What is Ethereum & How Does It Work

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Updated: 23 September 2020

Ethereum is the second largest cryptocurrency by market cap as of 2019. Ethereum is a special type of cryptocurrency that has a lot of innovative features and is used across industries and sectors.

  • Ethereum is a network for decentralized apps
  • Ether is the token that fuels the network
  • Around 18 million ethers can be mined yearly
  • Ethereum’s blockchain aims to decentralize the internet by forming a “world computer”

The (De)centralized Internet

The internet, as we know it today, is a centralized platform based on the server-client model. This means that all data such as websites, videos, music, articles, software and even passwords are stored on servers which are usually operated by third-party companies. Naturally, this centralized concept doesn’t reflect the idea of a free and decentralized internet. Hackers can gain control over information simply by attacking the central-points of the internet – the servers. There have already been numerous headlines of hackers stealing passwords, sensitive information or even credit cards of users by gaining access to servers operated by third-parties.

Companies can also decide to shut-down their services and restrict their users from accessing their information stored on the servers. Users are not directly in the possession of their data since everything is stored on third-party computers, and there is no guarantee that the data will not be changed, deleted or used for fraudulent activities.
While there have been many attempts to replace the existing server-client model and democratize the internet, blockchain has made the most significant progress so far. Blockchain is being increasingly utilized to decentralize the internet again, and the Ethereum blockchain plays an important role in this.

Ethereum – Brief History and Essence

Just like Bitcoin, Ethereum is an open-source computing platform that is also based on blockchain and is also public. However, the operating system of Ethereum is based on the so called smart contracts.

The founder of Ethereum is Vitalik Buterin. The Russian-Canadian software programmer, who dropped out of the University of Waterloo and became part of the prestigious Thiel Fellowship Foundation, which granted him $100,000 to develop an innovative idea.

Buterin co-founded Bitcoin Magazine in 2013. After winning the grant from the Thiel Foundation, he went on to fully develop Ethereum and the new technology based on smart contracts.

The one thing Buterin has always argued was that Bitcoin, while truly revolutionary in design and structure, needed a scripting feature. The scripting features or rather languages allow specific programs and applications to be built on the operating system so that there are multiple uses and developments along the way. According to sources, after Butelik came up with how different Ethereum will be, his team went on to work on the project. According to Wikipedia and official sources, the actual work on Ethereum began in the beginning of 2014 through a company based in Switzerland, Ethereum Switzerland GmbH or as it is often referred to EthSwiss. Later on, the Ethereum Founded was founded. Not long after that, in the summer of 2014, the token sale (ether) began and the team raised funds to continue to work on improvements on the new technology. While Ethereum was met with enthusiasm, there were certain issues regarding the viability of the project and how scalable it could actually get.

The name of Ethereum was made up by Vitalik, who said that ether meant the invisible medium that was responsible for the light to travel and was everywhere in the universe.

What is Ethereum

Enterprise Ethereum Alliance 

Ethereum became so successful and popular that in only after three years of its creation, in 2017, the Enterprise Ethereum Alliance (EEA) was born. This Alliance includes some of the largest Fortine 500 companies, together with numerous startups and research institutes. The organization grew extremely fast starting off with just 30 members and reaching 150 just three months after its foundation, noting a CAGR of 62.4% for the three months or 400%. Some of the most well-known members of the EEA are Microsoft, BNY Mellon, Toyota Research Institute and more.


Ether is the underlying cryptocurrency that fuels the network of Ethereum.

The validation and transactions happen in the same way as they do with Bitcoin. All records are called blocks, which are interlinked with one another through the process of cryptography. The major difference between Ethereum and Bitcoin is that the transitions that occur in Ethereum are state ones, since Ethereum uses balances and accounts. States are not deposited in the blockchain, they are stored in the so called Merkle Patricia tree. Transacting with Ether requires both public and private keys which denote the addresses of the Ether.

There are some unique features when it comes to Ether’s addresses. All Ethereum addresses are made of the prefix “0x”, a specific identifier for hexadecimal.

When we compare Bitcoin and Ether, we should keep in mind that Ethereum is not the cryptocurrency, but rather Ether is. There are certain differences between the largest two cryptocurrencies by market capitalization. Some of them are:

  • Ether has a much lower block time than Bitcoin. For comparison, while there are many improvements going on behind Bitcoin’s network, the block time for Ether is around 15 seconds, while for Bitcoin is around 10 minutes.
  • The transaction fees that apply to ether are much lower than that for Bitcoin. Again, for comparison, at the end of 2017, the price per transaction for ether amounted to around $0.32, while for Bitcoin – $23.
  • Another very important difference between the two is the mining process. While for Bitcoin the rate at which mines new coins halves every four years, ether mining involves more or less constant rate of producing new coins.
  • While Bitcoin has a limited supply of $21 million coins, Ether does not have a limited supply so far. As of the beginning of 2018, the supply of Ether in total was around 99 million Ether coins. However, just as with Bitcoin, Ether is expected to become a deflationary currency in the future. For now, there is no exact time on when and how this will happen.


The Ethereum Virtual Machine (EVM) is a 256-bit register stack and represents the runtime environment for Ethereum’s smart contracts. The EVM is probably the most crucial element of Ethereum, as it allows the stack to run the very same code exactly as required.


How does Ethereum work

Smart Contracts

The smart codes that run on Ethereum are usually coded in different computer languages, so that they can be used for different applications and functionalities. The EVM code is used to “crunch” the smart contracts and run them on the Ethereum blockchain for completion. Some of the languages that are used for smart contracts include Serpent, Mutan, Solidity, LLL and Viper.

According to data, these smart contracts may be vulnerable since they are open to the public and are not easy to fix if there is a “bug”.

Ethereum is probably the most versatile open-source computing platform, since it is used for multiple applications and has multiple uses across sectors and industries.

Some of the most famous deployments of Ethereum include: Prediction markets, IoT, crowdfunding, online betting and gambling platforms, security data systems, online financial exchanges, social media apps etc.

Ether’s Price Movements

Ethereum Chart

As it can be seen from the historical chart from Coinmarketcap, Ethereum’s price has been climbing even more rapidly than Bitcoin’s price. At the beginning of 2015, Ethereum cost was fluctuating between $1,23 and $2. However, the rapid increase in price occurred in the spring of 2017, when Ethereum only cost around $10. From then on, the price started climbing rapidly and by July 2017, the price was already above $300. With more application and improvements on Ethereum, the price continued to skyrocket and in the very beginning of 2018, Ethereum hit its all-time high of almost $1,500. The fluctuation in price has been mainly due to concerns with security and future development. While the crypto bull market may be gone, as some analysts predict, it can be clearly seen that Bitcoin and Ethereum have a cointegration relationship when it comes to their price movements. While all altcoins go up and down with Bitcoin, more or less, Ethereum probably mimics Bitcoin’s price swings most closely. One possible explanation for that is: blockchain is the foundation for both cryptocurrencies. Blockchain has been embraced by corporations and governments, but it has also affected the price of Ethereum and Bitcoin. This is perhaps one possible reason why once Bitcoin goes down, the whole cryptocurrency market goes down as well.

Bitcoin vs. Ethereum – Main Differences

  • Bitcoin promised lower transaction costs and faster payment processing compared to traditional ways of sending money, without a central authority that regulates and oversees the transactions (such as central banks and governments).
  • Bitcoins relies on a decentralized blockchain network, which is a public ledger that includes all transactions that have ever been executed.
  • The ledger consists of so-called blocks which are added to the ledger through cryptography, ensuring the data remains safe and unchangeable except by the owner himself.
  • While bitcoin’s blockchain is used for the primary purpose of recording and processing transactions in bitcoins, Ethereum’s blockchain is a complete platform that can be used to run decentralized applications.
  • Bitcoin uses its blockchain only to facilitate payments, which is only one of countless operations that Ethereum’s blockchain can be used for.
  • Ethereum is also a programming language hosted on Ethereum’s blockchain, used to develop decentralized applications. An investor can use Ethereum to create the new bitcoin if they want (and it already exists – Ether), while bitcoin’s blockchain is only used to fuel bitcoins as an alternative to traditional currencies

Benefits of Ethereum

Benefits of Ethereum

The main benefits of decentralized applications are linked to the properties of Ethereum’s blockchain.

  • Security– Since the blockchain is decentralized and independent computers are used to verify and process each transaction, the system is protected against fraud and hacking attempts from third parties. In addition, all data is secured using cryptography (ethash for ethereum), and only the owner of the data can make changes to it after paying a fee in ethers for the network to process the change.
  • Immutability– The current server-client based internet makes it possible for third parties to access sensitive data on a server. On Ethereum’s network, this is not possible.
  • No downtime– Being a decentralized network, all apps are always accessible by users. There is no way that an app can be shut down by a third party or that any changes can be performed without all participants being notified.

The major disadvantage is closely tied to the network’s benefits. Since smart contracts are programmed by developers, any mistake can lead to unexpected problems once the program is on the blockchain. In order to rewrite the code and improve the program, you need first to obtain a network consensus which directly opposes the network’s concept of decentralization. The process may be lengthy and burdensome.

Benefits of Ethereum

The biggest advantage of Ethereum is the opportunity it provides to develop exciting and new apps for users. Some of these are listed below:

  • The Vevue project provides users with the possibility to earn cryptocurrency by taking short video clips of famous places around the world. Similar to Google Street View, only with video clips. Other users can request videos from certain locations in your neighborhood, and you’re paid via Ethereum’s network by uploading the clips online.
  • Eth-Tweet is another interesting project that focuses on microblogging. Similar to Twitter, Eth-Tweet allows users to send short tweets of up to 160 characters through blockchain, which ensures that no central entity can delete or change the message once it’s published. There is absolutely no censorship on Eth-Tweet, and only the owner of the message can change or delete it. Other users can send ethers as a donation to other users who add to the quality of the content being published.
  • Finally, WeiFund is a crowdfunding project that aims to take advantage of the capabilities of smart contracts. While existing crowdfunding sites, such as GoFundMe or Kickstarter, use traditional currencies, WeiFund will be based on ethers. In addition, smart contracts can be used to make complex agreements between parties, which are automatically executed once certain conditions are met.

The ins and outs of developing an Ethereum app

Ethereum, as we mentioned, is primarily used for development of apps. One of the most popular tools to join the ethereum network is through its native browser called Mist. Mist is not only a tool for writing and managing smart contracts, but also provides digital wallets for users to store ether.

If you’re using Google Chrome, the MetaMask extension may be interesting to you. It runs directly in your browser, so there is no need to install anything on your computer. MetaMask allows developers to write and run blockchain applications directly from their browser. While originally written for Chrome, the extension is now also available for Firefox and Opera. You can check more at www.metamask.io.

Another browser-ready solution is Ethereum’s Remix, which can be found at remix.ethereum.org. Just as with MetaMask, you can write and compile smart contracts directly from your browser, and run the final product. Remix also includes a handy file browser on the left-hand side of the screen, which can be used to scroll through any files you might need for your application.


Ethereum provides a complete platform to write decentralized apps on the blockchain. Unlike bitcoin, which utilizes the blockchain technology primarily to process and validate peer-to-peer bitcoin transactions, Ethereum’s network can be used in a variety of ways and new exciting DApps (decentralized apps) are being developed every day. This is why Ethereum has garnered so much attention in the last few years and has rivaled the “people’s currency” in a number of ways.

Ethereum’s main purpose is to decentralize the internet as we know it today. Volunteers across the world dedicate their computers to run DApps and smart contracts, and get paid in the form of ethers for performing these DApps. Around 5 ethers are mined every 12 seconds, which limits the total yearly supply to around 18 million ethers. Unlike bitcoin, which has a hard cap of 21 million, there is no similar restriction on the number of ethers available to mine.

Ethers, the token and cryptocurrency that fuels the Ethereum network, can be traded just like any other virtual currency on crypto exchanges. With a growing number of large companies and financial institutions joining Ethereum’s network and developing their own blockchain apps, ethers may have a long-lasting and bright future ahead.