What is Ethereum and how does it work? – Forbes Advisor

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Ethereum is often referred to as the second most popular cryptocurrency, after Bitcoin. But unlike Bitcoin – and most other virtual currencies – Ethereum is intended to be much more than just a medium of exchange or a store of value. Instead, Ethereum is called a decentralized computer network based on blockchain technology. Let’s find out what that means.

How does Ethereum work?

Like all cryptocurrencies, Ethereum works on the basis of a blockchain network. A blockchain is a decentralized and distributed public ledger where all transactions are verified and recorded.

It is distributed in the sense that all participants in the Ethereum network hold an identical copy of this ledger, allowing them to see all past transactions. It is decentralized in the sense that the network is neither operated nor managed by a centralized entity. Rather, it is managed by all distributed ledger holders.

Blockchain transactions use cryptography to secure the network and verify transactions. People use computers to “mine” or solve complex mathematical equations that confirm every transaction on the network and add new blocks to the blockchain that is at the heart of the system. Participants are rewarded with cryptocurrency tokens. For the Ethereum system, these tokens are called Ether (ETH).

Ether can be used to buy and sell goods and services, like Bitcoin. It has also seen rapid price gains over the past few years, making it a de facto speculative investment. But what is unique about Ethereum is that users can create applications that “run” on the blockchain like software “runs” on a computer. These applications can store and transfer personal data or manage complex financial transactions.

“Ethereum is different from Bitcoin in that the network can perform calculations as part of the mining process,” says Ken Fromm, director of education and development at the Enterprise Ethereum Alliance. “This basic computational capability transforms a store of value and a medium of exchange into a decentralized global computing engine and an openly verifiable store of data.”

Ether and Ethereum: what is the difference?

You can use Ether as a digital currency in financial transactions, as an investment, or as a store of value. Ethereum is the blockchain network on which Ether is held and traded. As mentioned above, however, this network offers a variety of other functions aside from ETH.

“It can be simple movements of funds, but it can also be complex transactions ranging from exchanging assets to taking out loans to acquiring a piece of digital art” , explains Boaz Avital, product manager at Anchorage. Transactions are processed and stored on the Ethereum network.

The Ethereum network can also be used to store data and run decentralized applications. Rather than hosting software on a server owned and operated by Google or Amazon, where only the company controls the data, people can host applications on the Ethereum blockchain. This gives users control over their data and they have open usage of the app as there is no central authority managing everything.

Perhaps one of the most intriguing use cases involving Ether and Ethereum is that of self-executing contracts, or so-called smart contracts. Like any other contract, two parties enter into an agreement on the future delivery of goods or services. Unlike conventional contracts, lawyers are not required: the parties encode the contract on the Ethereum blockchain, and once the terms of the contract are met, it automatically executes and delivers Ether to the appropriate party.

Ethereum versus Bitcoin

The primary use of Bitcoin is as virtual currency and a store of value. Ether also functions as a virtual currency and a store of value, but the decentralized Ethereum network makes it possible to build and run applications, smart contracts, and other transactions on the network. Bitcoin does not offer these functions. It is only used as currency and a store of value.

Ethereum also processes transactions faster. “New blocks are validated against the Bitcoin network once every 10 minutes while new blocks are validated against the Ethereum network once every 12 seconds,” says Gary DeWaal, president of Katten’s Financial Markets and Regulation group. And future developments could further accelerate Ethereum transactions, he notes.

Finally, there is no limit to the number of potential Ether tokens while Bitcoin will release no more than 21 million coins.

Ethereum Benefits

  • Large existing network. “The benefits of Ethereum is a proven network that has been tested over years of operation and billions of hands of value exchange,” Fromm says. “It has a large and engaged global community and the largest blockchain and cryptocurrency ecosystem.”
  • Wide range of functions. In addition to being used as a digital currency, Ethereum can also be used to process other types of financial transactions, execute smart contracts, and store data for third-party applications.
  • Constant innovation. A large community of Ethereum developers is constantly looking for new ways to improve the network and develop new applications. “Due to Ethereum’s popularity, it tends to be the preferred blockchain network for new and exciting (and sometimes risky) decentralized applications,” says Avital.
  • Avoid intermediaries. Ethereum’s decentralized network promises to let users leave third-party intermediaries behind, like lawyers who draft and interpret contracts, banks who are intermediaries in financial transactions, or third-party web hosting services.

Disadvantages of Ethereum

  • Rising transaction costs. The growing popularity of Ethereum has led to higher transaction costs. Ethereum transaction fees, also known as “gas,” hit an all-time high of $23 per transaction in February 2021, which is great if you’re making money as a miner, but less if you’re trying to use the network. Indeed, unlike Bitcoin, where the network itself rewards transaction verifiers, Ethereum requires those who participate in the transaction to cover the fees.
  • Crypto inflation potential. While Ethereum has an annual release limit of 18 million Ether per year, there is no lifetime limit on the potential number of coins. This could mean that as an investment, Ethereum might work more like dollars and not appreciate as much as Bitcoin, which has a strict lifetime limit on the number of coins.
  • Steep learning curve for developers. Ethereum can be difficult for developers to understand as they migrate from centralized processing to decentralized networks.
  • Future unknown. Ethereum continues to evolve and improve, and the continued development of Ethereum 2.0 promises new functions and greater efficiency. This major network update, however, creates uncertainty for the applications and offers currently in use. “Many new validators will be needed for Ethereum 2.0 to work,” says DeWaal. “The question is: will the migration work? There are a lot of new elements that need to be put in place!

How to buy Ethereum

This is a common misconception among people new to the Ethereum network. You are not buying Ethereum itself, it is the network. Instead, you buy Ether and then use it on the Ethereum network. Given the popularity of Ethereum, it is very easy to buy Ether:

  • Choose a cryptocurrency exchange. Crypto exchanges and trading platforms are used to buy and sell different cryptocurrencies. Coinbase, Binance, and Kraken are some of the biggest exchanges. If you are just interested in buying the most common coins like Ether and Bitcoin, you can also use an online brokerage like Robinhood or SoFi. Be prepared to pay some amount of trading or processing fees almost universally.
  • Deposit fiat money. You will need to deposit money, such as dollars, into your trading platform or link your bank account or debit card to fund Ether purchases.
  • Buy ether. Once you have funded your account, you can use the money to buy Ether at the current Ethereum price along with other assets. Once the coins are in your account, you can hold them, sell them, or exchange them for other cryptocurrencies in the future. Keep in mind that you may have to pay taxes every time you sell or trade cryptocurrencies.
  • Use a wallet. Although you can store Ether in your trading platform’s default digital wallet, this can be a security risk. If someone hacks the exchange, they could easily steal your coins. Another option is to transfer coins that you don’t plan to sell or trade soon to another digital wallet or cold wallet that is not connected to the internet for security reasons.

Should You Buy Ether?

According to DeWaal, you might consider investing in the Ethereum network for several reasons. “First, it has value and use as a virtual currency; second, the Ethereum blockchain may become more attractive as it migrates to the new protocol; and third, as more people use distributed applications Ethereum, demand for ETH may increase,” he says.

In addition to buying Ether directly, you can also try investing in companies that build applications using the Ethereum network. If you want help managing your investment, you can also buy a professional investment fund like the Bitwise Ethereum Fund or Grayscale Ethereum Trust, although they are currently only open to accredited investors.

Before making a large investment in Ether or other cryptocurrencies, first consider speaking with a financial advisor about the potential risks. Given the high risk and volatility of this market, make sure this is money you can afford to lose, even if you believe in the potential of Ethereum.

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