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Ethereum Basics: What Is Ethereum?

September 19, 2019 · 7 minute read

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Ethereum Basics: What Is Ethereum?

Imagine a world in which thousands of computers work together to create a global computer that stores data safely and completes transactions that are transparent, verifiable, and tamper-proof.

This is the realm of Ethereum, a blockchain-based computing platform that allows users to make smart peer-to-peer transactions, build applications, and pay for it all with a cryptocurrency called ether. Here’s a look at how Ethereum and ether work.

What Is Ethereum?

You’ve likely heard people talk about Ethereum in the same context as Bitcoin and other cryptocurrencies. However, Ethereum itself is not a cryptocurrency.

Rather, it’s a programmable internet platform that makes use of blockchain technology.

The platform was first proposed in a white paper by Vitalik Buterin in 2013. In 2014, he and a team of developers raised money in a presale of ether that helped them raiseabout $18 million to establish the nonprofit Ethereum Foundation and start funding development of the platform.

That platform launched a year later in 2015. Actions on Ethereum are powered by a currency known as ether.

But before getting into the specifics of what ether is, what it’s used for, and how to trade it, it helps to have a sense of how Ethereum works.

How Does Ethereum Work?

First, let’s take a step back and look at how data on the web is traditionally stored. Much of the information available on the internet is controlled by a few very large companies, like Google or Amazon. These companies store information, including users’ personal and financial information, in the cloud and on centralized servers.

This system is good for customers in a number of ways: It provides cheap data storage and allows users to access information from anywhere. However, having complete sets of information stored in one place leaves that information vulnerable to hackers and people looking to steal that data.

Additionally, a centralized model means that these companies are the gatekeepers for the applications available to you. For example, say one of these companies provides a word-processing application that allows you to store the writing you do on the cloud. At any point, the company could make that application unavailable to you and you could lose the data you stored there.

Ethereum represents a movement toward a new kind of internet platform, one based on a decentralized model. Instead of the cloud or a single set of servers storing all data, Ethereum makes use of “nodes”—computers and servers that are independently operated by volunteers.

No single computer holds the only copy of a given piece of data. Rather, each node contains software that syncs it with the larger Ethereum network where computers work together to verify data and carry out transactions.

These transactions are recorded using blockchain, which was invented by the person or group of people that use the name Satoshi Nakamoto to serve as a public record of bitcoin transactions. Companies like Ethereum have built on this technology, using it to record transactions on their own systems.

When using blockchain, data that is stored across a decentralized network of computers is entered into the blockchain at specific intervals. These intervals are the “blocks.” Each block has a time stamp and carries encrypted information.

Each block also carries a “hash” which is a marker that distinguishes it from other blocks. When a block is added to a blockchain it is immediately available for the public to view. Though remember, the data on the block is encrypted so that sensitive information—like names and Social Security numbers—is safe.

When a transaction takes place, it is irreversible and a record of it is kept across the decentralized nodes. In order for a transaction to take place, the system as a whole must verify it.

The nodes will compare their blockchains to make sure everything is correct. If so, the transaction is approved. This system of verification makes it very hard, if not impossible, to hack the blockchain.

One of the things that sets Ethereum apart from other applications that use blockchain is that it is programmable. Developers can build on it to make decentralized applications or DApps. Like the wider bitcoin network, the data to run these DApps is spread across many nodes.

Once a DApp is uploaded, it will run as programmed and no single person will control it. An app you use on Ethereum cannot disappear with no notice.

Additionally, Ethereum provides a level playing field for DApp creators. Its web of computers offers the same functionality to all users who want to use it to offer services.

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What Is Ether?

So, where does ether fit in? Ethereum is not owned by one entity. However, the programs that use it to run require computing power. Those computers need time and energy to execute applications—and we all know, neither of those things is free. The solution the founders of Ethereum came up with is the cryptocurrency ether, which is built in, or “native” to the system

Ether functions like cash: For one, it doesn’t need a third-party approval the way a credit card transaction would. Ether can be thought of as the fuel that helps drive Ethereum.

For example, when using an app on the system, you might need to provide a certain amount of ether to compensate the network for the time and processing power it takes to use the app.

What Is Ether Mining?

Currently, ether is mined in much the same way that bitcoin is, using a proof-of-work system. “Miners” use their computers to solve complicated mathematical problems, providing the “proof of work.” When they successfully solve the problem, they receive ether as a reward.

As more miners join in, the problems become increasingly difficult. What’s more, the yearly supply of ether is finite. No more than 18 million ether are issued each year, a strategy that is designed to curb inflation.

Eventually, Ethereum will switch to ETH 2.0, which will involve a number of updates to the core Ethereum protocol. At this time, Ethereum will shift away from the proof-of-work system of mining to a proof-of-stake system. This system relies on a set of algorithms that allow miners to mine ether in proportion to a stake, or amount of ether, that they already have.

Proof of stake addresses a number of problems inherent to proof-of-work mining. First, a proof-of-stake system uses less electricity to mine ether.

It’s estimated that currently, mining ether and bitcoin requires $1 million worth of energy per day each, under the proof-of-work consensus system. Proof of stake also reduces centralization risks, because users with more computing power won’t be at a greater advantage. And it reduces the risk of 51% attack , in which a miner who controls 51% of a mining pool can create fraudulent blocks for themselves.

Bitcoin vs. Ethereum: How Is Ether Different?

Ethereum shares similarities with other cryptocurrencies, including bitcoin. They both make use of a decentralized, distributed blockchain ledger system and both are encrypted. Each can also be traded on a digital currency exchange. Yet, the two differ in some significant ways, including the programming language they use.

Ethereum’s programming language is what is known as Turing-complete. Very simply put, Ethereum can compute anything that is computable given enough resources to do so. Bitcoin, on the other hand, is a stack-based language, which limits its function. Also, as a result of their programming, bitcoin transactions take minutes to confirm, while Ethereum’s transactions can occur in seconds.

However, when it comes to the big picture, the two cryptocurrencies differ mainly in purpose. While ether can be traded on a currency exchange, its main purpose is to facilitate transactions and applications on the Ethereum platform. It helps developers build and run DApps within the system.

The same amount of ether is produced every year, in part to head off a situation in which the currency becomes too scarce and expensive to make running applications viable. The overall value of ether on the market was about $17 billion as of spring 2019.

Bitcoin was developed as an alternative to regular money, essentially “cash for the internet” It represents a new payment system in which currency is completely digital. There are a growing number of individuals, online businesses, and brick-and-mortar businesses that accept bitcoin.

And unlike ether, there is a finite amount that will ever be produced—the total supply won’t go above 21 million bitcoins. In spring of 2019, the overall value of the bitcoin on the market was about $90 million .

In terms of purpose, the two currencies do not compete with each other. However, the two do compete as players traded in cryptocurrency markets.

How Do You Invest in Ethereum?

As of spring 2019, ether represents one of the top three cryptocurrencies in the world with bitcoin and ripple based on market value.

Generally speaking, the cryptocurrency market can be pretty volatile, experiencing wild highs and low lows. Ether, specifically, tends to be one of the most volatile cryptocurrencies. This volatility can be chalked up, in part, to the fact that this market is relatively new.

At this point, governments around the world don’t regulate it the way they regulate other currencies, stocks, and bonds. As a result, institutional investors, like big banks, which could bring some stability to the cryptocurrency market shy away from it.

Volatility may decrease as a greater variety of investors invest in the space, with more regulation, and as more merchants accept the currency.

Ether trades under the symbol ETH. Investors interested in adding it to their portfolios should first identify a trading platform, where they can carry out their trades. Payment options will vary by exchange.

Options include paying with cash, credit card, and even using other cryptocurrencies. Investors may see some exchanges referred to as fiat exchanges, which allow you to use government-issued currencies, like the U.S. dollar, to purchase cryptocurrencies.

Remember that this is a largely unregulated space, so it’s a good idea to research platforms carefully before choosing one. Look into where the company is based, whether it holds a license, and how secure its website and your funds will be.

When investors have decided on a trading platform to use, they will open an account that will function a lot like a brokerage account they’d use to trade stocks and bonds. Investors provide their personal information and the website verifies their identity.

Next, investors deposit currency in the account. Those using cash can usually transfer money directly from a bank account. Those using one cryptocurrency to buy another may need to provide codes to do so.

At this point investors are ready to start purchasing ether. The ether can later be withdrawn into a bank account or a digital wallet. If an investor is using an exchange that only deals in cryptocurrency and wants to cash out, then they will first need to transfer the currency to a platform that uses a cash, or fiat, exchange.

Keeping an Eye on the Big Picture

Investors who are interested in delving into the world of cryptocurrencies may want to consider their comfort with fluctuations in price.

Cryptocurrency markets tend to be volatile in general, so investors may want to consider a diversified portfolio and sound financial foundation before they buy and sell cryptocurrency.

Diversified portfolios contain multiple asset classes, such as stocks, bonds, and currencies. More diversity can be added within those classes by including assets that vary by factors such as geography, size, and sector.

If one area of the market experiences volatility under certain market conditions, another area may not react in the same way, experiencing little or no volatility. For example, if U.S. stocks fall, European stocks may not react the same exact way.

On SoFi Invest®, investors can trade their first cryptocurrency with as little as $10. Doing so will get them a bonus of $10 in Bitcoin. Unlike the stock market, investors can also trade cryptocurrencies like Bitcoin, Litecoin and Ethereum 24/7. Plus, SoFi takes security seriously and uses a number of tools to keep investors' crypto holdings secure.
Get started trading crypto on SoFi Invest today.

Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.
Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.
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