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How Ethereum Works

Last updated 25th May 2022
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Ethereum is no doubt one of the most fascinating and revolutionary cryptocurrencies of the last decade. While Bitcoin works in a relatively simple way, performing clear functions and having a conservative and rigid structure, Ethereum aims to do so much more. One way to think of Ethereum is the ying to Bitcoin’s yang; whereas Bitcoin is conservative in nature Ethereum is liberal, creative, and exciting.

One of the main reasons for this is because of how it works. Unlike Bitcoin, Ethereum uses something called smart contracts to execute transactions and on-chain interactions. It is undeniably one of the most critical components that led to the explosion of the blockchain metaverse. And it all started with Ethereum and how this decentralized network works.

With the Ethereum protocol having such a great deal of significance on the crypto space, we have formulated this easy-to-read guide to tell you the core concepts of how Ethereum works. While this network is certainly a very complex ecosystem it is possible to have a grounded understanding of the core pillars of the system that make it what it is.

What Is Ethereum?

Vitalik Buterin

Unlike Bitcoin, Ethereum has a talisman that is responsible for the original conception of the Ethereum network and is largely the leader of the whole project to this day - his significance to the project and cult status in the crypto community cannot be understated.

Originally born in Russia, Vitalik was the child of computer scientist Dmitry Buterin. His family soon moved to Canada to look for a better life and it didn’t take long for Vitalik to excel in mathematics, programming, economics, and cryptography.

By 17 he was thrust into the cryptocurrency having been told about Bitcoin by his father and then founded Bitcoin Magazine in 2011 having been writing for another publication, Bitcoin Weekly, shortly before that. Vitalik was paid 5 Bitcoin for every article (a value today of almost $200,000).

By 2013, aged 19, Vitalik Buterin was traveling around the globe sharing ideas with Bitcoin enthusiasts. He proposed changes to the Bitcoin Network that would allow the complete evolution of blockchain technology, but as often is with the Bitcoin community, it was met with hesitation. It's important to understand one of Bitcoin's core features is its rigidity. This then led to the creation of the Ethereum network as we know it today.

History

Having originally published a white paper proposing Ethereum in 2013 Vitalik began working full time on what would be a network very different from Bitcoin’s. In 2014 the original five founders of Ethereum launched the network: Vitalik Buterin, Charles Hoskinson (founder of Cardano), Gavin Wood (founder of Polkadot), Anthony Di Iorio, and Joseph Lubin.

The drama that surrounds the eventual split of the co-founders is something widely fixated over by the Ethereum community. Essentially, Vitalik wished the project to develop as non-profit but other members of the team, notably Charles Hoskinson, disagreed with this and left to form what are today some of the biggest projects in the space.

Ethereum subsequently launched as a smart contract-based network that would go on to completely open the blockchain and cryptocurrency space up for innovation and cause the subsequent explosion we see today.

What Is the Ethereum Network?

The Ethereum Network is a decentralized blockchain network that:

  • Has smart contracts as its foundations

  • Stores all transaction and smart contract history on its blockchain

  • Confirms transactions and issues new tokens into the supply through mining

  • Uses the Proof-of-Work consensus mechanism

  • Runs using the native currency: Ether

Purpose

Ethereum has many use-cases, with new ideas being developed every day, but here are the main purposes of the network:

  • A place for developers and entrepreneurs to build and develop new decentralized applications

  • To enable the development of smart contracts

  • A decentralized system without any third-party control, fraud, or malfunction

How Does Ethereum Work?

Understanding exactly how this system works is complex, but here we have laid out the core concepts that make it what it is to illustrate how Ethereum works.

Proof-of-Work

The blockchain consensus mechanism for Bitcoin and Ethereum. Requires miners to solve complex mathematical problems with extensive levels of computing power to verify transactions on the network and in turn earns miners rewards.

  • Very energy consuming

  • Requires specialist hardware

  • Mining is ongoing and indefinite in order to solve problems and verify blocks

Smart Contracts

Smart contracts are a relatively simple concept. They represent a transaction or agreement being made automatically, in a trusted fashion, and without the need for any third party. The use-cases for this are somewhat obvious - how many business deals could be streamlined and simplified when you don’t require a middle man to be a trusted party?

Ethereum was the first blockchain network to innovate and implement smart contracts. This innovated a completely new stream of use-cases for blockchain technology and led to an explosion of other blockchain networks.

Most critically, it also created a platform to be built on top of. Now activity could be undertaken on top of the Ethereum network, including building decentralized apps (dApps), decentralized finance (DeFi), initial coin offerings (ICOs), GameFi, and Non-fungible tokens (NFTs). All of these exciting new technologies started with the conception of the Ethereum Network.

Mining

There are two core concepts to understand about the nature and functions of mining that both hold incredible value to the wider system.

These two facets are:

  1. The process of new Ethereum entering the overall supply via rewards for work.

When users send transactions to one another they are entered into an unconfirmed transactions pool to be sorted and verified by the network’s miners. This verification process is called mining and essentially consists of computers solving complex mathematical equations. You need a lot of computer power to complete these problems so miners are required to have special hardware to do so.

  1. The process in which transactions become confirmed.

Essentially, once a problem is solved it means a block has been created. A block represents a collection of verified and confirmed transactions that give the network security of trade.

Once a miner successfully creates a block they are rewarded with Ether and the overall market supply is slightly increased.

This is much the same as how Bitcoin mining currently works but development is underway to completely change this.

Ethereum 2.0

Above we have described how Ethereum currently works, but this is quite different from how the Ethereum team wants it to work. Ethereum 2.0 is the long-anticipated update that will see a complete revolution in the way this system currently operates.

We have laid out some of the most important things for you to know:

Proof-of-Stake

Firstly, the Ethereum network will attempt to completely change its consensus model from Proof-of-Work to Proof-of-Stake.

Proof-Of-Stake is supposedly the future of blockchain consensus mechanisms. The Ethereum network has been working on transitioning from PoW to PoS for some time now but it is seemingly a stark challenge to actually implement. PoS does not require intensive energy consumption or computing power but instead a volume of the token native to the blockchain - for example on the Ethereum network this would be ETH.

In this system, there are no miners but validators. Validators are paid with all or part of the transaction fees that reside within the block they have validated. Validators are selected for the most part on how much ETH they hold. When they hold a certain amount they may apply to be a validator and begin to earn rewards for their services.

  • Requires 99.95% less energy than Proof-Of-Work

  • Validators are chosen based on their token holdings

  • No specialized hardware

  • Doesn’t require ongoing and indefinite work

The Future of Blockchain Networks

Many believe the transition Ethereum is trying to make is the future of blockchain technology. The reasons for this are:

  • Sustainability - PoS is drastically more resource sustainable than its PoW competitor.

  • Speed - PoS could also drastically improve the speed and throughput a network can provide which would make life better for users and developers building on the Ethereum network.

  • Cost - Costs, known as gas fees, would also be dramatically reduced for users and developers if using a PoS model.

Simply put, there’s not much PoS can’t do better, perhaps its only weakness is arguably security.

Final Thoughts

Ethereum did nothing less than open the door for the innovation of blockchain-based projects. Its smart contract-based network has led to the development of DeFi, dApps, NFTs, and ICOs that fuel the cryptocurrency/blockchain market. It really gave a place for people to begin building on top of and forged the path that the rest of the Alt community would follow.

It currently operates using the Proof-of-Work consensus mechanism but looks to change this and fold Ethereum into Ethereum 2.0, a Proof-of-Stake consensus mechanism. This would reduce costs and increase speeds for users and developers, while also solving the problem of PoW resource consumption which is widely documented in the mainstream media.

How Ethereum works hold answers to the questions of the future of blockchain technology and are best described as an evolving system looking to promote development and interoperability cross-chain. It is a complex and intricate system designed by perhaps one of the best minds we have seen in the 21st century, Vitalik Buterin.

FAQs

Does Ethereum use the Proof-Of-Stake consensus mechanism?
Is Proof-Of-Work more secure than Proof-Of-Stake?
What Is Ethereum?
Joshua Sherrard-Bewhay

Joshua Sherrard-Bewhay

Josh is a finance and Blockchain technical writer with experience in project design, consultancy and reporting. He is well-versed in white paper design, blog construction and freelance journalism. His academic credentials are in International Relations, Environmental Regulation and International Law. In his spare time he works as a sustainability analyst for a FinTech start-up Oxari and a private English tutor.