TL;DR
Ethereum is a crypto platform that allows other applications to use it’s blockchain. The token is a bet on the network. Smart Contracts have a lot of problems… but we’re getting there.
Ethereum
Ethereum looks like it is the future of the crypto economy. It’s proven itself to be the leading smart contract platform that allows anyone to utilize blockchain technology, easily. Ethereum allows for the creation of other Cryptocurrencies, like stable coins (cryptocurrencies pegged to fiat currencies) or even the recent evolution in NFTs.
Ethereum’s major innovation was a Turing complete scripting language that could help put the real world on the blockchain. This means that if you can reliably get data from the real world into your application and manipulate it on chain.
The real madness in Ethereum is that it is a non profit Open Source project, continuously developed by the smartest people in the crypto industry. Innovation on Ethereum happens every day, through updates to the protocol, and development in the ecosystem. The Ethereum Foundation, a Swiss based non-profit that oversees to the development and security of the network.
Simply put, Ethereum is a protocol for running smart contracts on a blockchain and has been called “one computer for the entire planet.” It will afford a more private and censorship resistant internet and applications that could change the way we interact with the internet and the real world.
Smart Contracts
Smart Contracts are the idea that sets Ethereum apart from the rest of cryptoland. A smart contract is designed to facilitate the administration of agreements in the physical world to the digital world. A smart contract codifies the terms of an agreement so that when condition x occurs, step y is executed. The simplest version of a smart contract is a vending machine, a machine that knows the money you put in is worth the product you get out.
Smart Contracts are important because they allow trust-less transaction between parties in a more sophisticated way. This means that they let people interact without any knowledge of who the person is, as long as both sides of the agreement are filled the transaction can proceed. This expands the use cases of blockchain technology into the realm of finance to include option trading and loans. Currently they are primarily used to ensure the payment of funds upon certain triggering events and imposing financial penalties if certain objective conditions are not satisfied.
Currently, Smart Contracts are not a replacement for legal contracts. They lack the capability to understand the nuance and intent that comes with any agreement; therefore they should not be seen as intelligent tools that can interpret a contract’s more subjective requirements. This could be solved with experts who use their understanding of law and code to understand the intent of an agreement. They are defined as a mechanism for the execution of code agreements, but aren’t yet able to accurately represent how parties do business. Because they are written in code, they are inaccessible to most. Users are generally unable to interpret and audit contracts. Since agreements are less interpretable, there is a knowledge gap in business to consumer transactions. An average consumer won’t have the resources to fully understand an agreement and is therefore at a disadvantage to a business. Because a blockchain is basically just an unchangeable ledger, Smart Contracts cannot be touched once they have been submitted. This means that they cannot be changed or easily terminated. Unfortunately, that eliminates the human element that is often a saving grace in agreements (think rent collection during a pandemic).
Regardless of the challenges, I do believe that in the next decade we will see an increase in the use of smart contracts and in the future they will become important legal devices. As more asset classes are tokenized onto blockchains, smart contracts will become more powerful and will be used as a ledger of truth in business.
$ETH
Ethereum has a native token called $ETH or Ether. A native token is the currency that is used on that blockchain. For example the native token of the United States is the Dollar, for the EU it is Euro and for Mexico it is the Peso. Similar to these currencies, Ether secures and fuels the Ethereum blockchain.
Every transaction that occurs on Ethereum requires a small transaction fee or tax to the network. This is similar to the tax you pay on your groceries or shoes. Every tax that you pay goes to those who have locked up their $ETH so they can earn a fee for protecting the network. This is called staking and is a mechanism that was just rolled out on Ethereum in December 2020. By incentivizing network users to hodl (sic) their currency, they cap the downside and increase the potential upside of their token. Stakers can be equated to a pensioned job in the some sense as they are sacrificing their ability to transact to earn a deferred reward and protect the network.
Currently, fees on the Ethereum Network are absolutely out of control. This has happened because the network can only handle around 30 transactions per second, and the complexity of a contract directly affects the transaction fee. This means that applications utilizing the Ethereum platform cannot build to its potential because the fees can get outrageously high.
Recently I’ve begun to look at $ETH in a new way. When you buy $ETH you are making a bet that the entire Ethereum Network will see more usage and therefore the value of the network will increase.
ERC-20 Tokens
ERC-20 (Ethereum Request for Comment) was a proposal to introduce a standard for the creation of Fungible tokens and smart contracts. Fungible means that there is no difference between individual tokens. If I take a dollar from your wallet and replace it with a different dollar, the value won’t change. That means that dollars, like ERC-20 tokens are fungible.
The major innovation of ERC-20 is the simplicity with which one can create new tokens and the interoperability of those tokens.
ERC-20 is important because it is the innovation that allows you and I to go build a token backed by Ethereum with minimal cost. Instead of each token reinventing the wheel and using their own blockchian, ERC-20 abstracts the base understanding out of the equation. It has made Ethereum crucial to the crypto ecosystem, because it has sped up development and unified standard for issuing new coins.
One example of ERC-20 use can be seen on Decentralized Exchanges, like Uniswap, which use the Ethereum network to power their transactions. On Uniswap you can freely swap coins for each other with minimal cost, eliminating the need for centralized exchanges within Ethereum powered tokens.
Ethereum 2.0
Ethereum 2.o is the upgrade to the ethereum network that could turn it into the platform that catapults decentralized Applications into the present. It makes the network more scalable, secure and sustainable.
The network becomes more scalable by allowing multiple blockchains to work together and increase the throughput of the network from about 15 transactions per second to somewhere in the multiple thousands. This increase in scale would solve Ethereum’s main problem, transaction fees, by essentially opening the spout for miners.
Proof of Work is the method of zero knowledge proof that secures the Bitcoin network. If you were to think about it as a simple system the input is Energy and the output is Bitcoin. This means that the Bitcoin network requires a lot of energy to remain secure. Ethereum is now transitioning to a Proof of Stake model, where the amount of $ETH that is locked up secures the network. This drastically lowers the environmental impact of the network.
Increased security comes from the increase in the amount of nodes due to the lower barrier of entry for staking compared to mining. Because the network becomes less centralized the attack surface is considerably lower. At scale Proof of Stake creates a more secure network because to “take over” the network (in the form of a 51% attack) you must control a majority of the staking power. That means that you must control a majority of over 500 million dollars in staked $ETH. That’s expensive.
Ethereum 2.0 will help stabilize the price of $ETH and guide it into the future. Because so much $ETH is staked and not moving, some downside volatility is capped
Why Ethereum
When thinking about $ETH I encourage you to examine it in a lens of buying into a protocol rather than an individual coin. The value of the protocol increases as use cases get better.
Ethereum’s biggest benefit is its usability. Because it was the first blockchain that was available to build on, many of the projects of the last three years built upon and use Ethereum as their backend. The growth of Decentralized Finance adds even more value to the network because they almost exclusively use the Ethereum network.
I’ve begun to see $ETH as a call on what Blockchain can become. So imagine if in 1997 you could buy a single index that represented the Internet Protocol Stack. This would include the biggest internet companies like Amazon, Google, PayPal and eBay. You can still invest in those stocks individually, but by buying into the protocol they use you would have exposure to all of them. Of course you’ll get a few Pets.com’s in there and some other trash, but for the most part that portfolio would outperform on a longer time horizon.
If you believe in Blockchain Ethereum has proven itself to be the dominating force when it comes to smart contracts, but other competitors are emerging. I’m excited to see the long term outcomes of the Ethereum network.
Please note that some things are simplified in an attempt to maximize the comprehension of the concepts e.g. Gas. Also none of this is financial advice, just my understanding of what’s going on. Ethereum is a wild beast that is really difficult to understand and simplify. If you have any questions or concerns, please email me.