Ethereum is a complex concept. You may read one-liners such as “Ethereum is a blockchain based software platform that allows developers to code and run decentralised applications”. This is a mostly unhelpful statement for those wanting to learn about it, so let’s delve a bit deeper into what Ethereum can do, and what it’s used for.
When most people hear or are told about Ethereum, they think about cryptocurrencies. This can be slightly misleading as while Ethereum technically does have an associated cryptocurrency token, this is only a small part of what makes up the Ethereum platform. We’ll talk about both and try and put it into context.
Ethereum’s cryptocurrency token
Ethereum’s cryptocurrency token isn’t actually called “Ethereum”. It’s called “ether”. Ether can be traded like a normal cryptocurrency and, like Bitcoin, is based on blockchain technology. To read more about blockchain technology and how ether transactions work, see the relevant sections on our What is Bitcoin page. Unlike Bitcoin, however, ether was not designed to be used as a store of value or transactional currency – it does not have a limited supply like Bitcoin and many other cryptocurrencies have. It is important to note that while the original purpose was not to act as a classic cryptocurrency, many people trade and invest as if it was. The core purpose of the ether token is to power the applications and services running on the Ethereum network. To understand what that means, we’ll need to talk about the other side of Ethereum.
Ethereum’s decentralised application platform
At its heart, Ethereum was designed to be a decentralised application platform. In layman’s terms this means you can create an application (called a “smart contract”) using Ethereum’s programming language, pay a fee, and have it run on many computers around the world – any that participate in the Ethereum network. Some examples of Ethereum smart contracts:
- Basic examples: Require 2 people to sign before releasing funds, or release funds on a certain date.
- Many ICOs are ERC20 based tokens. ERC20 is a token standard written on the Ethereum smart contract platform
- Games such as CryptoKitties and Fomo3D
- There are many possible other applications of the technology in various industries, for example healthcare, real estate, government, etc.
Every time you run an Ethereum smart contract, you need to pay a fee to the network. This is because the hardware and operational costs of running an Ethereum node (the thing that executes the smart contracts) isn’t free, so you need to incentivise the node operators. To do this you need to need to pay a fee known as gas. Gas can be confusing, as the currency behind it is actually ether – but due to the final gas cost not being known ahead of time, the price needs to be abstracted from ether. This works by setting a maximum amount of gas required for your smart contract, and then a gas price, which is your conversion ratio of gas to ether. The higher your gas price, the more likely an Ethereum node is to pick up your smart contract for execution. By separating gas from ether, it also allows the gas price to fluctuate without affecting the value of ether, and vice versa.
Like many other cryptos, Ethereum’s blockchain is available for all to see. And like the blockchain, any smart contract run on Ethereum is available for anyone to inspect. This helps develop trust in the system, as there are no black boxes. However it also means that any bugs in smart contract code are available for anyone to see, and for bad actors to exploit. Smart contract creators need to be very careful to review the contract code to ensure it is free of bugs.