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Ethereum is currently the second largest crypto asset by market capitalisation at around $425 billion.
This remains a long way behind bitcoin’s total value of around $1.3 trillion, as of March 2024. It is much earlier in its story than bitcoin though, having arrived six years later.
Although Ethereum is similar in that it is a blockchain with a native token, or ‘currency’, it has major differences with bitcoin. Its proponents believe it has advantages that mean it could take the number one spot in the future.
In this article we cover:
- What is Ethereum?
- What are smart contracts?
- In what ways is Ethereum different to bitcoin?
- How will Ethereum develop in the future?
What is Ethereum?
Ethereum was created by a group of software developers headed-up by Russian-Canadian Vitalik Buterin (pictured). Work began in 2013, and it was launched in July 2015.
Buterin was an early supporter of bitcoin, and the creation of Ethereum was in large part inspired by it.
Ethereum is a blockchain that hosts a decentralised, Turing-complete global computer called the Ethereum Virtual Machine (EVM). Through utilising the distributed power of thousands of computers, decentralised applications based on smart contracts (Dapps) can be run.
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To run an application on Ethereum a user must pay a ‘gas’ fee in the blockchain’s native currency Ether. Investors cannot actually buy ‘Ethereum’, it is ether that is bought. The two terms are often used interchangeably though.
What are smart contracts?
Smart contracts are pieces of computer code written in a language called Solidity. As with a normal contract they contain a range of terms that relate inputs to outputs. In other words, if A and B occur, C is the result.
The difference is that they are autonomous and self-executing, which is where the ‘smart’ designation comes from. They do not rely on a human to honour a deal as the outcomes from given inputs are predetermined in locked computer code.
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There are two main uses of Ethereum smart contracts; decentralised finance applications known more commonly as ‘DeFi’, and non-fungible tokens (NFTs). Blockchain-based gaming in the metaverse is another use case that is gaining ground.
DeFi
DeFi is a collection of blockchain-based protocols for trading crypto assets, lending or borrowing money, and various other forms of speculation.
There are also dapps that enable complex financial transactions such as trading on-chain futures, options and other derivatives.
The grand vision for DeFi is for anything done in the traditional financial services industry will have a decentralised, blockchain based equivalent. That remains some way off, but rapid progress towards this is being made.
NFTs
The second of the big two uses for Ethereum is NFTs. These are unique digital identities that can be permanently tied to a particular piece of digital content. This is typically a piece of art of some kind, but anything that can be digitised can be made into an NFT.
The digital item in question can then be traded in a transparent and traceable way, which makes producing counterfeits undetected harder.
Read more: What are NFTs
Gaming
Blockchain based gaming is in its infancy, but it is an area in which high hopes are being pinned by some.
Blockchains can facilitate a form of gaming where collecting items and developing characters in a permanent and purportedly un-hackable way is paramount.
It can also facilitate metaverse-based virtual worlds, which persist on the blockchain whether an individual is playing the particular game or not.
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In what ways is Ethereum different to bitcoin?
The principle difference between the two is the smart contract functionality and all that entails, as described above.
While there are technological options for running smart contracts on the bitcoin blockchain, this has not gained significant adoption.
One other fundamental difference is that ether can be staked and in doing so produce a yield.A criticism often levelled at bitcoin is that it is not a ‘productive asset’ as it offers no income stream from owning it.
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In the case of ether, investors can potentially receive a yield in ether itself, which comes from fees paid by users of the blockchain and a ‘block reward’ of newly issued ether paid to stakers. The yield on ether fluctuates, but in the past has generally been between 3% and 5% per annum.
How will Ethereum develop in the future?
Recently Ethereum made a fundamental change, moving from a proof of work blockchain to a proof of stake one.
Proof of work is how bitcoin operates. It involves using huge amounts of computing power to verify the blocks on the chain through sheer weight of computation. The well-known critique of this, is that it consumes a large amount of electricity and requires expensive, specialised equipment to take part.
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Ethereum used to operate like this too, but in September 2022 it transitioned to Ethereum 2.0 and became a proof of stake chain. Without getting into the technical complexities, this refers to verifying a blockchain using software that requires a fraction of the power of proof of work.
Any moderately powerful laptop or desktop computer can join a proof of stake network, provided the owner has a minimum amount of the blockchain’s native currency to ‘stake.’
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In the case of Ethereum the required amount is 32 ether. The stake functions as a form of guarantee that investors will verify the blockchain correctly and not try to sabotage or falsify the blocks. Doing so would result in the stake being cut or taken completely.
Layer 2’s
The main aspect in which Ethereum is still being developed is scaling. This refers to increasing the capacity of the blockchain to enable more activity to take place at lower gas cost to users.
At present, the main way this is being achieved is via ‘Layer 2’ blockchains. These are blockchains which process transactions separately from the main layer of Ethereum, then collate them, before checking back in to verify everything on the main chain.
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Two of the more talked about up and coming Layer 2 chains are Optimism and Arbitrum. Both have their own native tokens.
Sharding
Some way into the future, the hope is that sharding will further expand capacity and lower cost. This refers to splitting the main Ethereum chain into multiple ‘shards’ which process transactions separately, then periodically confirm they are logging everything correctly with the base chain.
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