications are accessed through browsers. They return information to the web pages by retrieving information from servers. Unlike centralized web applications, decentralized applications ensure that no one can change the code or steal funds from the website.

The Ethereum blockchain is like a worldwide computer with data stored in bundles of distributed ledgers. The bundles of data hold information about the history of all transactions on the network. The use of smart contracts on Ethereum makes it possible to automate the creation and maintenance of tamper-proof transactions on web applications.

Smart Contracts

Smart contracts are used to enable the storage and transfer of data in decentralized applications. A smart contract automatically executes the terms of an agreement once its criteria are fulfilled.

Smart contracts can automate traditional finance processes. In the earlier days of Ethereum, initial coin offerings (ICOs) were all the rage as people used smart contracts to raise funding for their ventures. Now, decentralized finance platforms have been made using higher standards for smart contract implementation.

Using Tokens on Ethereum

Different types of native tokens are used on the Ethereum network. Multiple types of standards are used to develop the tokens, but ERC-20 is the most commonly used.

Thousands of projects use the ERC-20 standard to create their tokens. An ERC-20 token has six functions that make it easier to create than other types of tokens on the Ethereum blockchain.

The functions describe how tokens can be transferred and how to access the data related to tokens. The functions include balanceOf, totalSupply, transfer, transferFrom, approve, and allowance.

The totalSupply function helps calculate the total amount of tokens in circulation, while the balanceOf function stores the balance of an address. A smart contract requires these values to execute operations that depend on the amount of money in circulation or held by users on the Ethereum blockchain. The approve function may be equally important for withdrawing amounts from addresses.

A specified amount of tokens may be transferred from an address by using the transfer function. The transferFrom function is used to take the extra step of automating transfers from your address without your intervention. Transfers between addresses can be limited by an allowance function which shows how much can be spent by an address from another address.

ERC-721 token standards are used to create non-fungible tokens. Non-fungible tokens, like cryptocurrencies, can keep immutable records of transactions on the blockchain. However, there are differences in interchangeability. Each NFT token is unique and irreplaceable, unlike cryptocurrencies.

Verifying Transactions and Maintaining Data with Nodes

A node, also known as a client, helps maintain data accuracy on the network and keep it secure. A network of nodes operates according to a unique set of rules determining the blockchain’s key operations.

The different nodes on Ethereum hold copies of the blockchain network. The volume of copies of the network makes it impossible for corporations, governments, or any bad actors to compromise the network.

Executing Transactions with Gas

Ethereum uses unique rules to incentivize miners to power transactions over the network. Gas is paid to miners by users of Ethereum for transactions they carry out on the network. The fees help secure the network, providing rewards to miners to solve complex algorithms to validate transactions on the blockchain network.

Related: Why Your Crypto Coin Is Not as Secure as You Think

Upgrading the Blockchain with Hard Forks

A hard fork is an update to a blockchain network that leads to the creation of a new version of the blockchain. Each version of the software has its unique codebase and features. Hard forks significantly impact the operational effectiveness of blockchains. The holders of tokens in the original blockchain usually receive tokens in the new fork.

One of the earliest examples of an Ethereum hard fork was caused by a decision to reverse the hack of an application on the Ethereum blockchain. Opposition arose as team members disagreed on the ethical grounds for a reversal of funds that were believed to go against blockchain technology’s fundamental principles.

Upgrades to the Ethereum blockchain require stakeholders in the network to make changes to their software or hardware.

Introducing Ethereum 2.0

The Ethereum 2.0 upgrade promises to make the network more scalable with up to 100,000 transactions per second, a huge improvement from 30 transactions per second of Ethereum 1.0. Buterin proposes the use of sharding technology to split different transactions into randomly selected groups of computers. This helps the blockchain handle more operations at a time.

Some miners have criticized the new upgrade due to fears that it could reduce the number of fees they can make money from. The new fee-reduction strategy has been criticized by two of the largest Ethereum miners and some of the largest mining pools.

Ethereum 2.0 requires at least 16,384 validators. This amount of validators makes the network more decentralized, which improves the resistance capabilities of the network.

An Evolving Ecosystem

Ethereum is an ecosystem of innovation for decentralized applications.

From ICOs to NFTs, new ways of digitizing goods and services have been created using both old and new technologies. If it is to meet expectations as a global, decentralized platform for money and new types of applications, many more updates will need to be made to improve the user experience of the open-source software.

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