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Updated: Mar 26, 2021, 3:04pm
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 simply a medium of exchange or a store of value. Instead, Ethereum calls itself a decentralized computing network built on blockchain technology. Let’s unpack what that means.
Like all cryptocurrencies, Ethereum works on the basis of a blockchain network. A blockchain is a decentralized, distributed public ledger where all transactions are verified and recorded.
It’s distributed in the sense that everyone participating in the Ethereum network holds an identical copy of this ledger, letting them see all past transactions. It’s decentralized in that the network isn’t operated or managed by any centralized entity—instead, it’s managed by all of the distributed ledger holders.
Blockchain transactions use cryptography to keep the network secure and verify transactions. People use computers to “mine,” or solve complex mathematical equations that confirm each 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’s also seen rapid gains in price over recent years, making it a de-facto speculative investment. But what’s unique about Ethereum is that users can build applications that “run” on the blockchain like software “runs” on a computer. These applications can store and transfer personal data or handle complex financial transactions.
“Ethereum is different from Bitcoin in that the network can perform computations as part of the mining process,” says Ken Fromm, director of education and development at the Enterprise Ethereum Alliance. “This basic computational capability turns a store of value and medium of exchange into a decentralized global computing engine and openly verifiable data store.”
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 exchanged. As mentioned above, however, this network offers a variety of other functions outside of ETH.
“These can be simple movements of funds, but they may also be complex transactions that do anything from exchanging assets to taking out loans to acquiring a piece of digital art,” says Boaz Avital, head of product at Anchorage. The 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 the one company controls the data, people can host applications on the Ethereum blockchain. This gives users control over their data and they have open use of the app as there’s no central authority managing everything.
Perhaps one of the most intriguing use cases involving Ether and Ethereum are self-executing contracts, or so-called smart contracts. Like any other contract, two parties make an agreement about the delivery of goods or services in the future. Unlike conventional contracts, lawyers aren’t necessary: The parties code the contract on the Ethereum blockchain, and once the conditions of the contract are met, it self-executes and delivers Ether to the appropriate party.
Bitcoin’s primary use is as a virtual currency and store of value. Ether also works as a virtual currency and store of value, but the decentralized Ethereum network makes it possible to create and run applications, smart contracts and other transactions on the network. Bitcoin doesn’t offer these functions. It’s only used as a currency and store of value.
Ethereum also processes transactions more quickly. “New blocks are validated on the Bitcoin network once every 10 minutes while new blocks are validated on the Ethereum network once every 12 seconds,” says Gary DeWaal, chair of Katten’s Financial Markets and Regulation group. And future developments could speed up Ethereum transactions even more, he notes.
Last, there is no limit on the number of potential Ether tokens while Bitcoin will release no more than 21 million coins.
It’s a common misconception to people who are new to the Ethereum network. You don’t buy Ethereum itself—that’s the network. Instead, you buy Ether and then use it on the Ethereum network. Given Ethereum’s popularity, it’s very easy to buy Ether:
You might consider investing in the Ethereum network for a few reasons, according to DeWaal. “First, it has value and use as a virtual currency; second, the Ethereum blockchain could become more attractive when it migrates to the new protocol; and third as more people utilize Ethereum distributed apps, demand for ETH may increase,” he says.
Besides buying Ether directly, you could also try investing in companies that are building applications using the Ethereum network. If you’d like help managing your investment, you could also buy into a professional investment fund like the Bitwise Ethereum Fund or Grayscale Ethereum Trust, though these are currently only open to accredited investors.
Before making any significant investment in Ether or other cryptocurrencies, consider speaking with a financial advisor first about the potential risks. Given the high risk and volatility in this market, make sure it’s money you can afford to lose, even if you believe in Ethereum’s potential.
David is a financial writer based out of Delaware. He specializes in making investing, insurance and retirement planning understandable. Before writing full-time, David worked as a financial advisor and passed the CFP exam.
Ben is the Retirement and Investing Editor for Forbes Advisor. With two decades of business and finance journalism experience, Ben has covered breaking market news, written on equity markets for Investopedia, and edited personal finance content for Bankrate and LendingTree.
What Is Ethereum And How Does It Work? – Forbes
