Many of us have heard of Ethereum, which is currently the second most valuable global cryptocurrency with a market capitalization of over $60 billion. Oddly enough, Ethereum isn’t actually a cryptocurrency but rather a software platform that lets programmers build applications using blockchain technology. Within the Ethereum platform, there is a cryptocurrency called Ether that is used to enable applications built on the associated blockchain.
From Bitcoin to Ethereum
Bitcoin uses a global network of computers that maintain a shared ledger called a blockchain, which used to keep track of Bitcoin transactions. This includes determination of current ownership. After the world was introduced to blockchain technology, people realized that it could be used to manage anything of value in the distributed cyber world. Blockchain roots go back to 2013, when a 19 year old named Vitalik Buterin introduced the Ethereum white paper. It proposed an open source platform allowing programmers to build blockchain applications that could facilitate the exchange of money, content, property, shares or anything else of value. Much like with Satoshi Nakamoto’s (of Bitcoin fame) paper, Buterin’s was met with widespread excitement from software developers around the world who began building toward the vision defined by Buterin.
Much like Bitcoin, Ethereum isn’t owned or controlled by any one person. Unlike Bitcoin, whose creator remains anonymous, Ethereum has a leader in Vitalik Buterin. While Buterin doesn’t control Ethereum in the way that a CEO does, his word carries tremendous weight in dictating the direction of the project. This is considered a strength or a weakness, depending on who you ask.
Programs built on the Ethereum perform are called smart contracts. Smart contracts are digital agreements that execute automatically based on the input of collected information. An easy way to think of them is an If-then statement. IF condition A exists, THEN perform function B.
As an example, let’s say grandma wants to make sure she never forgets to give little Billy birthday money each year. She could write a smart contract that says IF it’s little Billy’s birthday, THEN pay him $10 from grandma’s bank account. Once this contract is broadcast to the Ethereum network, it will execute automatically each year on little Billy’s birthday.
Smart contracts have applications far beyond improving the reliability and efficiency of a global group of grandmothers remembering birthdays. Another example of a simple application of a smart contract could be to solve issues associated with rental payments. Here we use a potential algorithm of IF date = 1st of the month, THEN pay landlord rent amount. Processes that currently involve manual interactions between two parties could be automated and the transactional payload can be moved, in real time, through a blockchain implementation versus settling days later as is experienced with traditional banking.
A Real World Example
Ethereum and smart contracts are becoming a major force in our society because they have the ability to usher in what’s been dubbed the ’smart economy‘ – slow manual processes prone to human error and deceit can easily be replaced with automated processes that are completely transparent and trustworthy. A real-world example that typifies the new smart economy is a project being run by a French insurance company called AXA.
AXA offers a flight insurance product that pays a policy holder in the event that a flight is delayed by two hours or more. It currently has a product in trial that will remit insurance policy and claim payments using smart contracts within the Ethereum blockchain framework. Payments from the policy holders process on specific days per the contract. For claims, the smart contract algorithm is relatively simple: IF flight X is over two hours late, THEN pay policyholder Y. The smart contract is connected to a database that monitors flight times. If the database shows that the flight is over two hours late, the smart contract is triggered and the policyholder bank account is paid automatically through the blockchain operation.
Without the smart contract, the policyholder would have to file a claim and wait for the insurance company’s claims department to process it, which could take several weeks. With a smart contract, neither the insurance company nor the policyholder are required to perform manual steps. This also creates trust between the two parties because there are no uncertainties – the customer can review the smart contract prior to purchasing the policy and feel assured of claim payment in the event of a delay.
Ethereum vs Ether
As stated in the intro, Ethereum is a platform for building blockchain applications using smart contracts. If you made a purchase on Coinbase (a cryptocurrency trading marketplace) of Ether, you basically bought the cryptocurrency that fuels the Ethereum network.
Ether functions more like a digital commodity than a digital currency. Just like you need gasoline to fuel your car, you need Ether to run applications on the Ethereum blockchain. In the grandmother example cited above, she would have to purchase small amounts of Ether to pay for her smart contract that provides little Billy with his birthday money.
The Ethereum blockchain functions in the same method as the Bitcoin blockchain: a network of distributed computers run software to validate transactions through system consensus. The people running these computers are called miners. Bitcoin miners are compensated for the use of their computing resources by being paid in slivers of Bitcoin.
Similarly, Ethereum miners are compensated in Ether. On little Billy’s birthday, grandma’s Ether transaction fee will go to the miner that adds the block containing grandma’s transaction to the blockchain. That miner will also receive bits of Ether in the process.
The same supply/demand economics that apply to commodities (such as oil) also apply to Ether. Oil is valuable because it powers many of the things we use in our everyday life – it heats our homes and fuels our automobiles. The more people and enterprises relying on Ethereum-based applications, the higher the demand will be for Ether which will increase its value. As with all cryptocurrencies, there’s plenty of speculation included in the purchase price – speculation that the demand for Ether will increase (or decrease) in the future. Since Ether is valuable, exchangeable and transferable, certain merchants are also starting to accept it as a currency.
dApps – Decentralized Apps
Applications that run smart contracts on the Ethereum blockchain are called dApps, or decentralized apps. Just as any developer can build apps on top of Apple’s IOS operating system, developers can build on top of Ethereum’s blockchain infrastructure. To the end user of a dApp, it might not look and feel any different than the apps you use today. It’s the underlying blockchain infrastructure that make them different.
Since dApps function on top of the blockchain, they can be used to transfer value in a peer-to-peer manner. To return to our grandmother example, there could be a dApp she can download that lets her schedule little Billy’s birthday payments without having to code the smart contract herself. dApps are also completely open source so other people can access the code and build on top of them. Someone could take the code to the birthday payment dApp and add the ability to add a note that says, “Happy Birthday!” Running dApps on the blockchain also offers added security benefits. Since the transactions are distributed and encrypted across the Ethereum blockchain, there is no central place for a hacker to breach and gain access to all of the world’s grandmother-to-grandson birthday payment data.
The grandmother/little Billy example might be a little stale at this point, but it represents a simple illustration for the kinds of applications that can be built on the Ethereum blockchain. In reality, dApps that are being built today are much more complex. Here are a few examples:
Weifund – blockchain crowdfunding:Users can launch traditional crowdfunding campaigns, but through the use of smart contracts backers can gain a financial stake in the project. If an Indie film gets funded on Weifund, a backer who financed 10% of the project can collect 10% of the film’s revenues. Payments will be issued in real time as the film generates revenue.
Ujo Music – licensing via the blockchain:An artist can create an original song and register it on Ujo’s platform and set their preferred licensing terms. If a film producer wants to use that song in a movie, they can purchase the rights according to the terms set by the artist (who, in turn, gets direct payment). This eliminates the need for industry middlemen (for example, Warner Brothers) who might take a lion’s share of their artist’s profits.
Virtue Poker – online play secured by the blockchain:At the height of its popularity, online poker platforms like PokerStars were burdened with issues that ranged from deck rigging to the abuse of player funds held by the company. Virtue Poker using Ethereum allows players to fund their bets directly, ensuring that no party external to the protection of the blockchain can access and misappropriate player money. Their code is open sourced so that users can understand how hands are dealt, also providing assurance that no one can rig the deck. Lastly, players are paid winnings in real time through the blockchain operation, so no more waiting weeks for a check to come in the mail.
Now that you understand that Ethereum is a network for building decentralized applications that require a cryptocurrency called Ether to run, I’m going to introduce a potentially confusing concept. Many dApps built on Ethereum can use other cryptocurrencies or tokens. In order to interact with the dApps, customers need to purchase the dApp’s native tokens or currencies.
Here’s a helpful analogy I came across. When you go to a waterpark, you pay the admission fee and in return, you get a wristband. That wristband gives you the ability to ride the waterslides in the waterpark. With certain dApps, the token is the wristband, and a user must purchase it to interact with whatever the dApp offers.
Let’s take a dApp called Golem as an example. Golem lets people rent out their excess computing power to people who need it – kind of like a computer Air BnB. To cite this article from Laura Shin, “If I’m a computer graphics artist that wants to render some kind of computationally intense animation, I can purchase Golem tokens that let me tap into the Golem network to generate my animation. I then pay the people who are renting me their computers with the Golem tokens.” The Golem token is a form of smart contract, and this transaction is recorded on the Ethereum blockchain.
Since Golem tokens are also a cryptocurrency, they can be traded on the free market. If I’m a speculator who has no intention of using the Golem network to rent computing power, I can still buy the Golem token on an exchange in hopes that it appreciates in value. Like Bitcoin, there is a fixed supply of Golem tokens, so if the demand for the service increases so will the value of the token. If I bought Golem at its original price of around 1 penny and held it to today, I would have made 35X my initial investment since Golem tokens currently trade around 35 cents apiece.
ICO stands for Initial Coin Offering, which is a fundraising mechanism for cryptocurrencies. ICOs have exploded in popularity this year. Incidentally, the majority of them are managed within the Ethereum framework. Similar to a KickStarter campaign, they allow entrepreneurs to raise money for projects by giving investors an early opportunity to purchase the cryptocurrency before the final product has been built. If the project is successful, the value of the cryptocurrency will rise in value and early investors can realize large profits.
ICOs have stirred up a lot of controversy because they represent a risky proposition due to limited investor protection. Let’s say I wanted to build a casino and to finance it, I gave investors the opportunity to buy chips that can be used at my roulette tables once the casino opened. If you bought $100K in roulette chips from me and I decide that I no longer want to build the casino, you’re stuck holding worthless chips.
If ICO investors don’t perform due diligence, they may end up buying tokens for a project whose creators might never have intended on building it in the first place. In this case the creators walk away with the money and investors have extremely limited means of legally recovering their losses.
On the other hand, early ICO investors in projects that go on to be successful have the opportunity to make hefty returns. For example, people who invested $1,000 in the Golem ICO would have $35,000 based on the current price of $0.35. If, by chance, the value ever reaches $10 per unit the $1,000 investment represents one million dollars. Another positive aspect of ICOs is that anyone, be they rich or poor, can invest at the earlier stages of an ICO. To invest in a company like Twitter or Facebook pre-IPO (Initial Public Offering), you needed to be an accredited investor – this basically means you’re already somewhat wealthy. To participate in an ICO, all you need is an internet connection and some amount of capital investment. The allure is that you have the potential to become wealthy by investing in the right projects with what funds you have available.
Far From Perfect
Ethereum has the potential to change the way humans transact with one another, but it is still an immature technology and it hasn’t been without its problems. While the blockchain architecture underlying the Ethereum network is secure, this might not be true of the applications built on top of it. Faulty code can (and has) made applications vulnerable to hacking and malfunctions. Here are two prime examples:
DAO Hack– DAO was a dApp built on Ethereum that enabled crowd-based venture capital investments. DAO token holders were given the right to vote on projects they wanted to support. If projects went on to be successful, DAO token holders would receive financial rewards. The DAO ICO received $168 million in funding. The DAO software was hosted on the Ethereum blockchain and was publically visible. A hacker spotted a flaw in the DAO’s code that enabled him to route $55M in Ether held by the DAO into an account that he controlled. The Ethereum team had to do something called a hard fork (something I won’t get into now) to restore the stolen funds.
Parity Wallet Freeze– Parity is a digital wallet used to store Ether. A flaw in Parity’s code let a user delete a specific line of code that was necessary for accessing funds in a Parity wallet. This led to $280 million worth of Ether being frozen – it hasn’t been stolen but it can’t be accessed either. Parity Technologies has proposed another hard fork to correct the issue, but that is something guaranteed to divide the Ethereum community and undermine participant confidence.
Despite the world-changing implications of Ethereum dApps and smart contracts, the blessing/curse is that any programmer can write them. If improperly written, they can behave in unintended ways and be exploited as in the above examples. Ethereum is still a very young network and security issues with dApps and smart contracts will have to be sorted out if it is to reach the expected potential.
Leading the Decentralized Revolution
Ethereum aims to take the promise of decentralization, openness and security that is at the core of blockchain technology and brings it to almost anything that can be computed. – Vitalik Buterin
With dApps, smart contracts, and blockchain technology, Ethereum is leading the decentralized contract management revolution. Bitcoin might be the world’s first decentralized currency operating on a global network of computers beyond the need for centralized intermediaries. Ethereum on the other hand, gives programmers a platform to develop a decentralized version of just about any contractual vehicle.
As an example, let’s examine Uber. Uber is a platform that brings people who need rides together with people who have cars. To facilitate this interaction, Uber collects 20% of every ride. With Ethereum and blockchain technology, there is nothing to prevent a group of software developers from writing a dApp that creates a decentralized version of Uber. Instead of 20% per ride, transaction fees are paid to the network and the driver takes home the larger share of a transaction’s profit. Tokens can be issued that represent ownership in the network. Coders who work on improving the network can get paid for their efforts in ownership tokens. Non-technical individuals can create marketing campaigns that spread awareness for the network and also get compensated in ownership tokens. As the sample decentralized Uber network grows and improves, the value of ownership tokens increase, rewarding the people that built it. The result is what is referred to as a Decentralized Autonomous Organization (DAO) and there is a strong possibility that DAOs could actually replace a fair number of the world’s largest corporations.
This may sound like a radical concept, but blockchain technology enables these kinds of decentralized organizations to exist and even thrive. Ethereum provides the platform and tools for people to go out and build this brave new business world.