What is Ethereum and how does it work?

What is Ethereum and how does it work?

Ethereum is a type of digital currency or cryptocurrency, a medium of exchange that exists exclusively online. Ethereum is among the most popular cryptocurrencies and ranks second in total size (as of October 2021), behind Bitcoin, a coin that has become synonymous with crypto.

Cryptocurrency has created a lot of controversy, from those hailing it as the world’s next payment system to those who simply view it as a speculative bubble. Here’s what Ethereum is and how it works.

What is Ethereum?

Ethereum is one of thousands of cryptocurrencies that have sprung up over the past few years. As the brainchild of 8 co-founders, Ethereum debuted in 2015. The cryptocurrency or platform is called Ethereum, while the individual unit is called an ether (2 ether, 17 ether , etc)

Ethereum operates on a decentralized computer network, or distributed ledger called blockchain, which manages and tracks the currency. It can be helpful to think of a blockchain as a running receipt of every transaction that has ever taken place in cryptocurrency. Network computers verify transactions and ensure data integrity.

This decentralized network is part of the appeal of Ethereum and other cryptocurrencies. Users can exchange money without the need for a central intermediary such as a bank, and the lack of a central bank means the currency is almost self-sufficient. Ethereum also allows users to transact almost anonymously, even if the transaction is publicly available on the blockchain.

Although the entire domain is referred to in terms of currency, it may be more useful to think of crypto as a token that can be spent for a specific purpose enabled by the Ethereum platform. For example, sending money or buying and selling goods are functions enabled by the coin. But Ethereum can do much more, and it can also form the basis of smart contracts and other applications.

What does Ethereum do?

Ethereum can power a number of applications offering a wide range of functions:

  • Change: With a cryptocurrency wallet, you can send and receive ether or pay for goods and services, if digital currency is accepted as payment. Some platforms, such as Coinbase, even allow you to store your coins in a digital wallet, making them less exposed to hackers, in theory.
  • Smart contracts: Smart contracts are a kind of permissionless application that automatically runs when the terms of the contract are met.
  • Digital applications or dapps: Ethereum powers digital applications that allow users to play games, invest, send money, track an investment portfolio, track social media, and more.
  • Non-fungible tokens: These tokens can be powered by Ethereum and can allow artists or others to sell artwork or other items directly to buyers using smart contracts.
  • Decentralized finance: By using Ethereum, some people may be able to avoid centralized (governmental) control over the movement of money or other assets.

Again, it might be more accurate to think of Ethereum as a token that powers various applications rather than just a cryptocurrency that allows users to send money to each other.

Where do ether coins come from?

In October 2021, there were approximately 118 million ether. And although new coins can be “mined”, the total annual issuance is limited. This is in stark contrast to Bitcoin, where a maximum of 21 million coins can be mined and new minting gets harder every year. And this contrasts even more with Dogecoin, where the issuance is completely unlimited.

Ether coins and those of other cryptocurrencies are “mined” by computers in the network. They perform mathematical calculations that effectively unlock coins or fractions of coins.

However, this configuration is changing. Bitcoin and Ethereum blockchains use what is called “proof of work” to mine new coins and validate transactions. It is an expensive, energy-intensive and time-consuming process that can clog the network. So, the minds behind Ethereum decided to change their system to a “proof-of-stake” system, which is dubbed Ethereum 2.0.

The new system makes it difficult for miners to generate new coins. Instead, those who own the currency essentially “stake” their own crypto holdings and validate transactions. Stakeholders could lose their investment if they verify transactions that do not comply with Ethereum rules.

It is expected that the change along with transaction fees being “burnt” – destroyed forever – will lead to less existing ether and a deflationary spiral, sending the crypto skyrocketing.

Is Ethereum a good investment?

Ethereum has grown significantly over the past few years, so those who bought and held years ago have done well. But rather than looking at yesterday’s price movements and being afraid of missing out, it’s important to understand what you’re investing in. And based on this, those who buy Ethereum are buying a cryptocurrency that is not backed by any hard asset or cash flow. .

It may seem trivial, but this is the main difference between stocks and cryptocurrency. A stock is a co-ownership in a business, so its performance over time is due to the continued success of that business. If the company increases its earnings, its stock is likely to follow that growth over time. Shareholders have a legal stake in the assets and cash flows of this business.

In contrast, Ethereum – and most other popular cryptocurrencies – are not backed by anything at all. The only thing holding the price up is the optimism of other investors, who all think they can sell the cryptocoin for more money later to someone else – the so-called “most theory”. big fool” of investing. Speculation is the only thing pushing Ethereum and other cryptos higher.

For this and other reasons, investing legend Warren Buffett won’t touch cryptocurrency and even called it “the rat’s death squared.” Buffett’s approach is a good indicator of the sustainable value available in cryptocurrencies.

Should you buy or mine Ethereum?

If you are looking to speculate on Ethereum, it is simple to buy and trade the cryptocurrency on a popular trading platform such as Robinhood or Binance.US. You can access the market around the clock and you will have good liquidity, which means you can trade without moving the price too much. Calculating profit is also simple: you make profit when you sell coins for more than you paid.

If you plan to mine Ethereum, you need to think like a business owner. You will have to invest large sums in mining rigs in order to produce the cryptocurrency, and then you will have to spend expensive electricity to mine it. You’ll need to crunch the numbers to see if it makes financial sense for you to make the initial investment and keep your operation going. Simply put, you want to earn coins that are worth more than what you paid to mine them. With the change in Ethereum’s validation system, would-be miners need to be sure that the profit is still there.

In the end, it is easier to buy Ethereum than to mine it and requires less effort. There may be profit potential in cryptocurrency mining, but you’ll have to see if the numbers work out.

At the end of the line

Speculators can invest directly in cryptocurrencies such as Ethereum, but they can also invest in companies that stand to benefit from a move towards digital currencies.

Whether you are trading Ethereum, Bitcoin or any cryptocurrency company, it is essential to understand the risks, including the potential loss of your entire investment. Investors should take a measured approach with cryptocurrency, given its volatility and many risks. Those looking to sample the action should not invest more than they can afford to lose.

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Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. Further, investors are cautioned that past performance of investment products does not guarantee future price appreciation.