Ethereum is a cryptocurrency, like bitcoin, but the two differ drastically. In this article, I will break down Ethereum, how it’s used, and how it differs from Bitcoin. I will explain each aspect in a simple way, free of confusing jargon.
What is Ethereum?
Ethereum is both a cryptocurrency and a platform. The idea behind Ethereum is that you can build and design applications (apps) much like the ones on your phone. These are referred to as Dapps, which is short for Decentralized applications. The Ethereum coin which is called Ether is used to pay for gas in order to run these decentralized applications (Dapps). Just like a car Ethereum needs something to run on. The idea here is that Ethereum is creating a new and improved internet (web 3.0). A decentralized internet where each user pays for the computing power they use. As you might recall in my last articles explaining Blockchain and Bitcoin, Bitcoin uses a blockchain where miners solve complex problems in order for a transaction to take place. The miner gets paid a fraction for solving the problem and using computing power. Computing power costs money so when someone uses a Dapp they pay a small amount of Ethereum in order to run it. Even If you are just sending Ethereum from one person to another you will notice a gas price that will go to the miner. The price of gas you decide on paying helps the miners rank the transaction for when it should be placed in the blockchain. Think of it as the ranking goes to the highest bidder which gives the miners more incentive to execute your transaction. Additionally, miners can ignore transactions if the gas price is too low. If you do not have enough Ethereum to pay for the gas the transaction will be considered invalid. In addition, the gas price is deducted from the account sending the transaction. There is also a limit to how much gas a single transaction can use and each transaction has a different price of gas. The purpose of having a limit on gas is to help protect you from a bug or error that would deplete all of your funds.
What are smart contracts?
The Ethereum network uses smart contracts to process transactions without the need for a third party. A smart contract is simply IF This Then That logic (IFTTT) written using the programming language called Solidity. What that means is that there are an automated set of rules in place and when the rules are completed or the requirements are met the contract executes the transaction. Bitcoin uses them as well, but the use is much more limited compared to Ethereum. Smart contracts provide a trustless system for conducting transactions. These smart contracts help you exchange money for goods and services in a seamless hassle-free way without the need for a middleman.
What’s an ICO? And what are tokens?
The best way to explain tokens is to think of them like shares of stock even though they differ drastically. Some people might not agree with my comparison, but in the confusing world of Crypto the only way to fully understand things is to be given a real-world example that’s similar to provide you with something relatable. My hope is that you will build off that relation in order to gain a deeper understanding.
There are events called ICO’s which stands for Initial Coin Offering much like an IPO (Initial Public Offering). The only real difference is that Ethereum is not regulated by a government and the tokens you are buying in an ICO are to be used on the Dapp (I will cover this a little later). ICO’s are a form of crowdfunding by the company distributing tokens to their investors in exchange for Ethereum. These tokens are similar to shares of stock. If you participate in an ICO you will receive tokens and these tokens give the “shareholder” perks.
Each company that has their ICO gives their tokens different perks. A share of stock offers voting power, dividends, and legal rights. ICO tokens on the other hand have no government regulation so you have no legal rights. In addition, the issuer of the token can decide not to provide dividends and/or voting power. The only similarity between a publicly traded company and a company issuing an ICO is that they both have the option to offer dividends. Otherwise companies offering their coins have much more freedom in deciding what the coin offers.
The main purpose of these tokens is to be used on the Dapp. Each application on the Ethereum network has their own tokens called protocol tokens. Imagine for a minute that you are in a shopping mall. Each store in the mall has their own token and each store only accepts their individual token as payment. Before you enter the mall, you would exchange your dollars of each stores token you wish to shop at and redeem those tokens for the items you want. With that example in mind, in the Crypto world you would have to exchange your fiat currency like the US dollar for Ethereum. From there you will use Ethereum to purchase individual tokens and use those tokens to purchase something on that Dapp.
So, what’s the big deal?
The big deal is that there is now a platform that allows us to conduct transactions at a cheaper cost while also having proof that the transaction took place with the blockchain. Reduced transaction costs and a trustless system are the most important things. When people say Ethereum will eliminate the middleman it is an over exaggeration. What’s really happening is that they are replacing the middleman with an automated system that allows you to trust the unknown party when conducting a transaction. Ethereum is essentially becoming the new middleman that is much cheaper and seamless.