What is Ethereum?

Mar 27, 2020

Since its birth in 2015, Ethereum has been focused on one core principle: decentralization.

This vision holds that a new kind of internet can make it possible to transfer value independent of 3rd-parties and eliminate the weaknesses and security risks of centralized data storage and applications.

Ethereum’s native cryptocurrency, Ether (ETH), which helps power the Ethereum blockchain and keep it secure, has risen in value to become the second-largest cryptocurrency by market capitalization.

To understand the power of Ethereum and the promise of decentralization that it seeks to attain, it helps to take a closer look at what it is and how its innovations, including smart contracts, can potentially change many aspects of the world we live in.

The Beginnings of Ethereum

After the birth of Bitcoin, developers in the crypto space made many attempts to extend the possibilities of the Bitcoin blockchain for other use cases beyond peer-to-peer payments and finance.

One such developer was Vitalik Buterin. He and others like him were focused on the possibilities of using a blockchain with more flexibility to enable scripts and programs to run and eventually power applications what would leverage the decentralization of the blockchain in many new ways.

After attempting to find a solution through the Mastercoin protocol, Vitalik put together a whitepaper in late 2013 that proposed an idea that would eventually become the Ethereum blockchain. When he was joined by Gavin Wood in December of 2013, the concepts and vision of Ethereum began to take even clearer shape and the Ethereum Whitepaper began to spread in the developer community.

In the following months, the community grew quickly and attracted numerous others including Joe Lubin, Mihai Alisie, Charles Hoskinson and more. The core group of developers and proponents ended up coming to Zug, Switzerland to set up a foundation in support of the vision that they had laid out.

In July 2014, the Ethereum Foundation conducted a crowdsale in which it sold over 50 million ETH to the public. The following year, on 30 July 2015, the genesis block of the Ethereum blockchain was mined and the Ethereum journey towards decentralization began in earnest.

Ethereum as the World Computer

What began in 2015 was more than the launch of another cryptocurrency with its own blockchain. The vision was to create a world computer.

What does this mean?

Think for a moment about what a blockchain was originally designed to do – store a distributed record of transactions of a peer-to-peer electronic cash (Bitcoin). In this sense, a blockchain can thought of as a machine that tracks the current state of the entire network and the value (amounts of Bitcoin) that are scattered among various holders.

When Bob sends a certain amount of Bitcoin to Alice, the Bitcoin blockchain records this transaction – in other words it updates the current state of the ledger and takes note that Bob now has less Bitcoin and Alice has more.

Similarly, Ethereum records the transactions of ETH. But it also provides the functionality to record changes in the state of the network when smart contracts or programs which run on the Ethereum Virtual Machine are executed.

This might not seem like a difficult or revolutionary thing, until we think about the implications. Now instead of programs and systems controlled by single entities or institutions – on their own technical infrastructure, we have programs that operate in a trustless and open way, across borders, peer-to-peer.

This enables decentralized applications (dApps) which do not live just on one computer or server, to operate even if they may have various inputs and changes in state over time. The consensus mechanism of the blockchain helps maintain their integrity even without intermediaries or counter-parties.

Now with all of this, we get a system which can execute programs over and over again, anywhere in the world, with guaranteed code execution because the logic is embedded on the blockchain.

In other words, we get a world computer.

Ethereum as a smart contract platform

The programs – or more accurately scripts – which run on the Ethereum blockchain are commonly referred to as smart contracts.

Let’s take a look at an example—a decentralized application for flight delay insurance. The heart of the application is a smart contract – a program running on the Ethereum blockchain – which can:

  • Accept premiums (in ETH) from passengers wishing to buy flight delay insurance for their journey
  • Calculate the risk and premium level for individual flights based on historical data and current weather information (provided by so-called oracles)
  • Determine if the flight had been delayed based on a link to flight tracking database
  • Automatically distribute the correct insurance payout to passengers who were on a delayed flight.

Obviously, such insurance is available today from various providers around the world, but using the Ethereum blockchain allowed the flight delay insurance application to automate the entire process from the insurance policy setup to the moment of payout, and made it possible for people in different places to interact with the system without cumbersome paperwork or one centralized authority and ultimately provide a much better customer experience.

This is just one example of a smart contract in action. Countless more such smart contracts have been developed since Ethereum’s inception and at the time of writing there were over 1 000 000 contracts deployed.

Ethereum and decentralized finance

One of the most important use cases for such smart contracts is in the area of finance. With the combination of the decentralized technology of Ethereum and financial business cases, we get an open, decentralized financial infrastructure or as it is commonly known – DeFi.

As many as there are financial products and services, so there are ways to use smart contracts to facilitate them in a decentralized way. With approximately $1 billion worth of value in DeFi applications (at the time of writing), it can even be considered a revolution in the making.

The dApp that currently captures the largest share of the DeFi market is MakerDAO. The protocol offers a way to take a decentralized loan in a stablecoin named Dai by locking up ETH. Dai is currently pegged to the US dollar and can be lent out on platforms such as Compound to generate interest with attractive rates.

Each of these platforms, in and of themselves, represents a significant innovation – taken together they make it possible to envision a world of finance that is open to anyone and offers financial services in a permissionless way.

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