Ethereum used to be viewed as bitcoin’s little brother. But that was back when it was still worth a few hundred dollars, and many investors didn’t quite understand what it was. Today, things are different, and ethereum has carved out a sizable share of the crypto market, powering key innovations from decentralized finance to non-fungible tokens.
Ethereum’s Emergence and Technical Overview
Investors in the ethereum cryptocurrency, known as ether, see it as a key rival to bitcoin. But technical issues with the ethereum network are proving costly, and there’s a flood of new tokens that are hot on its tail. So what is ethereum exactly, and does it have what it takes to unseat bitcoin as the king of crypto? Ethereum was conceived in 2013 by Russian-born computer programmer Vitalik Buterin. He was just 19 years old at the time. Buterin was initially a strong proponent of bitcoin. He even co-founded Bitcoin Magazine, one of the oldest media outlets dedicated to covering the cryptocurrency. But he soon grew concerned with what he viewed as shortcomings in bitcoin’s underlying technology.
The basic idea of a blockchain is to spread out the responsibility of processing digital currency transactions across a decentralized network of computers. But Buterin saw potential for the technology beyond just making payments. I visited Chris Dick, a quantitative trader at the crypto trading firm B2C2, to learn more. Bitcoin was the major innovation, the original innovation in cryptocurrency. But arguably ethereum is equally as big a step forward for the cryptocurrency industry. Whereas bitcoin brought money onto the internet in a way that those funds could not be spent twice, and you didn’t have to have a central trusted counterparty, ethereum brought all that, but with the full capabilities of a computer on top of it.
Smart Contracts and Decentralized Applications
In the ethereum white paper, Buterin proposed the launch of a new platform that would support two key innovations, known as smart contracts and decentralized applications. Smart contracts are lines of code written into the blockchain. They carry out certain functions once a set of conditions are met. Say I wanted to pay my rent using crypto. With a smart contract, I could specify when my rent is due each month, and have the appropriate funds sent to my landlord, without any time delays or middlemen like an estate agent facilitating the transaction.
These smart contracts are what power decentralized applications, or “dapps,” on ethereum. Think Facebook or TikTok, but on the blockchain. With ethereum, you can have any software that’s running remotely somewhere around the world on the blockchain, and you don’t have to have a central point of trust for that software. So that means you can actually launch companies and launch entire pieces of software on top of ethereum network and have it safe, working quickly and working in a secure way, like completely around the world.
Ethereum vs. Bitcoin and Trends in the Crypto Space
Like bitcoin, ethereum has attracted renewed interest from investors in the past couple of years. But backers of both cryptocurrencies say they offer starkly different investment cases. Bitcoin is predominantly used for transactions, and backers of the cryptocurrency believe it to be a store of value, similar in some ways to gold. Ethereum, on the other hand, is considered as more of a platform for the crypto economy. It’s become the destination of choice for apps developed on the blockchain. There are two key trends in crypto that have come about thanks to ethereum: decentralized finance, or DeFi, and non-fungible tokens, otherwise known as NFTs.
DeFi is an umbrella term used to describe a plethora of new financial products that are built using the blockchain. Such services allow you to make trades or apply for a loan or savings account, all while bypassing traditional intermediaries like banks. NFTs, meanwhile, are like the crypto equivalent of collectible items. They’re essentially tokens on the blockchain that say whoever owns them is the rightful owner of a specific digital item – say, a work of art, or a character in a video game.
The entire market value of the ether cryptocurrency is now almost half that of bitcoin’s. In 2021, the total funds deposited into DeFi accounts swelled to more than $270 billion, while trading in NFTs reached a record $40 billion. Still, ethereum isn’t without its flaws. In the early days of its development, ethereum suffered a severe hack that led to the theft of tokens worth around $50 million at the time. The victims in the attack were a group of investors known as the DAO, or Decentralized Autonomous Organization. It was a kind of investment fund, but with no traditional corporate structure or hierarchy. Hackers exploited what’s known as a recursive call bug. It’s sort of like if you were to withdraw cash from an ATM, but the system kept on churning out funds without updating the balance.
The impacts of this heist was so large that it cause the ethereum blockchain to split into two separate branches – Ethereum and Ethereum Classic. Tom Robinson, co-founder of crypto compliance firm Elliptic, says such vulnerabilities are now a common sight in the DeFi industry today. The problem is that code, that smart contract has been created by human beings, and humans make mistakes. And so what we’ve seen over the past two years, is that there are errors being made in these DeFi protocols, which are identified and exploited by hackers. And, as has long been the case with cryptocurrencies of all stripes, ether is a volatile asset. Its price rose to an all-time high above $4,800 in November 2021, at the peak of the latest crypto craze. It has since pulled back considerably from those levels, though.
Scalability Issues and Future Directions
But human error and market volatility aren’t the only problems impacting ethereum. Rising transaction costs, coupled with the huge amount of energy required to validate transactions, have resulted in the creation of a multitude of new coins known as “ethereum killers.” An issue that’s long plagued the crypto space is what’s known as the “scalability problem.” In essence, this refers to the idea that, as a cryptocurrency’s usage grows, its underlying platform struggles to keep up with the increased demand. We’ve seen this already with bitcoin. On the bitcoin blockchain, a new block of transaction is added to the chain around every 10 minutes. But as usage of bitcoin begins to climb, the network can only confirm so many transactions at a time, and so, the time required fluctuates. The same can be said for ethereum. With all these NFTs and DeFi services cluttering up the network, the fees required to process those transactions, and the time taken for them to go through, have been on the rise.
One thing you’ll often hear in discussions about ethereum is “gas fees.” And no, that doesn’t have anything to do with the cost of refilling your fuel tank. Gas fees is really a metaphor in this case for the transaction fee that a user has to pay when sending funds on the ethereum network, or indeed, when interacting with a smart contract. When you pay that transaction fee, somebody who you will never meet will run their code and be able to process your transaction. In order to get them to process your transaction, you pay this transaction fee that’s also called the gas fee.
Another issue ethereum shares with bitcoin is its impact on the environment. Both of the cryptocurrencies use a mechanism known as proof of work, which requires power-intensive crypto mining to confirm transactions and mint new tokens. A growing number of investors are turning to new crypto protocols, such as cardano, solana and polkadot, due to frustration with these problems. The developers of those networks are hoping to take the crown, with the promise of being faster and more energy-efficient than ethereum.
Ethereum 2.0 and Its Potential
However, ethereum isn’t taking the challenge lying down. It’s currently in the process of upgrading to a new standard that proponents say would make it run more efficiently, and in a way that’s environmentally friendly. This upgrade, known as ethereum 2.0, will see the ethereum network move over to what’s known as “proof of stake.” I asked Larisa Yarovaya, associate professor of finance at the University of Southampton’s Business School, to elaborate on what that means. The current consensus algorithm that is used by both ethereum and bitcoin, in order to create a new coin and to validate the transaction, the whole network needs to agree on it. It requires huge number of computer power, a huge amount of computer power, huge amounts of energy. If you’re talking about proof of stake, then here it’s slightly different. Validator nodes are the computers that contribute to the security of blockchain networks like ethereum. At the moment, those validators require specialist equipment in order to participate. But with proof of stake, rather than miners, ethereum will rely on so-called “stakers” that lock up a portion of their ether to show they’ve got skin in the game – kinda like a deposit. The more tokens someone commits, the higher their chances of being chosen to approve a new batch of transactions, and therefore get rewarded in some ether.
Proponents say this will deter bad actors, as validators’ ether is at stake if they try to cheat the system. That should, in theory, make the network more secure. There are some downsides, however. Here we can see straight away the distribution of the power and less decentralization than is the case of bitcoin. Also, some experts suggest that there are some security concerns in terms of proof of stake, that it’s much less secure system and consistent mechanism in comparison to the proof of work. Nevertheless, Larisa thinks that’s a risk ethereum users should be willing to take. We need to think about overall benefits, in my opinion, and if proof of stake is so much more efficient, if it can offer better scalability, if it’s more environmental-friendly, that maybe community will be willing to compromise on safety and will be able to compromise slightly on centralization and decentralization to accept more centralized technology. The ethereum upgrade is expected to kick in properly at some.
