What is Ethereum & how does it work?

Ethereum is one of the world’s most-traded cryptos, and also an ambitious blockchain network that seeks to transform financial transactions.
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Updated: Dec 28, 2023
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This guide explains the basics of Ethereum, how it works, and what you can use it for.

What is Ethereum?

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Ethereum is the world’s second most popular cryptocurrency. It was created in 2015 as an alternative to Bitcoin, and as a blockchain that was capable of hosting a wide range of decentralised applications.

Ethereum is both a blockchain network that allows for applications like blockchain gaming and decentralised finance, as well as a cryptocurrency in its own right that you can spend, store, or send to other people without any traditional financial intermediary.

Who created Ethereum?

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Ethereum was devised and created by Vitalik Buterin.

The idea behind Ethereum was first put forward in 2013, when Vitalik was just a 19 year-old blockchain enthusiast. In his article, Vitalik proposed the creation of a blockchain network platform that would allow for decentralised applications (known as dApps) to be built on top of it, almost like how mobile apps can be built for the App Store or Google Play Store.

Development on the Ethereum blockchain started after the article gained traction amongst the early cryptocurrency community, and the first publicly available version of the platform was launched on the 31st of July of 2015, the day the first block was created.

Why was Ethereum created?

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Vitalik envisioned that the potential for blockchain technology could be extended beyond simply allowing users to transact peer-to-peer with each other without a central authority. Ethereum was created because Vitalik wanted a blockchain network that allowed its users to create their own decentralised applications on it.

The purpose of Ethereum was to go beyond simply being a cryptocurrency, and also provide a network which allowed users to make blockchain technology a part of everyday life. Unlike cryptocurrencies such as bitcoin, which use a blockchain simply to record the movements of currency, the Ethereum blockchain allows for people to set up automatically executing ‘smart contracts’.

How does Ethereum work?

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Ethereum uses a public blockchain to verify transactions. A blockchain is like a digital database that keeps a record of who sent Ethereum to whom, and when. The blockchain is kept secure by a process known as ‘proof of stake’, which is where people put up some of their own Ethereum tokens as collateral and then verify a transaction.

The collateral serves as insurance, as the validators lose that stake if they approve an incorrect transaction. In exchange for their services, these validators are paid a reward in Ethereum tokens each time they approve a transaction correctly.

This is a slightly different process to how Bitcoin works, as Bitcoin is based on an energy-intensive proof of work system, that requires computers solve complex algorithms in order to approve new transactions and add blocks to the blockchain. Ethereum used to operate in a similar way, but in 2022 it transitioned to a proof of stake blockchain, which does not require significant computational resources.

What are ‘smart contracts’?

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‘smart contracts‘ are virtual ‘if-then’ contracts: a set of code that automatically executes an action when certain conditions are met. Think of a vending machine; a vending machine is programmed to give you a bag of sweets that costs £1 automatically once you have inserted £1 and selected the bag of sweets.

This is what is meant by an ‘if-then’ contract: if you pay the right amount and select what you want, then the machine will give it to you. If you don’t, it won’t.

The possibilities for what can be created are virtually endless, as the functionality of a smart contract is only limited by the complexity of the code it was written with. Anything can be coded as a smart contract, from the creation of a democratic voting network for shareholders of a company, to decentralised gambling and casino games, to simple exchanges of goods and services.

What is Ethereum used for?

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Ethereum has two main usage purposes: to use as ‘gas’ to fuel smart contracts, and for ordinary everyday use like a ‘regular’ currency. It can also be ‘staked’, which is a process by which you use your tokens to support the network and earn extra coins as a reward.

‘Gas’ is simply a unit of ether that is necessary for the successful operation of a smart contract on the Ethereum blockchain. Just like a car needs fuel to run on the road, smart contracts need ‘gas’ to operate on the Ethereum blockchain.

FAQs

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Who owns the Ethereum blockchain?


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James Knight
Editor of Education
James is the Editor of Education for Invezz, where he covers topics from across the financial world, from the stock market, to cryptocurrency, to macroeconomic markets.... read more.