Ethereum (ETH): What It Is, How It Works

ETH is more than a cryptocurrency: It powers a crypto-centric ecosystem.

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Ethereum is a blockchain network on which decentralized applications, contracts and other services built around cryptocurrency are built. Its native token, Ether (ETH), is the second-most valuable cryptocurrency by market capitalization. While they are distinct concepts, “Ether” and “Ethereum” are often used interchangeably as the name of the token.

Ethereum’s platform is not just used to record transactions. It also:

  • Supports decentralized finance, or DeFi, in which services that traditionally need an intermediary from the traditional banking or legal system can be performed by the network instead. It does this by supporting smart contracts, which are financial agreements between two or more parties that are stored on the network and are automatically executed when the contract’s conditions are met.

  • Hosts decentralized applications, or Dapps, which are made by developers using the network's programmable language.

  • Is used to build other cryptocurrencies, like Binance coin.

  • Is home to popular non-fungible tokens, or NFTs, which are one-of-a-kind digital assets that you can buy and trade with others.

Ethereum: Key facts

Market cap

High. Ethereum has been the second-most-valuable cryptocurrency for years. In November, its market cap was about $130 billion.

Max supply

No max supply. There isn’t a cap on the total number of ETH that will go into circulation, but its current supply of about 120 million is expected to remain relatively stable.

Network speed

Medium to high. Ethereum’s network approves new blocks every 12 seconds, on average.

Fees

Medium to high. Users bid to get their transaction requests picked up. This supply-and-demand approach means that prices vary. During times of high network use, prices have surged to over $190.

Security

High. In 2016, Ethereum underwent a controversial hard fork to escape a serious hack, called the DAO hack, that took place on the network. Nothing as serious has occurred since then on this heavily-trafficked network. The merge, like any technology, still needs to develop a track record before it can be adequately judged .

Pros of Ethereum

It already has an extensive user base

Ethereum is among a few projects with high levels of adoption. There are routinely more than 1 million transactions per day on the Ethereum network. For comparison, Cardano transactions have recently been closer to 100,000 per day. Some of the most popular consumer-oriented crypto projects, such as games and NFTs, are built on Ethereum.

Recent upgrades could lead to better performance

Ethereum’s merge may convince skeptics that blockchain technologies can work without a huge environmental cost. Ethereum, like Bitcoin, had historically used a “proof-of-work” system to ensure that transactions on the network are recorded correctly. Ethereum has now moved to a “proof-of-stake” system, which instead uses a process known as staking. Proof-of-stake systems use much less energy.

Cons of Ethereum

It’s not cheap to use

The cost of a single transaction on the Ethereum network has, at times, exceeded $20. And while that may not be a considerable amount for a trade worth thousands of dollars, the fees for small transactions can sometimes be higher than the value of Ethereum changing hands. These transaction costs may not matter if you’re simply holding ETH, but they could be a roadblock to the growth of the Ethereum network as a whole.

Mediocre speed

Ethereum processes somewhere around a dozen transactions per second. That is dramatically slower than some other blockchains, and far slower from legacy technologies such as the Visa network, which can carry out 24,000 transactions per second.

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Ethereum vs. Bitcoin: Notable differences and price history

Ethereum and Bitcoin, which have the two biggest market capitalizations among cryptocurrencies, have notable differences.

  • Founder involvement. Vitalik Buterin, Ethereum cofounder, still guides its development. Bitcoin’s pseudonymous founder, Satoshi Nakamoto, has been silent for a decade.

  • Technology. In September, Ethereum started using a technology called proof-of-stake to approve blocks of new transactions. Using a process called staking, users post their own ETH as collateral. In contrast, Bitcoin uses proof-of-work, in which miners run resource-hungry computers to confirm new blocks.

  • Function. Bitcoin’s design is focused almost exclusively on recording transactions. In contrast, Ethereum can be used to write applications, execute smart contracts, host NFTs and more. Many other cryptocurrencies are built and run on Ethereum’s network.

Frequently asked questions

You can use it as a form of payment, an investment vehicle or as a platform for building and accessing apps and NFTs, or non-fungible tokens.

You can send your Ethereum to anyone who has a crypto wallet. When you do, you’ll need additional Ether to pay the network’s fees.

Ethereum is also a platform on which applications and other cryptocurrencies can be built and used. If you want to run or use these applications, you’ll need Ether.

Nobody owns or controls the Ethereum network. When you buy Ether, you’re not buying it from Ethereum — you buy it from someone else who owns it. A non-profit foundation, called the Ethereum Foundation, promotes and builds Ethereum-related technology. Ethereum is upgraded from time to time, and these changes are made through an informal consensus building process and a formal stakeholder vote.

Ethereum’s value is determined by what others are willing to pay for it. As a result, its future price is impossible to predict. Like most cryptocurrencies, its price history is volatile and has many instances of big gains and big losses.

The price of 1 ETH fluctuates, but its cost has exceeded $1,000 for nearly two years. But Ethereum is divisible, like breaking a dollar into 100 cents, which means you can buy a fraction of it instead.

A single Ether can be broken down into one quintillion pieces. Each of those microscopic units is called a wei.

Fees for using the Ethereum network are calculated in gwei. One gwei equals 1 billion wei, or 0.000000001 ETH.

Ethereum is not a company and does not make money. Instead, the Ethereum network is a distributed network, which means that it’s maintained by individuals around the world instead of in a centralized location. These are the individuals to whom network fees go.

If you don’t own any cryptocurrency already, the easiest way to buy it is on a centralized exchange, where you can pay cash for Ethereum. Bank transfers and credit cards are accepted on many popular crypto exchanges.

If you own another cryptocurrency, you can trade it for Ethereum on an exchange.

Ethereum is stored in a crypto wallet. Some wallets use hardware for an extra layer of security, but many are purely software. Top wallets support many different cryptocurrencies and support online storage.

Some exchanges let you store cryptocurrency with them using a custodial wallet. A custodial wallet is not the same as a crypto wallet, which you control completely. You could potentially have trouble accessing your crypto if an exchange on which you store crypto faces technical or legal issues.

Yes, you can use a centralized exchange to trade your Ethereum for cash. The process is the same as buying crypto for cash, except that you are the seller instead of the buyer.

If you sell Ethereum for a profit, you’ll owe taxes on that amount and should follow the same capital gains rules used when selling other investments, like stocks. If you sell at a loss, you could offset taxes owed on capital gains you had elsewhere.

Yes, Ethereum is a cryptocurrency. Cryptocurrencies use blockchain technology to keep secure lists of transactions across a distributed network of computers running its software.

If you own Ethereum, you can use it to earn passive income through a process called staking. Ethereum’s current annual percentage rate, or APR, is 5.3%, but that requires you to have 32 ETH to stake directly. If you don’t own that much, you can still earn income by joining a staking pool — a group of Ethereum owners who collectively commit 32 ETH. Some centralized exchanges coordinate pooling if you store cryptocurrencies with them. You can also use a staking pool service, which connects directly to your wallet. In both cases, the companies running the staking pools keep a fraction of the income as their fee.

The author did not own Ethereum at the time of publication.

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