What is Ethereum?
Ethereum is an open source, distributed computing platform that uses blockchain technology and features smart contract functionality. What this sentence actually means will hopefully become clear in what follows. Proposed by Vitalik Buterin ( 1), in 2013, the Ethereum platform launched on 30 July 2015 ( 2). In many ways, Ethereum extends the Bitcoin idea of decentralised money in the direction of a decentralised internet. Or, to really risk hyperbole, the Ethereum network promises the creation of a global computer! Let’s stick with the decentralised internet for now. Hang on a minute, you might say, isn’t the internet already decentralised?
The need for a decentralised internet
In theory and in respect to the spirit of Tim Berners-Lee’s original intention, when he laid out his vision of the World Wide Web ( 3), the internet might be described as a decentralised network of information. Unfortunately, it could be argued, this is not what has actually materialised in practice, when you consider the reality of the internet today. GAFA (Figure 1), Gang of Four, Big Tech, call them what you want, the technology companies of Google, Apple, Facebook and Amazon have certainly had an affect on the way the internet age has developed. Reflect upon the influence these companies, in addition to an ever-growing host of large companies, have on your online interactions. Remember that Google owns YouTube and Facebook owns both Instagram and WhatsApp.
Figure credit: ( 4)
With echoes of the corruption and inefficiencies now so apparent within the government- and bank-controlled global financial system, it seems that these tech companies potentially pose a new problem for the world to deal with. Evidence of this being the case becomes clear when consideration is made of the charges made against them of privacy invasion, tax avoidance, anti-competitive practices, ever-increasing financial power and domination of intellectual property law ( 5). Nowadays, little activity takes place on the internet without the assistance of some sort of intermediary, or third party. As the saying goes: power corrupts, but absolute power corrupts absolutely ( 6). In the same way that Bitcoin looks to provide an escape from the centralised control of the financial system, Ethereum offers a similar opportunity, replacing the centralised programs, platforms and companies which run the internet today with a decentralised alternative.
Decentralised applications, or Dapps, can be run on top of the platform provided by the Ethereum network. Utilising the same fundamental elements that also make up the Bitcoin network, Ethereum provides a pre-built environment for others to create services that can gain from the use of cryptography, a method of consensus and distributed ledger technology. These fundamentals mean that Dapps are open source, decentralised, resilient and transparent. They will also provide an incentive to those who help to secure the Dapp, by offering tokens as a reward. If this sound a little bit like how Bitcoin operates, then this is not surprising. In fact, Bitcoin could be considered the very first Dapp.
In other words, Ethereum has done the hard work, to ease the creative exploits of those that follow. In fact, this is already the case, as will be explored below, when we consider how projects have already been built on the platform. An obvious question is that if Ethereum is essentially constructed from the same building blocks as Bitcoin, why can’t this existing network simply be extended? The reason is because Ethereum is Turing complete and Bitcoin is not.
Bitcoin has proven itself to be a trustworthy, secure network. It could be said that this is due, at least in part, to an over-arching simplicity inherent in its design. Therefore, this simplicity could be seen as a feature, rather than a drawback. With limited potential for complex expression in the transactions made on the Bitcoin network, Bitcoin is considered Turing incomplete. In contrast, the developers of Ethereum have created a programming language, known as Solidity, that operates on top of the Ethereum network and allows the inclusion of the usual operations you might expect in a programming language, like looping and branching statements. The inclusion of these extra tools allows the use of smart contracts.
Nick Szabo is largely responsible for the concept of the smart contract ( 7– 9). To gain an understanding of what one is, consider a simple contract that you might have with a landlord, for example. If you pay rent on the first day of each month, say, this permits you to live in the property owned by the landlord. More or less, a smart contract that could feasibly be stored on the Ethereum network, might set a requirement that a digital payment is made before a set deadline, thereby allowing continued use of a keycard to open a property. Without going into the details, hopefully you can appreciate how this might be included on a blockchain as a set of logical operations, that could be written as a program using Solidity. For now, we’ll ignore the somewhat uncompromising nature of this arrangement and the lack of consideration of extenuating circumstances, the spirit in which the contract was created and all those other fuzzy things which are present in the current way we operate between one another. This is important, though, and certainly a challenge for Ethereum going forward, that requires consideration. Well, I hope it is considered, if we want to avoid building our very own dystopia.
A solution to the problem of centralised control of Big Tech
How is the payment of rent relevant to a decentralised internet? Never mind that, what about the creation of a global computer? Well, we’re still working towards the latter, but in terms of the former, consider how Google and Facebook make the majority of their revenue.
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At their core, these companies act as centralised stores of personal information that is harvested from users’ search queries, posted photos and all the other sneak peaks of ourselves that we willingly offer up ( 11). So what? This portal into our interests, preferences, perspectives and desires is valuable and therefore sold to those that wish to make use of it. Advertisers are an obvious choice, who can use this information to more effectively and efficiently sell us products. It is also of interest to other potentially nefarious individuals and groups, but let’s deal with one problem at a time. It’s clear how this information can be utilised by advertisers to attract our attention. What is scary to consider, as we enter an age of machine learning and artificial intelligence, is how the confluence of big data, ever improving algorithms and immense processing power, permits these advertisers to become better and better at their job. Heaven knows what opportunities this offers for these more nefarious actors. Dapps, as one potential use case, provide the means for users to regain ownership of their personal data. If they want to sell this to advertisers, they can choose to do this. The point is that they decide and profit, not Google, or Facebook.
As social media giants, Facebook, as well as Twitter, have grown into powerful monopolies who are not only using their power to sell advertising, but also promote a political agenda ( 12). When you factor in the social tools of censorship and the definition of ‘facts’, with the question of who decides in such complex matters, the promise of decentralisation of such powers seems ever more attractive.
How do decentralised applications differ from traditional web applications?
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This removes the need to trust GAFA, or any other intermediary. Since the code written within applications is open source, anybody is free to determine what it does and how. The network is shared across an immense number of globally dispersed computers, meaning no downtime. Being network resistant, an application cannot be stopped, or removed, by anyone. A smart contract entered on to the network is guaranteed to be executed and will be recorded permanently on the blockchain.
Potential use cases for Dapps
There are countless opportunities for making use of this decentralised alternative to traditional applications. These range from renting out unused storage and processing power on your personal computer, all the way to far-fetched, future examples, where perhaps you might have your self-driving car out on the road earning you income as a taxi. The invention of decentralised finance (DeFi) has become huge in the world of crypto and introduced a number of Dapps that are built on top of Ethereum. This term can refer to a number of traditional financial tools, operated in a decentralised manner, but often takes the form of lending. Put simply, this involves offering cryptocurrencies as collateral against the lending of other cryptocurrencies. Often the coin that is lent is a stablecoin, which is pegged to a traditional fiat currency like the dollar. The mechanics of this is perhaps too complicated for a discussion here, but hints at what is possible and points towards the potential importance of Ethereum in the future of finance.
The unit of currency used to incentivise running the Ethereum network is the Ether (ETH). The names given to the sub-units of Ether (Table 1) pay homage to computer legends Hal Finney, Nick Szabo and Wei Dai.
|Sub-unit||No. of Ether|
Due to its direct relationship with Ethereum, Ether is referred to as the native token. When people wish to create their own decentralised application and make use of the pre-built environment that Ethereum offers, this network will also need a token. Theses tokens can represent many things, such as physical objects, like gold; fiat currencies, as stablecoins; or a variety of other services provided by different projects. There are many examples that already exist and many more examples that have yet to be dreamed up. These tokens are purchased using Ether and often issued to the public through a process known as an initial coin offering (ICO). As a form of permisson-less crowdfunding for new projects, this is revolutionary in itself. Popular projects built on top of the Ethereum network include: Basic Attention Token (BAT), Dai (DAI) and 0x (ZRX).
ERC-20 (Ethereum Request for Comments 20) is a technical standard for tokens issued on the Ethereum network, providing a list of rules these tokens must adhere to and a description of the functionality that can be implemented. These rules dictate how the tokens can be transferred, how transactions are approved, how users can access data about a token and determine the total supply of tokens. The protocol is necessary to ensure compatibility between the many different tokens operating on top of the underlying ecosystem provided by Ethereum.
The Ethereum network is referred to as the main network, or mainnet. It is also said to be layer 1 in an ecosystem that is being built around Ethereum. The mainnet has finite limits in terms of speed and can be unreasonably expensive for some use cases, with regards to transaction costs. Solutions to this problem can be built on top of the mainnet and are referred to as layer 2. As always, solutions provide both benefits and limitations. The construction of any blockchain means making decisions on the relative importance of decentralisation, security and scalability. The fact that you can’t maximise all of these features at the same time is known as the blockchain trilemma (Figure 4). Ethereum has erred towards decentralisation and security, at the expense of scalability. Layer 2 blockchains can offer alternative approaches, perhaps providing more scalability at the expense of decentralisation and/or security. As developers continue to build an ecosystem around Ethereum, decisions of which layer might be appropriate will be context-specific. Of course, Ethereum is not standing still and improvements to layer 1 are being continually implemented that promise to improve scalability, without compromising decentralisation, or security.
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The large community of developers pushing the evolution of this project forward are working towards the release of Ethereum 2.0 (Eth2), with the aim of making the network more scalable, more secure and more sustainable ( 15). The blockchain trilemma still stands, of course, but the way to make Ethereum scale, without sacrificing decentralisation or security, is to improve all three elements.
Eth2 is being developed in parallel with the existing Ethereum mainnet (Eth1), in a process that began with the launch of the beacon chain on 1 December 2020 ( 16, 17). This marks the start of a journey (Figure 5) that will also see the introduction of sharding and eventually the merging, or docking, of Eth1 and Eth2. Completion is estimated to occur in 2022 ( 15).
Figure credit: ( 15)
The next iteration of Ethereum, originally introduced as Serenity ( 18), was guided by five design principles aimed at providing: simplicity, resilience, longevity, security and decentralisation. There are a lot of technical developments that will be implemented, but in general, this boils down to the implementation of sharding and a move to consensus through proof-of-stake.
For Ethereum to realise its full potential, the challenge of scalability must be solved. This means that the number of transactions that can occur on the network in a given period needs to be improved upon. The high cost of making transactions, which results from a large number of transactions attempting to be written to the blockchain and which has become a serious problem ( 19), highlights this need. The metric that is used to quantify this is transactions per second (TPS). For comparison, consider that Visa can handle 45,000 TPS versus Ethereum’s 15 TPS ( 15). Sharding is seen as the solution and route to vastly increasing TPS. This will be achieved by splitting the network into multiple shards, allowing parallel transactions.
Up until now, Ethereum has used approximately the same method of proof-of-work (PoW) as Bitcoin to provide consensus on the network. Moving forward, there is an intention to transfer to proof-of-stake (PoS) as a method of consensus. In fact, this has already started with the launch of the beacon chain, which uses PoS. Some Ether holders have converted their Eth1 tokens to Eth2 tokens and locked them up in a smart contract that supports the newly launched beacon chain. They will be earning rewards for this, but will be unable to withdraw their Ether until Eth1 and Eth2 are merged, in the docking process ( 20). This sees Ethereum entering a hybrid stage, where PoW and PoS are working in tandem, before PoW is dropped completely. As the name suggests, PoS requires people to stake their Ether. This Ether serves as an incentive to act honestly and consistently as a validator of the network, since failure to do so results in this staked Ether being fined, or even completely forfeited, as a penalty. This can range from a small fee for going offline, to losing all of the Ether staked, if attempting to cheat. The reward for acting as a validator on the network is in earning Ether, proportional to the amount staked. In contrast to the millions of processors simultaneously processing the same transactions, as is the case with PoW, a single validator is selected at random to do this in PoS. The chance of being selected is weighted in your favour according to the amount of Ether staked. Staking more means greater rewards, but also greater risk if caught acting dishonestly.
It is argued that an advantage of PoS over PoW is increased decentralisation. The economic challenges of returning a profit from the mining process that is fundamental to PoW means that, over time, this becomes more concentrated in larger and larger operations, causing an inevitable move towards a more centralised network ( 21). The need for economy of scale, access to cheap electricity and the means for efficient cooling drives this. PoS removes these needs and therefore lowers the bar for involvement in the consensus process.
To become a validator and take part in staking, the hardware requirements are minimal. Very minimal in fact and this is the point. A Raspberry Pi and a decent internet connection will be sufficient. Unfortunately, there is also a requirement to have at least 32 Ether, which is not such a minimal prerequisite . A solution to not having the required Ether will be joining a pool, but this will inevitably involve a reduction in the reward you receive, as the pool provider will require payment. The rewards for staking are determined by the total number of Ether staked and ranges between 4.9–21.6% APR. As of today (27 December 2020), the reward is 10.9% APR (Figure 6), with 2,059,554 having been staked ( 22).
Figure credit: ( 22)
Moving beyond PoW to PoS will vastly reduce the incredibly high energy requirements that are currently demanded by a global network of miners. This has obvious ecological benefits, not to mention addressing the ethical issues involved with ‘wasting’ energy in a world where many live in energy poverty. The International Energy Agency (IEA) define energy poverty as a lack of access to modern energy services ( 23). Currently, 1.1 billion people do not have access to electricity and 2.5 billion people rely on biomass for cooking ( 24). It is fair to say that there is an air of optimism associated with Ethereum and many hold high hopes of the positive effects it can help to bring about in the world. Reducing energy consumption is surely very important if considered in this light, allowing the project to retain the moral high ground in this regard.
That’s not all, since economic benefits will also materialise from reducing energy consumption. Profitable mining, as part of PoW, means ensuring that the rewards gained as Ether are higher in value than the money that is spent in its pursuit. Since PoS reduces the need for energy, it also reduces costs. This will play out in reducing the Ether that is needed to reward validators such that they remain profitable. Reducing the rate at which fresh Ether is issued will therefore reduce the dilution of Ether’s value. An important difference between Bitcoin and Ethereum is that Bitcoin has a finite limit of 21 million coins, whereas Ethereum does not.
A world computer
The ongoing development of Ethereum, with the promise of big improvements following the launch of Eth2 and an ambitious roadmap even beyond that, is leading towards the eventual goal of realising an ambition to construct an unstoppable, world computer. The network of connected computers that support the Ethereum ecosystem will eventually enable the collaborative construction of a single entity, that pervades the entire network, known as the Ethereum Virtual Machine (EVM). The EVM will be a continuous, uninterrupted and immutable state machine, providing an environment to contain all Ethereum accounts and smart contracts. If successful, the implications for the future operations of many elements of our world are immense. When you realise the full potential of what is being built, it is sobering, to say the least. With great power comes great responsibility.
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