Ethereum for beginners: what is it, and why should you care

Over the next few years, discussions around crypto assets in all business areas will become much more frequent. So it is vital to start the Ethereum education process now. That’s the opinion of Senior Analyst in Holon Investment Mark Roddy.

In a recent webinar on LinkedIn, Mark told how and why Ethereum was developed and what’s happening now.

Quick rehash

In the physical world, if I have $10 and I want to give it to you, I can just hand it over, and you can be confident that I have not tricked you.

In the digital world, if I send you an image across an email, you can not be sure that this is the only copy of that image. The same is with money. So, to determine exclusivity, we introduce a third party (typically a bank) to oversee all of the transactions. But we should trust the banks to perform that role.

Bitcoin provides an alternative solution. There is no intermediary, so transactions work in a peer-to-peer fashion. I’m sending money directly to you, and no one oversees those transactions or holds these funds in between.

Ethereum is about a similar concept, but it is not limiting it to money. It’s opening it up to any application that you want.

Why is it important?

When bitcoin was first invented, it was worth half and a half a cent and extremely volatile. So people were looking at it and trying to understand what they could do with this decentralized, shared database — that is, blockchain. 

But implementing use cases on top of bitcoin was highly challenging because of the scripting language that bitcoin uses. People were forced to copy a bitcoin code and create a new blockchain around a specific use case. And it was challenging since one of the most significant issues of blockchain is ensuring that it is secure. 

And Vitalik Buterin, the creator of Ethereum, thought: if we build a separate blockchain, why don’t we create one where you can do a whole range of different things? And this is how Ethereum came.

So the Ethereum team introduced a new programming language — Solidity. It is Turing complete language, meaning that given enough time, resources, and instructions, the programming language can compute anything. 

What are smart contracts?

The foundation of Ethereum is a concept called smart contracts. They are basically just instructions in computer code that auto-execute.

The difference between traditional and smart contracts is that, again, we don’t have a third party that executes transactions for us. In a smart contract, we put the trust into the Ethereum network, a public shared network. So this platform is open and transparent, and it can automate transactions for us, even quite complex ones.

To understand it, let’s look at it this way. Most of the Internet today is built upon infrastructure that is provided as a service by AWS or Google. The bottom layer of the data center and the computer can be pretty complex, but people can appreciate that the underlying infrastructure drives the application. The more applications are created on AWS, the more value AWS as well.

Ethereum is very much the same concept but in a decentralized (without third parties) world. And the applications built on Ethereum will attract more users, which should create value for the Ethereum network.

How is the Ethereum network different from others?

If you consider blockchain a shared database, two unique features separate Ethereum from a traditional database or AWS server. 

1. Interoperability. The assets that sit on Ethereum can interact with different applications. And the reason they can do that is that they work off smart contracts that are ERC20 standardized. That allows you to scale up very quickly, and people can start interacting with your smart contract very quickly, too.
2. Composability. It goes back to this idea of this shared database that Ethereum is. And because we are just one shared database on Ethereum, you can start to pull separate smart contracts together to create new products. Like LEGO 🙂 So a developer does not necessarily have to build everything from scratch.

And there is one other unique feature of Ethereum.

If we look at traditional financial transactions, typically, there is a hierarchy level in which you have to get permission from the layer above you. Whereas Ethereum flips that around: we start at the base of this open platform, and then we begin to build on top of it.

On the right hand, it is much harder, but on the other, it opens the door for much greater innovation and allows much more experimentation.

So, how to use Ethereum?

If I want to interact with a smart contract or deploy it as a developer, I have to pay for using the resources of the Ethereum network. The fuel or credit that I get is the ETH token.

And there are three kinds of fees that I pay:

1. The base fee is a set charge that the network applies. That charge will fluctuate based on the demand of the network. If the demand increases, i.e., a heap of people jumping on board to try and access something or transact at one point, the base fee will creep up.
2. An extra tip is a fee you pay if you want your transaction to be a priority. This fee incentivizes the people who wrong the network’s security and validate it to include your transaction immediately.
3. And also, there is a block reward to pay people who manage the security network. 

If we consider those tips at the top, what you have is a dynamic where you have got a reduction in Ethereum supply on the market from the use of the Ethereum network. So the more the individuals use the Ethereum network, the more Ethereum is burnt by that base fee and the more scarce it becomes.

And then, on the other side, we have that incentive mechanism where the supply is continually increasing. So we have this seesaw between burning and increased supply from the incentives. 

Down the bottom, you can see the Net issuance of Ethereum. And you can see a positive supply of Ethereum being added to the market every month. 

Transaction fees are driving scarcity into the Ethereum network, and it is also killing off a lot of use cases because of the high transaction fees. You can see here in parts it has been up to $10,000 for a transaction. 

So it is unlikely that many use cases will be able to run on top of the Ethereum network practically. 

It brings us to this massive upgrade that Ethereum is going through. It’s been a multi-year upgrade, and we are starting to get to a point where it will run live. It’s just gone through a testnet successfully, and we are going to see some pretty dramatic changes on it.

Stay aware not to miss anything.