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What is the Ethereum Network & How Does it Work? A Full Guide

Jon Ganor
Jon Ganor
What is the Ethereum Network & How Does it Work? A Full Guide
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tl;dr

  • Ethereum, introduced in 2015, revolutionized the blockchain landscape with its ability to execute smart contracts.

  • Ethereum is a decentralized blockchain platform designed for developers to build and deploy DApps.

  • Smart contracts are self-executing agreements with predefined rules and conditions that enable automation and trust on the Ethereum platform.

  • Ethereum's programmability allows the creation of various DApps, including DeFi platforms, DEXs, and gaming platforms.

  • Smart contracts are written in Solidity and executed on the Ethereum Virtual Machine, a decentralized computer.

  • Ethereum's vibrant community contributes to its growth, building innovative DApps and participating in decentralized governance.

  • Ethereum's future holds promise with its vibrant community, driving innovation and growth despite challenges like high transaction fees.

  • Ethereum's innovation often paves the way for other blockchains to follow suit.

Intro

In the early days of blockchain technology, following the groundbreaking introduction of Bitcoin in 2008, several alternative cryptocurrencies emerged as pioneers in the field. One notable example is Litecoin, which was launched in October 2011 by Charlie Lee, a former Google engineer. Inspired by Bitcoin's success, Litecoin aimed to address some of its predecessor's limitations, such as faster block generation times and a different hashing algorithm.

Litecoin quickly gained recognition as a "silver to Bitcoin's gold" and showcased the potential for innovation within the blockchain space. Its success highlighted the possibility of creating alternative digital currencies with unique features and use cases.

In subsequent years, other cryptocurrencies emerged, each with its own distinctive characteristics and goals. Ripple (XRP), launched in 2012, focused on providing fast and low-cost international transactions, while Ethereum, introduced in July 2015 by Vitalik Buterin, revolutionized the blockchain landscape.

What is Ethereum?

Ethereum is a decentralized blockchain platform that revolutionized the cryptocurrency landscape with its innovative features and capabilities. What sets Ethereum apart from other blockchains is its ability to execute smart contracts, which are self-executing agreements with predefined rules and conditions. This functionality opened up endless possibilities for decentralized applications or DApps and transformed how we interact with blockchain technology.

Unlike Bitcoin, which primarily serves as a digital currency, Ethereum was designed as a programmable blockchain. Its main goal is to enable developers to build and deploy decentralized applications on its blockchain infrastructure. This unique feature allows the creation of a wide range of applications, from DeFi platforms to DEXs (Decentralised Exchanges), gaming platforms, and much more.

Smart contracts are at the core of Ethereum's functionality. They are written in a programming language called Solidity and are stored and executed on the Ethereum Virtual Machine (EVM), a decentralized computer that runs on nodes across the network. Smart contracts enable trustless and automated execution of agreements without the need for intermediaries, such as banks or legal institutions. This opens up opportunities for transparent, secure, and efficient peer-to-peer interactions.

Ethereum's programmable nature also allows developers to issue and manage their own tokens, known as ERC-20 tokens, on the Ethereum blockchain. These tokens serve various purposes, such as facilitating crowdfunding through Initial Coin Offerings or ICOs, representing ownership in a project, or enabling utility within specific DApps.

Another aspect that sets Ethereum apart is its vibrant and active community. Developers, entrepreneurs, and enthusiasts worldwide contribute to the platform's growth. These developers build innovative DApps, improve the underlying technology, and participate in decentralized governance through proposals and voting.

What is Ethereum 2.0

Ethereum 2.0, also known as Eth2 or Serenity, marks a significant upgrade to the Ethereum blockchain, addressing some of the limitations and scalability challenges faced by the original Ethereum network. One of the core changes introduced in Ethereum 2.0 is the transition from its proof-of-work consensus mechanism to a proof-of-stake consensus mechanism.

The transition to PoS was completed in September 2022 with the activation of the Beacon Chain, which serves as the backbone of Ethereum 2.0. With PoS, Ethereum introduces validators who secure the network and create new blocks by staking their ETH as collateral. Validators are selected to propose and validate blocks based on the amount of ETH they hold and are willing to "stake" in the network. This shift to PoS drastically reduces the energy consumption associated with mining, making Ethereum more environmentally friendly.

Ethereum 2.0 is designed to significantly improve the scalability and efficiency of the Ethereum network. It achieves this through the introduction of shard chains, which run in parallel to the main Ethereum chain and process transactions and smart contracts. Shard chains divide the network into smaller pieces, allowing for increased throughput and scalability. Additionally, Ethereum 2.0 introduces a concept called "eWASM," which aims to replace the current Ethereum Virtual Machine or EVM with a more efficient and versatile execution environment for smart contracts.

The full implementation of Ethereum 2.0 will be completed in multiple phases, with subsequent upgrades rolling out over time. The transition to PoS and the introduction of shard chains are significant milestones that lay the foundation for a more scalable and sustainable Ethereum network. Ethereum 2.0 holds great promise for enabling faster transaction processing, reducing fees, and unlocking new possibilities for dApps, while ensuring the security and decentralization that Ethereum is known for.

How Does Ethereum Work? The Network & Main Features 

Ethereum is a decentralized blockchain platform that enables the creation and execution of smart contracts, as well as the development of DApps. At its core, Ethereum operates as a global, open-source, and distributed computing platform, enabling developers to build a wide range of applications on its network.

The Ethereum network consists of many nodes distributed across the globe. These nodes maintain the blockchain's integrity by validating and verifying transactions. Ethereum uses a consensus mechanism called proof-of-stake.

Smart contracts are a key feature of Ethereum, allowing users to execute self-executing agreements without intermediaries. These contracts are written in Solidity, Ethereum's programming language, and can be programmed to automatically perform specific actions when certain conditions are met. This programmability allows various applications, including DeFi, NFTs, DEXs, and more.

Ethereum's versatility and flexibility stem from its ability to support a Turing-complete virtual machine called the EVM. The EVM enables developers to execute code and run applications in a decentralized manner. It provides a sandboxed environment where smart contracts can be executed securely, ensuring that the code runs predictably and deterministically across all nodes in the network.

Another important feature of Ethereum is its native cryptocurrency, ETH. ETH serves multiple purposes within the Ethereum ecosystem, including as a means of exchange, a store of value, and a unit of account for gas fees required to execute transactions and smart contracts.

What is Proof-of-Stake and How Does it Work?

PoS is a consensus mechanism used by blockchain networks to achieve distributed consensus without relying on the energy-intensive process of mining. Unlike Proof of Work, which requires miners to solve complex mathematical puzzles, PoS selects validators to create new blocks and secure the network based on the number of tokens they hold and are willing to "stake" as collateral.

Scott Nadal and Sunny King first introduced the concept of PoS in their Peercoin whitepaper, which launched in 2012. Peercoin aimed to address the environmental concerns and resource-intensive nature of PoW mining. It introduced a hybrid PoW/PoS consensus mechanism, where participants could mine blocks through PoW initially and then transition to PoS to validate transactions and secure the network.

The idea of PoS was also mentioned in Ethereum's whitepaper by Vitalik Buterin. In Ethereum's vision of PoS, called Ethereum 2.0 or Eth2, the network transitions from PoW to PoS to improve scalability, security, and energy efficiency. Eth2 implements a novel PoS protocol called the Beacon Chain, which selects validators based on the amount of Ether they hold and is willing to lock up as a stake. Validators are chosen to propose and validate new blocks, and their rewards are proportional to their stake.

In a PoS system, validators are incentivized to act honestly because their stakes can be slashed or confiscated if they attempt to carry out malicious activities or validate invalid transactions. This economic punishment is a deterrent to ensure the security and integrity of the blockchain.

PoS offers several advantages over PoW, including reduced energy consumption, lower transaction fees, and increased scalability. It allows blockchain networks to achieve consensus more environmentally friendly and cost-effectively, making it an appealing alternative.

What are Smart Contracts and How do They Work?

Smart contracts are self-executing agreements written in code that automatically facilitate, verify, or enforce the terms of a contract without the need for intermediaries. They are an integral feature of blockchain technology, enabling DApps and providing automation and trust within the digital ecosystem.

Smart contracts work by leveraging the programmability of blockchain platforms like Ethereum. They are created using high-level programming languages, typically Solidity for Ethereum, and are executed on the blockchain. When certain predefined conditions within the contract are met, the contract automatically executes its programmed instructions.

These contracts have a few key components. First, they contain the contract's code, defining the rules, conditions, and logic that govern the agreement. Second, they have a state which represents the current status and data of the contract. Lastly, they have a set of functions that allow interaction with the contract, such as sending or receiving funds, updating data, or triggering specific actions.

The execution of a smart contract is triggered by specific events or transactions. Once triggered, the contract's code is run on every participating node in the blockchain network, ensuring decentralization and consensus. The code is executed deterministically, meaning that the outcome is predictable and consistent across all nodes.

Smart contracts offer numerous benefits. They eliminate the need for intermediaries, reducing costs and increasing efficiency. Additionally, smart contracts can automate complex processes, streamline transactions, and enable new business models.

What is Ether and How Does it Work?

Ether, commonly referred to as ETH, is the native cryptocurrency of Ethereum, and it serves as a fundamental element for the network's operation and ecosystem.

As a digital currency, Ether can be used for various purposes. It serves as a medium of exchange, allowing users to send and receive value in the form of ETH. It can also be used as a store of value, similar to traditional currencies or commodities. Additionally, Ether is used to pay for transaction fees and computational services on the Ethereum network. Every transaction or execution of a smart contract on Ethereum requires a certain amount of ETH as a fee, which incentivizes network participants, including miners and validators.

Beyond its role as a currency, Ether has utility within the Ethereum ecosystem. It is used to create and interact with smart contracts. When deploying a smart contract or interacting with one, users typically need to pay a small amount of ETH to cover the computational resources required for processing the transaction.

What is EVM and How Does it Work?

The Ethereum Virtual Machine or EVM is a key component of the Ethereum blockchain. It serves as a runtime environment for executing smart contracts. It is a decentralized, Turing-complete virtual machine that enables developers to write and deploy code on the Ethereum network.

The EVM operates as a sandboxed environment, isolating smart contracts from the underlying infrastructure and ensuring security and consistency. It provides a standardized framework for executing code across all nodes in the Ethereum network, enabling decentralized consensus and interoperability.

One of the core features of the EVM is its support for the Solidity programming language, which is specifically designed for writing smart contracts on Ethereum. Developers write their smart contracts in Solidity, and these contracts are then compiled into bytecode, a low-level representation that can be executed by the EVM.

The EVM employs a stack-based architecture, where each operation interacts with a stack of values. It uses a bytecode language called Ethereum Virtual Machine Bytecode (EVM bytecode), which is a sequence of machine-level instructions that the EVM can execute.

When a transaction or a contract interaction is initiated, the EVM takes the bytecode and processes it step-by-step, executing each instruction. It performs operations such as storage access, arithmetic computations, and message calls. The state of the EVM, including variables and storage, is updated during the execution.

Importantly, the EVM enforces a gas mechanism, which serves as a measure of computational effort and resource consumption. Each EVM operation consumes a certain amount of gas, and users must pay for gas using Ether. This gas mechanism discourages resource-intensive computations and helps prevent abuse and denial-of-service attacks.

The EVM's design allows for the execution of DApps and smart contracts in a trustless manner. It provides a secure and deterministic environment for the execution of code, ensuring that the results are consistent across all nodes in the network.

The Ethereum Network & DeFi

Decentralized Finance, commonly known as DeFi, refers to using blockchain technology and smart contracts to recreate traditional financial systems in a decentralized and open manner. It aims to provide financial services, such as lending, borrowing, trading, and asset management, without the need for intermediaries like banks or brokers.

DeFi emerged in the early days of blockchain technology, with the launch of platforms like MakerDAO in 2015, which pioneered decentralized lending and stablecoin creation. In the following years, the DeFi movement gained momentum, fueled by the development of Ethereum and its ability to support programmable smart contracts.

The growth of DeFi has been driven by several key factors. Firstly, it offers increased accessibility and inclusivity by enabling anyone with an internet connection to access financial services, regardless of their geographic location or socioeconomic background.

Secondly, DeFi introduces transparency, as all transactions and interactions are recorded on the blockchain, making them verifiable and auditable by anyone. This transparency reduces the risk of fraud and manipulation and builds trust within the ecosystem.

Furthermore, DeFi enables composability, allowing different protocols and applications to be combined and integrated seamlessly. This modular approach fosters innovation and encourages the development of new financial products and services.

As the DeFi ecosystem continues to evolve, it has witnessed exponential growth regarding total value locked or TVL and the number of users. DeFi has expanded beyond lending and stablecoins to include DEXs, yield farming, liquidity mining, and more.

What are Ethereum Staking and Liquid Staking?

Ethereum staking and liquid staking are integral parts of the Ethereum network. Ethereum staking involves locking up a certain amount of ETH to support the network's transition to a proof-of-stake consensus mechanism. Validators participate in securing the network and validating transactions, earning rewards in the form of newly minted ETH. Staking ETH helps enhance network security, reduces energy consumption, and allows participants to earn passive income through ETH staking rewards.

On the other hand, Ethereum liquid staking refers to the process of tokenizing staked ETH and making it tradable. Platforms like Hord offer liquid staking, enabling users to lock their ETH and receive staked tokens, such as hETH, representing their stake. These staked tokens can be utilized in various DeFi applications, such as lending, borrowing, or trading. Liquid staking allows users to earn staking rewards while having their staked ETH available for use in other DeFi protocols, enhancing liquidity and earning potential.

Learn: How to Stake Ethereum with Liquid Staking! 

Together, Ethereum staking and liquid staking contribute to the security, decentralization, and utility of the Ethereum ecosystem. Staking ETH helps secure the network and incentivizes active participation, while liquid staking unlocks the value of staked assets by making them usable in a wider range of DeFi applications.

What are Cross-chain Bridges and How do They Work with Ethereum?

Cross-chain bridges such as ChainPort are components in the blockchain ecosystem that enable the interoperability of different blockchains, including Ethereum. They facilitate the transfer of assets and data between distinct chains, allowing users to bridge tokens and information across multiple blockchains.

The primary purpose of cross-chain bridges with Ethereum is to enable communication and interaction between Ethereum and other blockchain platforms. These bridges function as connectors facilitating the transfer of assets and data between Ethereum and the target blockchain. They establish a secure and trustless environment for exchanging tokens or information, ensuring transparency and immutability.

The underlying mechanism of cross-chain bridges involves using smart contracts and decentralized protocols. Smart contracts act as the bridge's backbone, defining the rules and logic for token transfers and facilitating the validation and execution of transactions. Decentralized protocols ensure the security and integrity of cross-chain operations by utilizing consensus mechanisms and cryptographic techniques.

Users typically lock their assets on one blockchain, such as Ethereum, to initiate a cross-chain transaction and generate a corresponding representation or token on the target blockchain. This process, often called asset wrapping or locking, creates a pegged token representing the original asset's value. The pegged token is then transferred to the target blockchain, which can be utilized or exchanged within that ecosystem.

Use Cases and Features of Ethereum

dApps

Dapps leverage the EVM and the capabilities of smart contracts to provide decentralized solutions in various industries.

Ethereum serves as a platform for building dApps in various sectors such as supply chain management, voting systems, decentralized governance, identity verification, and decentralized social networks. These Dapps leverage the transparency, immutability, and programmability of Ethereum to provide efficient, secure, and tamper-resistant solutions.

One of the key use cases of Ethereum Dapps is in the field of DeFi. Ethereum has revolutionized the financial landscape by enabling the creation of decentralized lending and borrowing platforms, decentralized exchanges, yield farming protocols, stablecoins, and more. These DeFi Dapps eliminate intermediaries and provide users with transparent, permissionless, and programmable financial services.

DAOs

Ethereum has played a pivotal role in the rise of decentralized autonomous organizations, or DAOs, revolutionizing how communities operate. DAOs are entities governed by smart contracts on the blockchain, enabling decentralized decision-making, fund management, and resource allocation.

Read about the Most Common Governance Token Models for 2023

One of the primary use cases of Ethereum in the context of DAOs is decentralized governance. Ethereum allows the creation of DAOs where participants can vote on proposals, make decisions, and shape the organization's future. The transparent and auditable nature of Ethereum's blockchain ensures that voting processes are fair, secure, and tamper-resistant.

Another key feature of Ethereum DAOs is the ability to manage and allocate funds in a decentralized manner. Through smart contracts, DAOs can hold and manage digital assets, enabling transparent financial operations and eliminating the need for intermediaries. Members of DAOs can collectively decide on how funds are distributed, invested, or used to support projects within the ecosystem.

NFTs

Ethereum has become a pioneering platform for creating and utilizing non-fungible tokens or NFTs, introducing a new era of digital ownership and unique digital assets. NFTs are blockchain-based tokens representing ownership of a specific digital item or asset, such as artwork, collectibles, virtual real estate, and more.

One of the key use cases of Ethereum in the realm of NFTs is the facilitation of digital art ownership and provenance. Through Ethereum's smart contracts, artists can mint and tokenize their creations as NFTs, establishing verifiable ownership and ensuring scarcity. The transparent and immutable nature of the Ethereum blockchain provides a secure and auditable record of ownership, mitigating issues like counterfeiting and unauthorized duplication.

Moreover, Ethereum's programmability allows for implementing additional features in NFTs. Smart contracts can be utilized to include royalty mechanisms, enabling creators to earn ongoing royalties each time their NFT is sold or transferred. This introduces new revenue streams and incentives for artists, ensuring that they continue to benefit from the success of their work.

Ethereum's decentralized infrastructure also offers vibrant marketplaces for buying, selling, and trading NFTs. These marketplaces provide a platform for artists, collectors, and enthusiasts to engage in a global marketplace, fostering a vibrant digital art and collectibles ecosystem.

Furthermore, Ethereum's support for programmable NFTs opens the door to innovative applications and experiences. NFTs can represent ownership of virtual assets in gaming environments, granting players unique and verifiable ownership of in-game items. They can also enable tokenizing real-world assets, such as real estate or intellectual property rights, facilitating fractional ownership and new investment opportunities.

The Ethereum Network - The Pros & Cons

The Ethereum network has gained significant traction as a leading blockchain platform, providing various advantages for developers, users, and businesses. Its standout feature is the support for smart contracts, enabling the creation of DApps with predefined rules and conditions. This programmability and automation make Ethereum an attractive choice for building innovative solutions.

Ethereum offers a developer-friendly environment with tools like the Solidity programming language and the EVM. These resources empower developers to explore and create a diverse range of DApps, protocols, and DeFi applications. The Ethereum network also provides token standards such as ERC-20 and ERC-721, fostering interoperability and the token economy's growth, including the rise of NFTs.

While Ethereum has witnessed substantial growth, the network's popularity has increased gas fees and congestion. This has sparked the need for layer-2 solutions and alternative blockchains to alleviate the Ethereum network strain and offer more cost-effective and efficient transaction options.

The Future of Ethereum: Final Thoughts 

The future of Ethereum holds immense potential as the platform continues to drive innovation and serve as a catalyst for the broader blockchain ecosystem. Ethereum's vibrant development community, consisting of talented developers, researchers, and entrepreneurs, has been instrumental in pushing the boundaries of blockchain technology. Many groundbreaking ideas and projects have originated on Ethereum and have been replicated or adapted on other blockchains.

Despite challenges such as high transaction fees during network congestion, Ethereum's strong community and ecosystem will continue to propel its growth. The Ethereum community is known for its collaborative spirit, open-source ethos, and commitment to driving forward the decentralized revolution. This community-driven approach ensures that Ethereum remains at the forefront of blockchain innovation and attracts diverse projects and contributors.

Furthermore, Ethereum's role as the foundation for the DeFi ecosystem and the growth of NFTs have solidified its position as a key player in the blockchain industry. These use cases showcase the versatility and potential of Ethereum for revolutionizing traditional finance, digital art, gaming, and various other sectors.