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What is the Ethereum Blockchain: A Beginner’s Guide

Last Updated June 27, 2023 9:01 AM
Andrew Kamsky
Last Updated June 27, 2023 9:01 AM

Key Takeaways

  • Ethereum blockchain was created to address the limitations of Bitcoin and provide a platform for developers to build decentralized applications using smart contracts.
  • A hard fork in 2016 resulted in the creation of two separate Ethereum networks called Ethereum (the current version) and Ethereum Classic.
  • It transitioned from a proof of work (PoW) to a proof of stake (PoS) consensus mechanism in 2022 to address energy consumption concerns and improve scalability.
  • Ethereum blockchain offers versatility and cost efficiency through its support for smart contracts, enabling innovation and reducing transaction costs.

In 2009, Satoshi Nakamoto introduced a groundbreaking alternative to fiat currency using cryptography to form a sound medium of exchange, called Bitcoin, which became the first cryptocurrency that offered a decentralized alternative to centralized traditional currencies. 

Bitcoin’s creation opened the door to a new era of financial freedom and innovation. The potential of blockchain technology was swiftly realized, explored, and admired by numerous individuals. As a result, developers and cryptography enthusiasts began to contemplate whether blockchain had more untapped potential.

When he was merely nineteen years old, Vitalik Buterin, one of the founders of the Ethereum blockchain, embarked on an audacious new venture with a mission to push the boundaries of Bitcoin’s capabilities.

Bitcoin, due to its limited design, lacked the versatility to support various functionalities, prompting Vitalik to conceive Ethereum. The latter aimed to establish a platform where developers could construct decentralized applications using smart contracts.

To realize this vision, a team of individuals such as Gavin Wood (creator of Polkadot and Kusama), Charles Hoskinson (creator of the Cardano blockchain), and Joseph Lubin (founder of ConsenSys), among others, worked assiduously to bring Ethereum to fruition.

Launched in 2015, Ethereum was initially built on a proof of work (PoW) consensus mechanism, much like its predecessor, Bitcoin. However, the network was designed to be more than just a cryptocurrency exchange platform and switched to proof of stake (PoS) consensus mechanism in 2022. As Ethereum’s story continues to unfold, its community eagerly awaits the many innovations and developments that lie ahead. 

What Is The Ethereum Blockchain

As of Q2 2023, Ethereum blockchain holds the second spot on CoinMarketCap  as the largest cryptocurrency with a market capitalization of $220 billion. The project offers a total and leading technology with a vision to change the world in a variety of interesting and debatable ways. 

Ethereum is an attempt at a decentralized blockchain platform that offers unique features centered around the provision of smart contracts, decentralized finance (DeFi), and decentralized applications (dApps). 

A smart contract can be likened to a digital vending machine. When you insert the precise amount of coins into the machine and select your desired beverage, you’re essentially entering into a smart contract with the vending machine.

This is because the vending machine acknowledges your payment, identifies the specific drink you’ve chosen, and fulfills its end of the deal by dispensing the beverage. Fundamentally, a smart contract functions on the same principle as a vending machine: it is straightforward and reliable.

Smart contracts serve as the foundation of Ethereum’s vision, enabling the development of DeFi and dApps on its platform. These self-executing contracts have terms of the agreement directly written into code and are immutable once deployed on the Ethereum network. This means once the contract is entered it cannot be changed.

Ether (ETH), the native cryptocurrency of Ethereum, powers these smart contracts and is used as a fuel for transactions and computational services on the network.

History Of The Ethereum Blockchain

Ethereum, like Bitcoin, has a rich history, and  has faced many challenges, such as its infamous DAO attack in 2016. The decentralized autonomous organization (DAO) was a blockchain-based venture capital fund that utilized smart contracts to allow investors to fund projects and receive returns on their investments. However, the smart contract code contained a flaw that enabled the attacker to drain a significant amount of ETH from the DAO’s funds into a child DAO.

The DAO attack ultimately led to a hard fork of the Ethereum network, which involved rolling back the blockchain to a previous state to undo the damage caused by the attack. This fork resulted in the creation of two separate Ethereum networks, the current Ethereum blockchain (resulting forked blockchain) and Ethereum Classic (the original version of the Ethereum blockchain).

It is important to note that Ethereum Classic still uses the PoW consensus method, whereas Ethereum moved to a PoS consensus mechanism, commonly known as the Merge upgrade. The decision to switch to a PoS method is driven by the environmental concerns surrounding the PoW mining method. 

Prior to the planned Merge, a hard fork of the Ethereum network known as ETHW was created, still employing the PoW consensus mechanism. This resulted in a victory for ETH miners. Chandler Guo, a Chinese miner who opposed the PoS consensus method, launched the PoW-based Ethereum blockchain.

Token Standards On The Ethereum Blockchain

Technical Alert! – Ethereum holds different ERC tokens (Ethereum Request for Comment) that are akin to different types of digital items or assets created on the Ethereum platform. Ethereum token standards are guidelines that dictate how new tokens should be created on the Ethereum blockchain. Here’s A  brief on these token standards:

  • ERC-20 tokens: These tokens are fungible and can be exchanged with one another, signifying that each token inherently possesses the same value as the others.
  • ERC-721 tokens: Act as non-fungible tokens (NFTs), these unique digital assets are perfectly suited for representing digital art, collectibles, and in-game items, effectively showcasing their irreplaceable nature. There is only one Mona Lisa painting and like a painting, ERC-721 tokens are unique in nature that only one exists of its type. One of the earliest and most famous examples of an NFT is CryptoKitties, a blockchain-based game where users can buy, sell, and breed virtual cats with unique traits and characteristics. 
  • ERC-1155 tokens: Is often viewed as a hybrid of both the ERC-20 and ERC-721 token standard. This means that it allows for the creation of both fungible and non-fungible tokens, useful for developers creating unique and interchangeable items.

By offering a comprehensive suite of solutions, Ethereum strives to decentralize the internet, creating a network of computers that combine into a powerful decentralized supercomputer, enabling transparent and secure transactions without intermediaries such as banks or escrow services. 

Whereby this means a neutral or impartial third party whose role is to retain funds, assets, or documents until all pre-established terms are fulfilled, documented in a contract, ensuring that the agreement between the involved parties is honored.

How Does Ethereum Blockchain Work? 

Ethereum is more than just a cryptocurrency because of the many features it can provide its network users. At its origin, Ethereum’s PoW consensus mechanism relied on miners to secure the network and validate transactions; this gave it a highly decentralized image. 

As mentioned, Ethereum has migrated away from PoW to PoS. The reasoning behind this shift includes issues related to high energy consumption and centralization as stated by the media. BUT by sheer coincidence or not it also helped the Ethereum community scale, as this would not be possible on a PoW system like Bitcoin when operating smart contracts. 

Here’s an overview of Ethereum’s PoS consensus mechanism in six steps:

  1. Validators: PoS uses validators instead of miners. Validators are users who hold a certain amount of Ether and choose to stake it in the network. Recently Ethereum’s “Shanghai hard fork”, has been completed. This update allows users who staked their ETH for securing and validating transactions on the blockchain to withdraw their funds.
  2. Block proposals: Validators take turns proposing and validating blocks on the Ethereum blockchain. When it’s a validator’s turn to propose a block, they create a block with transactions and broadcast it to the network. 
  3. Block validation: Other validators then validate the proposed block, checking to make sure that the transactions are valid and that the proposed block adheres to the network’s rules. Validators can either vote to accept or reject the proposed block. They essentially check what the Block proposal is following the rules of the Ethereum network.
  4. Rewards and penalties: Validators who participate in block proposals and validation are rewarded with ETH. However, validators who behave maliciously, such as by proposing invalid blocks or trying to double-spend, are penalized by having their staked ETH slashed.
  5. Randomness: Ethereum PoS uses a randomness function to select validators who get to propose and validate blocks. The more ETH a validator has staked, the more likely they are to be chosen. This concept might give Ethereum’s lead developers significant control over the consensus mechanism, potentially leading to authoritarian decisions in the future.
  6. Finality: Once a block is accepted by the network and added to the blockchain, it is considered final. This means that transactions on the block cannot be reversed, which is an important property for decentralized applications.

Although Ethereum and its smart contracts are designed to be immutable, there are situations where contracts may need to be reversed due to errors or mistakes, including human error during the programming phase or incorrect data inputs. This has raised concerns about the immutability of smart contracts and sparked debates in the community.

Bitcoin vs Ethereum

Bitcoin and Ethereum are the most well-known cryptocurrencies, yet they hold notable differences in their underlying objectives and architectural design. The following points highlight some of these key differences::

What is the Ethereum Blockchain: A Beginner's Guide

Ethereum Wallets

Ethereum is a decentralized network of computers that work together to execute code or smart contracts. To interact with these contracts, users need Ethereum wallets , which are software or hardware tools that hold private keys and provide public addresses for sending and receiving Ether, the native cryptocurrency used on the Ethereum network.

There are two types of Ethereum wallets: full nodes and light nodes. Full nodes are also known as “full client” wallets and hold the entire blockchain history and verify transactions, while light nodes rely on third-party full nodes to get information when needed.  They are often referred to as “lightweight” or “thin client” wallets and are typically faster to sync and use less storage space.

Hardware wallets are the physical devices that store a user’s private keys offline. They are the most secure way to store Ether; however, unlike smart contract-powered wallets, hardware wallets can only send and receive Ether and ERC-20 tokens. Some examples include Ledger Nano and Trezor.

Software wallets are digital wallets that run on a computer (e.g, desktop wallets like Exodus and web wallets like MetaMask ) or mobile device (e.g., MyEtherWallet ) that stores the private keys for accessing cryptocurrencies online. 

Additionally, there are paper wallets, which are simply a printed copy of your private and public keys, which are then stored offline. While paper wallets are considered one of the most secure options, they are not as convenient for frequent transactions and require careful handling to avoid loss or theft.

Popular Ethereum dApps 

dApps, or decentralized applications are software programs that run on the Ethereum blockchain. They are designed to be decentralized which means they operate on a distributed network of computers rather than being controlled by a central authority. 

dApps can be used for a variety of purposes, including creating marketplaces, managing digital assets, and executing complex financial transactions through the integration of smart contracts.

Popular dApps On Ethereum  

Uniswap

Uniswap  is a decentralized exchange (DEX) built on the Ethereum blockchain that allows users to trade cryptocurrencies without the need for intermediaries. It uses an automated market-making (AMM) system and enables users to trade any ERC-20 token pair, earn rewards, and provide liquidity to the platform.

AMMs use a mathematical algorithm to determine the price of assets based on the ratio of the available tokens in a liquidity pool. Instead of relying on order books like centralized exchanges, AMMs automatically adjust the price based on the amount of assets being traded, providing liquidity to the platform and enabling decentralized trading without the need for intermediaries.

Aave Protocol 

The Aave  protocol which enables users to borrow and lend from a selection of over 30 Ethereum-based assets. Offering flexibility to choose between stable and variable interest rates, based on their preferences and market conditions. Whereby users can also obtain flash loans. In addition to traditional assets, Aave also offers pools for real-world assets such as real estate. The platform’s governance token, AAVE, allows users to participate in voting on Aave Improvement Proposals (AIPs).

OpenSea

OpenSea  is a peer-to-peer (P2P) marketplace for buying, selling, and discovering non-fungible tokens, including digital art, gaming items, collectibles, and other unique digital assets, using cryptocurrency.

Benefits Of Ethereum

Ethereum is a blockchain-based decentralized platform that has several benefits compared to traditional centralized systems. These include:

  • Versatility: Ethereum supports various functions like smart contracts, DApps, and DAOs, enabling innovation and collaboration across industries.
  • Cost and time efficiency: Smart contracts automate complex transactions, eliminating intermediaries and reducing expenses for businesses and individuals.
  • Enhanced performance: PoS system increases scalability, security, and energy efficiency, elevating the platform’s potential.
  • Continuous improvement: Developers actively work on updating Ethereum’s functionality and security, ensuring its competitiveness in the blockchain landscape.

 Disadvantages Of Ethereum

Ethereum, like any other technology, has its share of disadvantages including:. 

  • Rising transaction costs: As Ethereum’s popularity grows, transaction fees increase, potentially limiting access for small businesses and individual users.
  • Ether volatility: The unpredictable price of Ether can pose challenges for day traders  and long-term investors.
  • Scalability concerns: Ethereum must continuously adapt to accommodate the increasing demand for decentralized applications and smart contracts.
  • Ongoing development: Ethereum developers face the challenge of finding effective solutions to improve network performance and accessibility.

The Future Of Ethereum

Since Ethereum’s inception in 2015, questions have been asked about the future evolution of the protocol, particularly in addressing significant challenges such as scaling. Phase one known as the The Merge took place on September 19, 2022, and was an essential part of the development of Ethereum as it transitioned away from PoW to PoS consensus. By making this leap, the Ethereum Foundation is actively envisioning the state of Ethereum a decade from now. 

Ethereum’s development is undergoing a complex and lengthy transition to become a more robust, secure, and powerful version of its former self, ultimately enhancing its capabilities and potential impact to deliver scalability. Ehereum’s development roadmap, outlined by Vitalik Buterin, consists of five key phases that begin with the Merge. 

The second phase, called the Surge, aims to enhance Ethereum’s scalability through sharding, allowing it to process more data and become more cost-effective. The Verge phase involves the adoption of Layer 2 solutions, such as Optimism and zkRollups, to compete with traditional financial systems in terms of transaction throughput and efficiency. 

The Purge phase involves cleaning up Ethereum’s chain state to improve efficiency and reduce storage requirements, making it more accessible for individuals to run nodes. The final phase, the Splurge, focuses on improving the user experience for developers, attracting more innovative applications and solutions to the Ethereum platform.

The future of Ethereum is rich with innovation, development and promise. These advancements, whilst challenging, aim to address some of the network’s current limitations and transform Ethereum into a more scalable, efficient, and user-friendly platform for developers and users alike. As Ethereum continues to innovate, it will likely remain a dominant force in the blockchain and cryptocurrency space over the next decade.

FAQs

What is Ethereum? 

Ethereum is a decentralized blockchain platform that enables the creation of smart contracts and decentralized applications. 

What is a smart contract and how does it function on the Ethereum network? 

A smart contract is a self-executing agreement with the terms directly written into code. On the Ethereum network, these contracts are immutable, meaning once deployed they cannot be changed.

Why did Ethereum switch from proof of work to proof of stake, and how does it work? 

Ethereum switched to proof of stake to address environmental concerns and scalability issues associated with proof of work. In proof of stake consensus mechanism, validators, who hold and stake Ether, propose and validate blocks. Rewards are given for participation, while penalties are imposed for malicious behavior.

What are the examples of popular dApps on Ethereum? 

dApps, or decentralized applications, are software programs that operate on the Ethereum blockchain. They are autonomous and operate on a network of computers, which prevents central control. Examples of popular Ethereum DApps include Uniswap, a decentralized exchange; Aave protocol, a lending platform; and OpenSea, a peer-to-peer marketplace for non-fungible tokens (NFTs).

What are some advantages and disadvantages of Ethereum? 

Advantages of Ethereum include its versatility, cost and time efficiency, enhanced performance due to its PoS consensus mechanism, and ongoing improvement. Some disadvantages include rising transaction costs, Ether volatility, scalability concerns, and the challenges posed by continuous development.