Image: Shutterstock

Okay, WTF Is Ethereum?

ByDaniel OberhausandJordan Pearson

A beginner’s guide to the world’s second most popular cryptocurrency.

Image: Shutterstock

By now, chances are pretty good that you've heard of bitcoin, the cryptocurrency unleashed on the world in 2009 by a mysterious person or group that goes by Satoshi Nakamoto. Maybe you've heard it's the currency that fuels massive darknet drug markets like the now-defunct Silk Road. Or maybe your encounter with the cryptocoin was more benign and you saw one of the weird looking bitcoin ATMs in a convenience store.

But unless you're already pretty involved in the cryptocurrency world, you may not have heard of ethereum, the second largest crypto asset that's recently been giving bitcoin a run for its virtual money. Even if you have heard of ethereum, you may be at a loss when it comes to explaining how it differs from bitcoin.

In either case, you've come to the right place.

WHAT IS ETHEREUM?

Ethereum is often touted as a "world computer."

What that fancy language really means is that ethereum is a platform for the creation of decentralized applications (dapps), using what are known as smart contracts. Smart contracts are bits of code that automatically execute an action after certain requirements have been met—say, sending a slice of an app's profits to investors after a predetermined date has passed. Bitcoin has smart contracts, too, but ethereum makes them really easy to use since they're baked into the system's design.

All of this takes place on a blockchain, which bitcoin uses, too. All a blockchain does is act as a public ledger that lists everything that goes on in the network in real-time. It's the tool that makes the whole thing possible. The blockchain, and thus the ethereum network, is distributed across thousands of computers (or "nodes") around the world. It's also "Turing complete," which means that smart contracts on the blockchain can handle most computational functions, allowing them to be pretty sophisticated.

For example, say that I want to send my colleague Jordan some money. I would register this contract between myself and Jordan on the blockchain and the ethereum network would automatically facilitate the exchange of money. Since the blockchain is a public ledger, anyone and everyone can see that this transaction happened.

You may have heard that bitcoin is relatively anonymous, since people are identified by cryptographic addresses, not their names. Ethereum is similar. Unless Jordan or I decide to broadcast our identities on the network, no one will know who executed that transaction—they'll just see that a transaction for X amount of money occurred at a given time.

If you want to take a look at what's happening on the ethereum blockchain for yourself, you can check out all the transactions on the ethereum network, or look at a particular user's history, at any time using a tool called Etherscan.

WHO MADE ETHEREUM?

Ethereum was invented by Vitalik Buterin, a Canadian computer programmer born in Russia who cut his teeth on bitcoin as a teenager. In 2013, Buterin published the white paper that would lay the foundations for the ethereum network. He was only 19 years old at the time, which is why he is often hailed as as a boy genius.

In 2014, Buterin hosted a crowdsale to fund the launch of ethereum and raised 18 million dollars through his Swiss company, the Ethereum Switzerland GmbH. On July 30, 2015, the first (or genesis) block of data on the blockchain was created and the ethereum network was born.

It's early days for ethereum, and Buterin is still leading the bulk of development work. He has a team of programmers behind him, however, and the ethereum community is fairly active when it comes to sharing ideas about what should come next. Buterin still holds most of the influence, although he told Motherboard in an interview that he is already thinking of reducing his role and getting others to take up the mantle.

Vitalik Buterin, inventor of ethereum. Image: Wikimedia Commons

HOW IS ETHEREUM DIFFERENT THAN BITCOIN?

The short answer is: ethereum can do a lot more. Bitcoin was created to be a decentralized currency that would be an alternative to the centralized banking systems and fiat currencies of national governments. Both ethereum and bitcoin are based on a blockchain and have their own currencies, and like bitcoin, ether (ethereum's currency) can be used as virtual money.

But because the ethereum network also functions as a global computer thanks to smart contracts, this ether isn't limited to being used as a currency. Rather, ether can be used to underpin any sort of computer application you can imagine. The use cases for the ethereum network are only limited by the imaginations of application developers. For example, people are developing apps for energy distribution, digital advertising, and a digital marketplace for unused computing power.

Ethereum also promises to be even more decentralized than bitcoin. The method that bitcoin uses to upload blocks of data to the blockchain, called "mining," pits people against each other in a race to be the first to complete a useless math problem. All this does is waste resources, but the computational effort ensures that only serious people are contributing. In return, miners get a reward in bitcoin. This is called "proof of work."

Because of this requirement, bitcoiners are using increasingly powerful (and expensive) computer chips, preventing most normal folks from participating. Ethereum's mining scheme, on the other hand, was designed to be "memory hard," which means that using more powerful chips won't improve your chances of being the first to win the race. In practical terms, this means that individuals will always to be able to use their home computers or low-cost chips to mine ether. Ethereum miners are also rewarded with ether.

However, bitcoin will always be based on wasting computational resources in this way, but ethereum is already planning to move away from the "proof of work" mining system to something called "proof of stake"—more on this later.

WHAT IS ETHER?

The ethereum network runs on a crypto asset (sometimes called a cryptocurrency) called ether, which is abbreviated ETH.

Ether is how people pay for things in the ethereum network. For example, when someone invests in a new ethereum app, they do so by sending ether to the developers. Ether's value is determined by a market where people buy and sell it for real-world money. Like bitcoin, new ether is mined by people using their computers to complete useless math functions that prove they did some work.

At the moment there are about 90 million ether in circulation. No more than 18 million ether are newly minted each year. While bitcoin has a hard cap on the number of coins that will ever exist, ethereum has no predetermined limit for the total number of coins that will be in the network years from now.

But that doesn't mean new ether will be entering the system at that rate forever. Soon, ethereum will change the method it uses to mine new ether, which will in turn cause the cap of newly issued ether to be restricted. As for how much lower the cap will actually be, ethereum's website simply says it's still being researched.

WHAT IS GAS?

Gas is the "fuel" that runs the ethereum network. The value of gas is determined by the cost of computation for an action the network performs—basically, everything that dapps and smart contracts do cost gas. This ensures that nobody does work for nothing, and discourages inefficient code.

Gas is paid out in ether, and currently the value of gas is a tiny, tiny fraction of ETH. The reason that ether itself isn't the fuel for ethereum is that the price of ETH can change based on market demand. It wouldn't be good for anybody if the cost of performing actions on the network was suddenly unaffordable because ETH had a good week. Instead, gas will always be pegged to the actual cost of computation, and paid out in ether.

HOW IS ETHER BOUGHT AND STORED?

Just like in bitcoin, users on the ethereum network need a wallet in order to buy, sell, and hold ether.

Unlike a wallet you use for cash in the real world, ethereum wallets don't actually contain any of your cryptocurrency. Rather, all cryptocurrency is floating around in the blockchain network itself. Wallets are just an address that you use to register your transactions on the blockchain and signal to everybody else that you own some of that cryptocurrency.

When you create an ethereum wallet, just like in bitcoin, what you're really doing is creating a pair of unique cryptographic keys. The public part of the key pair is your wallet address, which others can use to send you ether. The second half of the key is secret, and known only to you. This secret key allows you to move the ether that is associated with your wallet address on the blockchain.

A good way to do this is by creating a 'paper wallet' on a service like myetherwallet, which will generate a public and private key that you can then print and store in a safe location. A more secure method, however, is to use a hardware wallet like the Nano Ledger or Trezor, which allow you to store your keys offline and away from hackers. Fair warning: If you lose your paper or hardware wallet, you've lost your private key. This means you've lost all the ether in your wallet forever. There is no possible way to recover it.

You can buy more ether using real-world money on sites known as "exchanges." These are kind of like stock markets for cryptocurrencies. One popular site is called Coinbase, which is part exchange, and part wallet service that lets you store your ether. On Coinbase, instead of having to remember your keys, you just need to remember your email and password.

This sounds easy, but it can be dangerous. Coinbase actually stores your private key, which allows their service to be very user-friendly, but could mean disaster for you if hackers ever compromise their site and take your key. That would allow them to steal your cryptocurrency. If you do use Coinbase, use an application like Authy or Google Authenticator to make it a bit more difficult for the bad guys.

WHY SHOULD I CARE ABOUT DECENTRALIZED APPS?

The main selling point of decentralized applications, or dapps, on the ethereum network is that they can be run without a central authority facilitating the transactions.

In a centralized system, like, say, Facebook, there is one central point of control—and of failure. If Facebook's company-owned servers go down, so does the site. But on a decentralized model, each node on network is both a server and a client, which means that if any one node gets taken offline, the platform will still be able to keep on trucking. To take down the ethereum network completely, you'd have to take down the 30,000 nodes around the world that comprise the network—that's not likely to happen.

Dapps, because they're based on smart contracts, also allow for a relatively easy model of collective ownership and even governance using what are known as "tokens." Tokens are kind of like shares in a corporation, and are sold by dapp owners to eager investors during Initial Coin Offerings, or ICOs.

WHAT IS AN INITIAL COIN OFFERING (ICO)?

Initial Coin Offerings (ICOs) are essentially the blockchain equivalent of Initial Public Offerings (IPOs), when a company issues its first shares to investors. But in ethereum, they're called "tokens." It's important to note that buying tokens in an ICO is not the same thing as owning stock in the company. Rather, these tokens have specific utility relative to the company's function. Often, they may allow token-holders to vote on company decisions or get a share of the profits.

Over the last few months, the number of ethereum ICOs has skyrocketed. Many of the ICOs have managed to raise tens of millions of dollars in just a matter of minutes (or occasionally, a matter of seconds). This has become a point of concern for the ethereum community, who worry that ICOs will essentially function like Kickstarter—purely a method of raising startup capital. This isn't a bad thing in and of itself, but many ICOs have been funded without deploying a single line of code, leading some to worry that bad actors could get funded and eventually screw investors.

WHAT IS ETHEREUM CLASSIC?

The largest ICO in history was the Decentralized Autonomous Organization (DAO), an ethereum venture capital fund that managed to raise $150 million before a previously unknown glitch in the smart contract saw an anonymous attacker run off with $55 million.

To fix this, ethereum implemented a hard fork, which saw the currency split into two versions, each with their own blockchains. On the new version of ethereum, the hacker's stolen funds were invalid. This was a controversial decision, since the blockchain's great virtue is that it's supposed to be unchangeable, and a group of stubborn enthusiasts kept using the old version of ethereum, eventually rebranding it as its own currency: Ethereum Classic.

Ethereum Classic is still chugging along, and it stands as a testament to how nobody really knows what's going to happen next in the world of cryptocurrency.

WHAT IS PROOF OF STAKE AND WHY DOES IT MATTER?

As of March, ethereum is on the second version of its network, called Homestead. At some point in the future, it will be transitioning to the fourth version of ethereum called Serenity, which will shift the network from a Proof of Work (PoW) model to a Proof of Stake (PoS) model.

For now, mining ether requires demonstrating that miners have actually done the wasteful computations necessary to add a new block on the chain. Although this prevents spam attacks on the network, it's also incredibly resource intensive and makes it hard for ethereum to scale. Bitcoin, unlike ethereum, is locked into this system forever.

Proof-of-Stake, on the other hand, doesn't require miners to do useless math in a race to solve a block. Rather, the creator of each new block on the chain is chosen by an algorithm, based on the amount of of ether that the user has—or, stake. The larger your stake, the more likely you are to be chosen to validate a new block. Under PoS, there is no longer a reward for creating a new block. Rather, the user responsible for creating the new block—called a forager—is rewarded with the gas associated with that block.

PoS will also drastically reduce the amount of electricity required to perform a transaction on the blockchain. For example, Bitcoin still operates on a PoW model and the energy required for a single bitcoin transaction required the same amount of energy that 1.5 American households use every day. The PoS model is a more green, sustainable alternative.

Now that you're all brush up on the basics, take a deeper dive into the world of cryptocurrencies with Motherboard's Primer on Bitcoin and Ethereum.

Correction: A previous version of this article stated that the ethereum network would switch to Proof of Stake during the third version of its network, Metropolis. The transition to PoS will actually occur during the fourth version, Serenity. Motherboard regrets the error.