What Is Ethereum? A Beginner's Guide to How It Works

Ethereum is a decentralized, programmable blockchain: a shared world computer that no company owns and anyone can build on. Its native currency, ether (ETH), pays for every action on the network, and the programs that run on it, called smart contracts, follow their rules without a middleman.

This guide is part of CryptoCatalyst's "What Is" series, which explains one major cryptocurrency each day in plain English.

The Problem Ethereum Solves

Bitcoin proved that money could move between people without a bank. But Bitcoin was designed mainly for one job: transferring value.

Most of what we do online needs more than payments. Loans, exchanges, contracts, games, and marketplaces all depend on a company in the middle. That company can:

• change the rules whenever it wants
• freeze or close your account
• go out of business and take its service with it

Ethereum's answer is to let developers write those rules as code that runs on a public network with no single owner. Once deployed, the code runs the same way for everyone.

Who Created Ethereum, and When

Ethereum was proposed in late 2013 by Vitalik Buterin, a young programmer who had been writing about Bitcoin. His Ethereum whitepaper described a blockchain with a built-in programming language, so it could run any kind of application rather than just payments.

A group of co-founders helped turn the idea into working software, and a public crowdsale in 2014 funded development. The network went live on July 30, 2015. Since then it has been upgraded many times by an open community of developers and researchers. Work on future upgrades continues today, including research into a quantum-resistant transition.

How Ethereum Stays Secure: Proof of Stake

Every blockchain needs a way for many independent computers to agree on one shared history. Ethereum uses proof of stake.

• Validators lock up at least 32 ether as a security deposit, called a stake.
• Validators take turns proposing new blocks and vote on whether other blocks are valid.
• Validators who break the rules can lose part of their deposit, a penalty known as slashing.

Ethereum did not always work this way. Until September 2022 it used energy-intensive mining, much like Bitcoin. An upgrade called the Merge switched the network to proof of stake, which, according to the Ethereum Foundation, cut its energy use by more than 99 percent.

How Transactions Are Confirmed

When you send ether or use an app, your transaction waits in a queue. Currently, every 12 seconds one validator is chosen to bundle waiting transactions into a block. Other validators check that block and vote on it. After roughly a quarter of an hour, the block is considered final and is practically impossible to reverse.

Every action costs a fee called gas, paid in ether. Gas works like a taxi meter: the more computing work you ask the network to do, the more you pay. Fees also rise when many people want to use the network at the same time.

Smart Contracts: Code That Runs Itself

The big idea behind Ethereum is the smart contract, a program stored on the blockchain. A simple way to picture one is a vending machine. You put in the right coin, and the snack comes out. No cashier is needed.

A smart contract works the same way with digital assets. Every node runs the same code inside the Ethereum Virtual Machine (EVM), so everyone agrees on the result. Once deployed, a contract follows its rules exactly, including any mistakes its authors left in. That is both its strength and one of its biggest risks.

Ether: The Fuel of the Network

Ether has two core jobs: it pays for gas, and validators stake it to secure the network. One ether can be divided into 18 decimal places; the smallest unit is called a wei, and fees are often quoted in gwei (one billionth of an ether).

Unlike Bitcoin, ether has no hard cap on its total supply. New ether is issued as rewards to validators. But since an upgrade in August 2021, part of every transaction fee, called the base fee, is burned, meaning it is permanently destroyed. When the network is busy, burning can offset new issuance.

How to Hold and Use Ether

To use Ethereum you need a wallet. A wallet does not really store coins. It stores your private keys, the secret that proves you control an address.

• Ethereum addresses start with 0x, followed by a long string of characters.
• Most wallets give you a recovery phrase of 12 or 24 words. Anyone with that phrase controls your funds, so never share it or type it into a website.
• Every transaction costs a gas fee, so you need a little ether even to move other tokens.

The official Ethereum.org guide has more on choosing and using wallets safely.

Ethereum vs Bitcoin

Ethereum is most often compared to Bitcoin, but they are built for different jobs.

• Bitcoin focuses on being digital money, with a fixed supply of 21 million coins and a deliberately simple design.
• Ethereum is a programmable platform. It trades some simplicity for flexibility, so developers can build almost any application.

Ethereum is also compared to newer smart contract blockchains, which often promise faster or cheaper transactions. Many of them run Ethereum-compatible code, which shows how widely its design has been adopted. Both bitcoin and ether are now listed on traditional exchanges in some countries.

Why People Use Ethereum

People value ether because it is needed to use a busy network. Common uses include:

• Stablecoins, tokens designed to track a currency such as the US dollar, many of which run on Ethereum.
• Decentralized finance (DeFi), apps that let people lend, borrow, and trade without a bank.
• NFTs, digital collectibles and records of ownership.

To handle growing demand, layer 2 networks bundle many transactions together and settle them on Ethereum, which can make fees much cheaper. Some of these networks also focus on privacy, like Aztec's private transaction proofs.

The Risks to Understand

Ethereum is powerful, but it carries real risks:

• Volatility: ether's price can rise or fall sharply in a short time.
• Smart contract bugs: hackers have drained funds from poorly written apps.
• Fees: gas costs can spike when the network is congested.
• Scams and mistakes: transactions cannot be reversed, and lost recovery phrases cannot be restored.
• Regulation: regulators in some countries are still deciding how to treat crypto assets.

Only risk money you can afford to lose. This guide is educational and not financial advice.

Ethereum in Short

Ethereum is a shared world computer that nobody owns. It runs smart contracts that work without a middleman, it is secured by validators who stake ether, and ether pays for every action while part of each fee is burned. Next in CryptoCatalyst's "What Is" series: XRP, explained in plain English.