Ethereum

Introduction

On July 30, 2015 the open-source platform and mining network Ethereum was launched. Developed by Vitalik Buterin, Ethereum is built on the concept of blockchain technology and aims to provide a protocol for creating decentralized applications. Even though the network has its own cryptocurrency, the Ether (ETH), Ethereum is much more than just a decentralized coin. In this article, we will discuss what Ethereum exactly entails, why it was developed, and what it strenghts and weaknesses are, in order to analyze whether Ethereum fulfills its promises. Furthermore, we will elaborate on the ether and on the governance of Ethereum.

History of Ethereum

Before Ethereum

Attempts at creating a form of decentralized digital currency were made as early as the 1980s and 1990s, before Bitcoin became the first truly successful attempt in 2009. Bitcoin combined existing ideas of using cryptography to manage ownership, with a consensus mechanism called ‘proof of work’ to keep track of changes in the currency’s ledger and to provide entry into the consensus process for everyone who desired to participate. Proof of work requires a computational effort from participants with full nodes to add blocks to the blockchain. 

In 2012, an alternative to proof of work was developed, called ‘proof of stake’. In a proof of stake consensus mechanism, the participants of full nodes have to ‘stake’ a certain amount of coins as collateral when they want to add blocks to the blockchain.

The Ethereum whitepaper

In 2013, two years before the launch of Ethereum, its concept was described in a whitepaper by Vitalik Buterin. This concept revolved around building decentralized applications, where there is no need for a central entity. Buterin’s main argument for creating such a concept was that Bitcoin and blockchain technology could benefit from it. Furthermore, he argued that a more robust scripting language was needed.

Behind the name

The name Ethereum was chosen by Buterin after he researched elements from science fiction on the internet. The name Ethereum contains the word “ether”, which is the hypothetical invisible space between objects in the universe. In a way, ether is the invisible backdrop of the universe, similar to what Buterin wanted his platform to be: an underlying basis for decentralized applications.

Development

In early 2014, the development of the software underlying Ethereum began. In the Ethereum Yellow Paper, the idea of including smart contracts in a blockchain was described. The money for the development was raised by an online public crowd sale during which those interested could buy an ether, the value token of Ethereum, with bitcoin. 

Before the official release of Ethereum, several prototypes were developed and tested. The last prototype, codenamed Olympic, also underwent a public beta pre-release, in which users could earn a set amount of ether for stress-testing the blockchain underlying the network.

Planned upgrades and the DAO

The development of the Ethereum network did not stop after its launch; the network has undergone several planned upgrades to its protocol, which are being carried out through a hard fork. One well known hard fork within the Ethereum network happened when a hacker stole $50 million of DAO tokens. The theft of these tokens ignited a debate in which voices were raised for Ethereum to carry out a hard fork and reappropriate the funds that were affected by the hack. Eventually, the hard fork was performed and the network split into Ethereum Classic, which continued on the original blockchain, and simply Ethereum, which continued with a blockchain in which the theft was reversed. 

Switch to proof-of-stake consensus mechanism

One of Ethereum’s biggest upgrades was its switch from a proof of work to a proof of stake consensus mechanism. The goal of this upgrade was to cut down on energy use, to improve transaction speed and to make transactions cheaper, consequently fixing some problems the network had been experiencing.

The network’s transition from a proof of work to a proof of stake consensus mechanism was planned out in Ethereum 2.0, a set of multiple updates. The first of three upgrades was carried out in December 2020, and the last upgrade, finalizing the switch to proof of stake, took place in September 2022. The price of Ethereum (ETH) dropped after the transition, but it has since recovered a little bit, albeit with great fluctuations.

After the switch

Despite the advantages, not everyone could appreciate Ethereum’s switch from proof of work (PoW) to proof of stake (PoS). When the merge was finalized in 2022, a miner created a forked version of the Ethereum blockchain that still runs on a PoW consensus mechanism. In this network, the validation process for miners is the same as in any proof of work system, with ETHW, the native coin of the ETHPoW chain, as reward. For miners, the creation of this fork was a victory, but from the start, this network experienced problems. After a few months, the price of ETHW is still at the very bottom, while the PoS Ethereum network enjoys much more popularity.

The Shanghai Upgrade

In March 2023, the next big upgrade for the Ethereum network is scheduled to be carried out: the Shanghai Upgrade. The main goal of this hard fork update is to implement an improvement proposal that allows validators to unlock staked ether that they have acquired since the switch to a proof of stake consensus mechanism. There are convergent opinions on what the consequences of this upgrade will be for the price of ETH. Some argue that the unlocking of staked ETH results in an increase in supply that will lower the price, while others expect the ability to withdraw quickly to encourage more people to stake ETH, which would reduce the supply and consequently increase the price. However, it is expected that there will not be any drastic changes on the short term after the Shanghai Upgrade.

Core values

The ideology behind Ethereum is to create a trustworthy, decentralized system that eliminates the need for trusting in a centralized third party, such as a bank of government. This desire to create a decentralized system is similar to the ideology behind the development of Bitcoin, which also strives to create a network free from trusted third parties. However, whereas Bitcoin was created as a decentralized currency, Ethereum was developed as a platform to build decentralized applications, which can include a digital currency but is not limited to this. Additionally, Ethereum has a more sophisticated programming language, enabling developers to build more complex decentralized applications on its network. The development of Ethereum was driven by the desire to provide a more flexible and versatile platform for decentralized app development than what was offered by existing blockchain technologies, such as Bitcoin. Some of the reasons why the developers of Ethereum sought to create a decentralized platform include:

1. Lack of flexibility: Existing blockchain technologies and centralized systems had limited capabilities for customizing and adapting to new use cases.
2. Centralized control: Centralized systems are susceptible to censorship, manipulation and control by a single entity.
3. Security concerns: Centralized systems are vulnerable to security breaches, hacking, and data breaches, as large parts of the data are stored in central locations or on central servers.
4. Intermediary reliance: Intermediaries are required to facilitate transactions and enforce agreements, creating a barrier to entry and increasing costs. Ethereum’s decentralized character eliminates the need for these intermediaries.

By providing a decentralized platform for building and deploying decentralized applications, Ethereum aimed to address these limitations and challenges and provide a more open, secure, and efficient way to build and interact with decentralized systems.

Ethereum aims to provide what its whitepaper calls “the ultimate abstract foundational layer”. This includes a versatile blockchain foundation with a built-in Turing-complete programming language, allowing anyone to create smart contracts and decentralized applications that have their own custom rules for ownership, transactions and state transition functions. A key value within this concept is creating a protocol that is suitable for applications where a quick development pace, security for small and little used applications, and efficient synergy between different applications are important.

By making use of a built-in Turing-complete programming language, Ethereum intends to provide a platform for the construction of a wide variety of systems based on blockchain technology, such as smart contracts, name coins, colored coins, and smart property. Ease of development and suitability for light client properties are important aspects in this process.

Advantages of Ethereum

The Ethereum network has a whole range of advantages, both compared to other decentralized networks as well as centralized systems that provide the same type of servives.

Decentralization

The Ethereum network eliminates the need for intermediaries and operates without a central authority, creating a network that is decentralized. Decentralized networks provide a variety of benefits. The first advantage of a decentralized network over a centralized system is that a decentralized network enjoys increased security; the data is not stored in a single location or on a central server, which are vulnerable to security breaches and attacks. Instead, the decentralized system of Ethereum relies on a distributed network of nodes to validate and process transactions, maintain the network state, and enforce rules and agreements. Each node holds a copy of the Ethereum blockchain, so an attack on one node does not jeopardize the network.

Decentralized networks also provide more transparency than their centralized counterparts, because there are no central authorities or intermediaries controlling the flow of information or transactions. Transactions and information are publicly visible and can be verified by anyone on the network, creating an auditable trail of all activity. This reduces the risk of fraud by central entities. In line with this, decentralization also has a reduced risk of censorship and manipulation. Especially in countries with strict regimes, freedom of censorship and government involvement is often limited. However, in a decentralized network it is harder for authorities to oversee and restrict activities.

Flexibility

Whereas the Bitcoin network is limited to the bitcoin digital currency, Ethereum provides a platform for building and deploying a wide range of decentralized applications and custom digital currencies. The built-in Turing-complete programming language allows developers to create all kinds of apps with their own rules for ownership, transaction formats, and state transition functions. With this, Ethereum moves beyond the scope of traditional financial transactions.

The use of smart contracts on the Ethereum network also provides greater flexibility, as these automated agreements can be programmed to execute actions based on specific triggers and conditions. This enables the creation of complex decentralized applications and services that can interact with each other and with the outside world.

Smart contract functionality

The Ethereum network can be used to create smart contracts, which have several benefits over traditional contracts. The main advantage of using smart contracts is that they are self-executing, meaning they automatically enforce the terms of the agreement once certain conditions have been met. This eliminates the need for intermediaries or intermediating processes, reducing the risk of errors and fraud.

Smart contracts on the Ethereum network are also transparent and auditable, as the code is publicly visible and the execution of the contract is recorded on the blockchain. This creates a tamper-proof and secure record of all transactions, ensuring that all parties have equal access to information.

In addition, smart contracts on the Ethereum network can interact with other smart contracts and with the outside world, making them ideal for building complex decentralized systems and applications. This opens up new possibilities for creating innovative and efficient solutions across a wide range of industries, from finance and insurance to supply chain management and more.

Interoperability

One of Ethereum’s key aims and advantages is its interoperability; decentralized applications built on Ethereum can interact with each other and with application from outside of the network, creating a unified ecosystem of decentralized systems. In the Ethereum network, interoperability is enabled through the use of common protocols, such as the Ethereum Virtual Machine (EVM), and the development of common standards, such as the Ethereum Request for Comment (ERC) standards.

Interoperability also opens up new opportunities for creating decentralized solutions and services, as different systems can leverage each other’s capabilities and build on top of existing solutions. This creates a more efficient and dynamic ecosystem of decentralized systems, where new solutions can be developed and deployed more quickly and at lower cost.

Security

Finally, the Ethereum network uses cryptography and consensus algorithms to secure its blockchain, making it resistant to tampering and hacking. Furthermore, the Proof of Stake consensus mechanism used by Ethereum provides security, as it is more difficult and expensive for a malicious actor to control a significant portion of the network’s stake.

In addition, the Ethereum network is designed to be decentralized and distributed, with no single point of control. This eliminates the risk of a single point of failure, making the network more resilient and resistant to attacks.

The Ethereum network also benefits from its large and active community of developers and users, who continuously monitor and improve the network’s security. The Ethereum network is constantly evolving, with new security upgrades and improvements being developed and deployed regularly.

Disadvantages of Ethereum

Complexity

The Ethereum network is complex and requires a high level of technical expertise to understand and use. This can make it challenging for users with limited technical knowledge to participate in the network. However, there are more user-friendly wallets and interfaces that allow users to interact with the Ethereum network without needing to understand the underlying technology. Additionally, there is a growing ecosystem of decentralized applications (dapps) that are designed to be user-friendly and accessible to a wide range of users.

Regulatory risks

While a decentralized network’s freedom from censorship by authorities is one of its key strengths, it also poses a challenge. The decentralized nature of the Ethereum network makes it difficult for governments to regulate and control. This could result in regulatory risks, such as the possibility of the network being banned in certain jurisdictions. For example, there have been concerns about the use of the Ethereum network for illegal activities, such as money laundering, tax evasion, and fraud. As a result, some governments may take action to regulate the use of Ethereum and other cryptocurrencies in order to prevent these activities.

Scalability issues

The Ethereum network has faced scalability issues in the past and may continue to face scalability challenges in the future. Scalability refers to the ability of a network to handle increasing amounts of transactions and data as the network grows.

One of the main scalability issues faced by the Ethereum network is the size of its blockchain, which has grown significantly since its launch. As the blockchain grows, it takes longer to validate transactions and mine blocks, resulting in slower transaction times and higher fees. Ethereum’s switch from proof of work to proof of stake has to help in tackling this issue.

Proof of Stake

What is Proof of Stake?

The Proof of Stake (PoS) consensus mechanism is both an advantage and a disadvantage of the Ethereum network and therefore deserves its own section. The switch from proof of work (PoW) to proof of stake has not been an undisputed decision. In this section, we will briefly highlight how a proof of stake consensus mechanism works, and what its advantages and disadvantages are for the Ethereum network.

In a proof of stake system, validators are chosen to validate transactions and secure the network based on the amount of stake they hold in the network, rather than the computational power they contribute, as is the case with proof of work. This incentivizes validators to act honestly and in the best interest of the network, as they have a financial stake in the network’s success.

Advantages of Proof of Stake

Ethereum’s switch to a proof of stake (PoS) consensus mechanism has several advantages over networks that operate based on a proof of work consensus mechanism. PoS is designed to be more energy-efficient and environmentally friendly, because it requires significantly less computational power to validate transactions and secure the network.

PoS also enables faster and more efficient block production, as validators are selected randomly and are able to validate transactions more quickly and efficiently than in a PoW system. This results in a more scalable and efficient network, capable of processing more transactions per second, which increases transaction speed and capacity, and lowers transaction fees.

Disadvantages of Proof of Stake

However, critics of the switch to proof of stake worry about the risk of centralization: validators are chosen based on the amount of stake they hold, which means that those with larger stakes have a higher chance of being selected as validators. This could result in the centralization of the network, with a small number of large stakeholders controlling the validation process. Since the decentralized character is key to Ethereum’s existence, the risk of centralization is a serious threat.

Governance of Ethereum

The governance of Ethereum refers to the process of making decisions about the future development and direction of the Ethereum network. This includes decisions about changes to the network’s protocol, the allocation of funds for development and research, and the prioritization of various projects and initiatives.

Ethereum is a decentralized network, meaning that no single entity controls it. Instead, decisions about the network are made through a consensus-based process, involving a diverse group of stakeholders, including developers, users, and investors.

One of the key elements of Ethereum’s governance is its open-source nature, which allows anyone to contribute to the development of the network and propose changes. Decisions about changes to the network are made through a process of community discussion and voting, typically involving a proposal and voting process conducted through the Ethereum Improvement Proposal (EIP) process.

In recent years, the governance of Ethereum has become a more formalized process, with the establishment of organizations such as the Ethereum Foundation and the Ethereum Alliance, which play a role in coordinating and facilitating decision-making about the network.

Ethereum Improvement Proposal

The Ethereum Improvement Proposal (EIP) process is the mechanism through which proposed changes to the Ethereum network are discussed, reviewed, and ultimately decided upon.

The EIP process typically follows these steps:

1. Proposal: A person or group of people submits a proposal for a change to the Ethereum network through an EIP. This proposal should include a detailed description of the change, including the motivations behind it, as well as any potential impact on the network and its users.
2. Discussion: The proposal is then open to public discussion, with members of the Ethereum community providing feedback, raising concerns, and suggesting modifications. This stage is important for ensuring that proposals are well-understood and that any potential problems are identified and addressed.
3. Implementation: If the proposal is deemed to have merit, a developer may then implement the change and create a pull request on the Ethereum Github repository.
4. Review: The implementation is then reviewed by other Ethereum developers and members of the community to ensure that it meets the required standards and that it works as intended.
5. Voting: If the implementation is deemed to be of high quality, it is then submitted for a formal vote, which may involve a public poll of the Ethereum community.
6. Adoption: If the proposal receives enough support from the Ethereum community, it is then adopted and included in the next Ethereum network upgrade.

Ethereum’s native currency: the ether (ETH)

While the Ethereum network was not developed solely for cryptocurrency, it does come with its own native currency: the ether (ETH). The ether is used as a form of payment for transactions on the network, as well as for the creation and execution of smart contracts.

Mining of ether

More ether can come into circulation through the process of mining. In the early days of the Ethereum network, miners were incentivized to validate transactions and secure the network by being rewarded with newly minted ether.

However, with the transition to the Proof of Stake consensus mechanism, the process of mining has been replaced by the process of staking, in which validators are incentivized to participate in the network by being rewarded with a portion of the fees generated by transactions and smart contracts.

Another way that new ether can enter into circulation is through the process of issuance, in which the Ethereum Foundation, the entity responsible for the development of the Ethereum network, may choose to release new ether into circulation to support network development and growth.

The difference between ether and bitcoin

Ether and bitcoin are two of the most well-known cryptocurrencies in the market, each with their unique characteristics and purposes. While both use blockchain technology and are decentralized, they differ significantly in terms of their goals, design, and capabilities.

One of the main differences between ether and bitcoin is that ether is not just a digital currency, but also a fuel for the Ethereum network. This means that in order to execute smart contracts and run decentralized applications on the network, users must pay a fee in ether. This fee, known as “gas,” is used to compensate the network’s nodes for the computational power they provide in processing transactions and executing smart contracts. However, the ether can also be used outside of the platform, with various online and offline merchants.

Another difference between ether and bitcoin is that the ether does not have halvings like bitcoin. The process of halving in Bitcoin is a mechanism to control its inflation and limit the amount of new Bitcoin that can come into circulation. In Ethereum, there is no set limit on the total supply of ether, and new ether can continue to be generated through the process of staking. The Ethereum network is designed to have a controlled rate of inflation, with the issuance rate decreasing over time, but there is no predetermined limit on the total amount of ether that can come into circulation.

Ethereum burn fee

To induce some kind of scarcity for the ether, Ethereum uses a concept called a “burn fee”.

In Ethereum, every time a transaction is processed on the network, a fee is charged. This fee is called the “gas fee,” and it is paid in ether. The gas fee is used to compensate the network’s miners for their computational work in processing the transaction.

In addition to the gas fee, there is also a concept called “burning” in Ethereum. When a transaction is processed, a portion of the gas fee is not given to the miner but is instead destroyed, or “burned.” This portion of the gas fee is known as the “burn fee.”

The purpose of the burn fee is to reduce the total supply of ether over time, which intends to increase the value of ether by making it a scarcer resource. Burning also helps to prevent spam and other malicious activity on the network, as it makes it more expensive to send large numbers of transactions.

The burn fee is determined by the Ethereum network itself, and it varies based on the level of network congestion at the time of the transaction. When the network is congested, the burn fee will be higher, as the demand for processing transactions is greater.

Overall, the Ethereum burn fee is an important mechanism in the Ethereum ecosystem, helping to incentivize miners to process transactions while simultaneously reducing the total supply of ether and promoting network security.

Conclusion

Ethereum is a decentralized platform designed to eliminate the need for trusted centralized third parties. It provides a more flexible and versatile platform for decentralized app development than existing blockchain technologies. The network offers advantages such as decentralization, flexibility, smart contract functionality, interoperability, and security. Decentralization provides increased security and transparency, and the use of smart contracts and a built-in Turing-complete programming language allows for greater flexibility and the creation of complex decentralized applications.

However, the Ethereum network also faces challenges such as complexity, regulatory risks, and scalability issues. The network requires a high level of technical expertise to understand and use, and its decentralized nature makes it difficult for governments to regulate and control. Additionally, the Ethereum network has faced scalability issues in the past and may continue to do so in the future. Finally, the switch from proof of work to proof of stake may pose a risk of centralization.

Overall, the Ethereum network offers a unique and powerful platform for the development of decentralized applications but also faces several challenges and risks that must be addressed. It sure holds great potential for a future in which there is a larger role for blockchain technologies and decentralized networks in creating a better and free world for everyone.