In this installment of “Understanding the Crypto Craze” we will focus on Ethereum. Ethereum is the second largest cryptocurrency behind Bitcoin. The digital currency had been on quite a run, hitting a record above $4,000 in early May before experiencing significant volatility in the past week. Let’s begin by taking a look at the basics behind Ethereum.

Ethereum and Ether

First, we must define Ethereum (the network) and Ether (the cryptocurrency).

Ethereum is a network comprised of thousands of computers all over the world. It is not a currency, instead it is a platform. Applications can be written on the Ethereum network to process financial transactions, store data, execute smart contracts, and those are just some of the possible uses.

Ether is the name of the cryptocurrency. When people talk about purchasing Ethereum, they are actually talking about Ether, the cryptocurrency used to power the Ethereum network. It is used to incentivize people to run the Ethereum program on their computers, lending their computing power to the network. This is similar to individuals using their computing power to mine Bitcoin. Code writers must also pay to have their application run on the Ethereum network. Like Bitcoin, Ether can be converted to fiat currencies, has the potential to be very volatile, and its value is largely driven by supply and demand characteristics. However, unlike Bitcoin where everything is tailored to run the currency, with Ethereum the currency is used to run the network.

Building Blocks

Ethereum builds on both the theory of decentralization and blockchain technology, that were first made popular by Bitcoin. Although there are several differences between the two cryptocurrencies, a basic understanding of Bitcoin and blockchain is helpful when discussing Ethereum. For more information on Bitcoin and the principles behind it, check out the first blog in our series “A Beginners Guide to Bitcoin.”

A Leap Forward in Decentralization

Bitcoin is designed to be a currency and its code is written in a “Turing Incomplete” language, which means there are limited applications that the code can be programmed to solve for. Basically, it is built to be able to support the functions needed by Bitcoin, but nothing else. Bitcoin is often referred to as a “first generation” blockchain.

As Bitcoin became more popular, users started asking the question: what else can be decentralized? Enter Ethereum – a D.I.Y. platform for decentralized applications (DApps). Ethereum is built as an operating system, which coders can use as a base for other applications. To support DApps, Ethereum uses a “Turing Complete” language, meaning given the necessary instructions, enough time, and sufficient computing capacity, it is capable of solving any computational problem. “Solidity” is the Ethereum programming language and anyone can code a program using this language. Once a program is written, the Ethereum network will execute it exactly as it is written. Due to its increased capabilities, Ethereum is considered a “second generation” blockchain.

The System

Rather than hosting software on a centralized server owned by a corporation or government entity, the Ethereum blockchain is hosted on a decentralized network made up of scores of computers. This gives the users control of the data and removes the centralized authority that is in charge and controls the data. This means that the programs running on the network cannot be shut down or censored.

The Smart Contract Example

One of the most promising uses of Ethereum is to run self-executing contracts. These “smart contract” can be defined as an application program that runs on blockchain, with parameters written in code and executed on the Ethereum network.

The goal is to remove “middlemen” and allow the parties of the contract to deal directly with each other. They agree on the specifics of the contract, including provisions for enforcement, management, performance, and payment. The contract then acts as the judge, executing the if-then statements laid out in the contract.

A popular example is using a smart contract to secure a rental agreement. A renter and property owner can use a smart contract to lay out the terms of the lease of an apartment and ensure all parties abide by the agreed upon terms. The only parties necessary are the property owner and the tenant. If the correct payment is made by the renter at the correct time, the renter’s keycard to enter the building works. However, if the renter misses a payment, the keycard does not work as the terms of the contract have been violated.

One downside is the smart contract is uncompromising and letter strict, it does not consider the “spirit” of the contract, or any mitigating circumstances that we all know occur in real life.

How We Can Help

In our next installment of “Understanding the Cypto Craze,” we take a closer look at the variations of the Ethereum network as well as exactly how Ether is used to power the network.

As with any investment, it is important to weigh the risk against the potential returns. If you are interested in finding out if investing in cryptocurrency is right for you, or if you would simply like to learn more, contact us online or at 410-685-9685.