In 2018, the first major boom of cryptocurrencies took place: that’s when the general public learned about digital assets, and new projects were emerging every day. A considerable part of initial coin offerings, or ICOs, was carried out on Ethereum — and since then, the platform has played a key role in the crypto market. It’s home to hundreds of services, its founder is one of the most influential people in the industry, and for many, the ETH coin has become an asset as important as Bitcoin.
In this introductory article, we will break Ethereum down. You will learn about DApps, smart contracts, and their use cases. We will explain the issues of Ethereum and how the platform is to become more scalable and accessible with the transition to Ethereum 2.0, or Eth2.
To start, let’s cover a few concepts essential for understanding Ethereum.
Ethereum is a distributed computing environment, a blockchain that allows developers and businesses to create decentralized applications, or DApps. The founder of Ethereum Vitalik Buterin calls it a “world computer”: it’s a network of thousands of nodes that share and simultaneously update information about transactions in this network. To validate a transaction, all nodes have to agree upon it — and given the size of the network, approving a wrong or malicious transaction is close to impossible in Ethereum.
Ether, or ETH, is a native coin that serves as a means of payment for every transaction in the Ethereum network. Since ETH has become a second-largest crypto asset, it’s used by many as an investment tool.
DApps that run on Ethereum resemble regular applications, but they are based on blockchain and leverage its security and immutability. On the contrary, “traditional” apps that we use in daily life are run on centralized servers and are fully controlled by single entities.
The major technology that has made Ethereum widely used is a smart contract — a contract written in code that executes automatically without human intervention. Users set conditions, and once they are fulfilled, the deal self-executes. Pretty much everything that Ethereum has runs on smart contracts. For DApps, such contracts serve as backend. Developers write DApps using a tool called Ethereum Virtual Machine, or EVM.
How DApps and smart contracts work
One of the biggest DApps on Ethereum is Uniswap, a decentralized exchange that allows users to swap Ethereum-based tokens. First, each of these tokens is based on its own smart contract. Second, in Uniswap, there are liquidity pools that also run on smart contracts. In these pools, users lock their funds (liquidity) so that others can exchange their tokens. Each pool’s smart contract sets rules for such exchanges.
Smart contracts enable tons of use cases for Ethereum, the main of which are:
- Decentralized finance services — blockchain-based borrowing and lending (Compound, Aave), decentralized token exchanges (Uniswap, Sushiswap).
- Blockchain-based games and their native tokens (Axie Infinity, Sandbox, Decentraland).
- NFT marketplaces (OpenSea, Rarible).
Here are the advantages of smart contracts:
- They are trustless. Unfamiliar users don’t have to trust each other to interact: they only have to believe that the smart contract operates properly. Good protocols and their contracts are trusted by the community and are proven to be secure through audits.
- They are irreversible, immutable, and transparent. As soon as the contract’s conditions are met, the deal will execute without the possibility to reverse. Its records will stay in the blockchain forever, and everyone can see them.
- They offer clear rules of the game. In regular contracts run by people, there is always room for maneuver regarding what parts of the deal to execute and how. Disputes are resolved in court. In smart contracts, all conditions are clearly described, and once they are fulfilled, the deal executes according to the “all or nothing” principle.
Ethereum gas and transaction fees explained
Currently (and supposedly until mid-2022), Ethereum is running on the Proof of Work consensus algorithm — like in Bitcoin, Ethereum miners compete with each other in computing power for the right to validate transactions and get block rewards.
The power necessary for a miner to validate a transaction is called gas, and the price you pay to the miner for their work is called gas price. If we multiply the two, we get the transaction fee. The average fee in Ethereum is pretty high and varies between $2–5 and all the way up to $50–80 at times of big network congestion. Fees in Ethereum are paid in ETH coins but are denoted in gwei (or gigawei, which is 1*10^-9 ETH).
Although the system suggests an optimal transaction fee automatically, you can add a miner tip to make miners more incentivized to process your transaction as fast as possible.
Ethereum vs Bitcoin
In 2013, Vitalik Buterin proposed to enlarge the functionality of Bitcoin by adding smart contracts, but the community said no. This is how Ethereum was born — a dedicated platform with improved transaction speed that allows building DApps and tokens on top of it.
Ethereum and ICOs
When the crypto markets started mooning in 2017–2018, Ethereum became the main platform for ICOs, or initial coin offerings. Crypto enthusiasts were proposing ideas for new blockchain projects and raising money for their implementation. This is how many notable projects that we know today emerged: EOS, another DApp platform, raised $185 million over 5 days and $4B in total; Brave web browser attracted $35 million in 30 seconds. NEO and IOTA also had an ICO in those days.
Money was raised in ICOs throughout 2017
However, due to poor regulation of ICOs, it turned out that many of them were scams. Later, projects started to raise their first money in different ways, but Ethereum has never lost its significance after the ICO boom.
Why Ethereum 2.0? Scalability, security, and sustainability
As mentioned above, Ethereum was a huge step forward compared to Bitcoin: it accelerated mining to just 10–20 seconds and introduced new robust functionality. However, Ethereum could still only process no more than 15 transactions per second (TPS), while the demand for smart contracts was rising. The platform’s throughput couldn’t meet it, and the blockchain often got congested, which caused frequent surges in fees.
Ethereum 2.0 aims to solve this: the new network’s configuration will allow it to handle up to 100,000 TPS with improved security. The first step towards Eth2 is switching from the Proof of Work consensus to Proof of Stake. PoW currently used in Ethereum is very energy-consuming: miners engage enormous computing power in their competition, but only one of them ultimately mines a block. Others still contribute to the network’s security, but the waste of energy is nevertheless too high.
In PoS, there are stakers instead of miners. Everyone staking at least 32 ETH gets a reward, and stakers are one by one assigned the right to validate a block. By eliminating miners’ competition, PoS drastically reduces energy consumption in Ethereum, making it more sustainable and scalable without harming security. If a user doesn’t have 32 ETH but still wants to participate, they can become a pool validator — join hands with other users and receive a share of rewards.
There are 3 key elements in Ethereum 2.0 that are to be rolled out consecutively.
- Beacon chain. This is the Ethereum blockchain that runs on the PoS consensus. Its implementation is referred to as Phase 0 of the Eth2 roadmap, and the chain has already been launched. However, the main Ethereum chain remains PoW at the time of writing.
- Merge. This is an event scheduled for 2022 when the PoW Ethereum 1.0 mainnet will merge with the Beacon chain, and the platform will mark the full transition to PoS. The Merge will open the door for the implementation of sharding.
- Sharding. This is the key solution for improving Ethereum’s throughput (scalability). Sharding spreads Ethereum across 64 separate shard chains that run in a relatively autonomous way. This allows processing far more transactions than originally.
The beacon chain will become the core of the system and will coordinate shard chains. PoS makes such a structure possible — running 64 chains on PoW would require unprecedented amounts of energy, and it would be hard to maintain operation of so many miners. The security of such a system would be flawed.
Ethereum hard forks: from Berlin to Altair
Besides implementing the 3 concepts of Eth2 listed above, the transition to PoS implies a few updates that bring the network closer to the ultimate goal. These are hard forks — radical changes in the protocol’s functioning that make the previous version of the blockchain obsolete and require all nodes to update their software.
In 2021, 4 hard forks took place to prepare the current Ethereum mainnet for the Merge with the beacon chain.
The Berlin hard fork was rolled out on April 15 and included 4 Ethereum Improvement Proposals, or EIPs — propositions that are put forward by developers and are actively discussed in the community. EIPs of the Berlin hard fork reduced fees for some transactions and made DoS attacks on Ethereum more complicated.
The London hard fork took place in August and consisted of 5 proposals. The most significant one of them, EIP-1559, aimed to make fees in Ethereum cheaper and more predictable.
Before this update, transaction fees were defined in an auction: users proposed a fee based on the network congestion data. The high demand for transactions pushed the fees up significantly. EIP-1559 removed the auction system and instead, introduced the base fee: now, gas price is determined automatically and changes very little from block to block, eliminating sharp increases in gas price.
Another side of the EIP-1559 enraged miners: it prescribed to burn the base fee, thus slashing a big part of their rewards. Miner tips were also introduced: users could now add tips to the base fee to promote their transaction, and these tips would reach miners. Fee burning is meant to protect ETH from inflation by creating deflationary pressure on the coin.
Another proposal in the London update was the EIP-3238 introducing the “difficulty time bomb.” This is an algorithm that will once activate, making Ethereum mining obsolete since it will become too difficult and cost-ineffective to mine ETH. This move aims to disincentivize miners and push them to engage in staking.
The Altair update in October 2021 facilitated the upcoming Merge for the beacon chain, enabled support for “light clients” to promote decentralization, and set penalties for inoperative nodes. Finally, the Arrow Glacier hard fork in December delayed the activation of the difficulty time bomb for June 2022. This means we will see Ethereum fully switch to PoS not earlier than this summer.
The way Ethereum grew over the past 6 years is a tremendous success for its founders. However, Vitalik Buterin who is now the youngest crypto billionaire doesn’t seem to be a person for whom personal wealth is of critical importance: rather, improving the Ethereum ecosystem is his priority. His approach and the transparent work of hundreds of developers have helped Ethereum gain trust in the crypto community, and the ongoing transition to Eth2 will help retain this trust and ensure the platform’s competitiveness for years to come.