What if there was a world computer that wasn’t controlled by any central authority?
What if this computer could independently move money, and guarantee the execution of transactions?
Enter 23-year-old Vitalik Buterin. A Russian-Canadian computer science prodigy with a passion for cryptocurrencies (decentralized digital money).
Vitalik was born in Russia, but immigrated to Canada with his parents when he was six.
It was quickly discovered he was gifted, and he eventually gravitated towards computer science.
Vitalik Buterin – creator of Ethereum
Photograph courtesy of the Ethereum Foundation
“a platform for building and deploying smart contracts, decentralized applications, and decentralized autonomous organizations”
The Ethereum Foundation
More specifically, it’s a platform for building and deploying smart contracts, decentralized applications, and decentralized autonomous organizations (DAOs) that don’t rely on third-party trust, and cannot be controlled by any central authority.
Okay, breathe. Let’s unpack each component one-by-one.
The venerable Nick Szabo (inventor of Bit Gold, one of Bitcoins early ancestors), coined the term “smart contract,” back in 1994.
However, to date, no authoritative definition of smart contract actually exists.
Personally, I gravitate towards the clear and concise description provided by Josh Stark of Ledger Labs:
“A smart contract is an agreement whose execution is both automatable and enforceable. Automatable by computer. Enforceable by either legal enforcement of rights and obligations, or tamper-proof execution.”
In other words, a smart contract is a legal agreement, turned into code, that automatically executes on a Blockchain.
“A legal agreement, turned into code, that automatically executes on a Blockchain”
Imagine a scale at your gym that automatically pays out Ether (Ethereum’s native digital currency) or Bitcoin, to your Personal Trainer’s digital wallet anytime you lose weight – based on terms in your membership contract.
Now that’s training smart.
To further clarify, smart contracts combine:
- A legal agreement
- The execution of that agreement (moving money and making payment)…
…into one thing.
- A smart contract also guarantees execution
- And once that execution occurs, it’s almost impossible to stop (at least for “pure” smart contracts)
These key features offer several benefits, the most important one being – forcing honesty.
Once the legal terms have been agreed upon and the contract executed, neither party can:
- Pay late, or
- Manipulate the other party
This leads to additional advantages:
- Increased trustworthiness (reliable and predictable outcomes)
- Disintermediation: the need for lawyers and banks is dramatically reduced – or even completely eliminated
- Reduction in litigation costs
We still need lots of testing and monitoring before we can fully embrace smart contracts, especially within Financial Services.
All you have to do is look at the DAO fiasco (scroll below) to fully appreciate how far we still have to go.
However, as Ethereum’s adoption rates increase, smart contracts will quickly become a vibrant niche. Instead of software engineers getting MBAs, they’ll start getting JDs…and lawyers will be pulling all-nighters on Coursera.
Decentralized Applications (Dapps)
A Dapp (pronounced “D” app) is a decentralized application that runs on a Blockchain. The key word here is “decentralized.”
It’s the next level up from your basic smart contract.
Instead of the smart scale I described above, consider a prediction market platform that rewards you for correctly predicting real-world events, sexy user interface included.
Guess what, Augur, an Ethereum-based Dapp, is already doing that.
According to this white paper, a Dapp must satisfy these four criteria:
1) The application must be completely open-source and operate autonomously
2) The application’s data must be cryptographically stored on a public, decentralized Blockchain
3) The application must use a digital currency or other cryptographic token (e.g. Ether or a token native to its system)
4)The application must generate tokens according to a standard cryptographic algorithm
In practice, not all Dapps will meet these criteria. For instance, many Dapps will be developed for private blockchains versus public ones. Whether or not they would still qualify as true Dapps is up for debate.
Decentralized Autonomous Organizations (DAOs)
A Decentralized Autonomous Organization (DAO) is a completely independent entity that resides on a Blockchain and is exclusively governed by rules programmed into it.
It’s much more complex than a typical Dapp.
DAO use case: A fleet of self-driving cars that manage their own car rental business
For illustrative purposes only
I remember watching the Terminator as a kid. You probably know the story – Skynet, a super-computer that “gains self-awareness after spreading to millions of computer servers across the world,” sends Arnold Schwarzenegger back in time to destroy the future of mankind…
…an eerie similarity to how a fully fledged DAO is designed to operate on a Blockchain.
1) A DAO is a collection of smart contracts (organized to create an autonomous company)
2) It owns digital assets (without this, it would simply be a smart contract “library”)
3) The entire company is computer code – and once that code is executed on the Blockchain, it’s almost impossible to stop
4) A DAO sustains itself (buys and sells)
5) It also provides a useful service to real world entities or other DAOs
Bitcoin and Ethereum themselves could be considered DAOs. However, the most famous example of a DAO, is The DAO – an autonomous entity created in 2016 by former Ethereum CCO, Stephen Tual, and coded by Christoph Jentzsh (both also founders of Slock.it).
The DAO was created to finance Ethereum-related startups. A venture fund of sorts.
It even set a record for the largest crowdfunding in history – $150 million!
The DAO Heist – A Cautionary Tale
Unfortunately, the ambitious undertaking quickly imploded when the DAO was hacked on June 17, 2016. The hackers eventually got away with $50 million worth of Ether.
Remember point (3) above – a DAO is almost impossible to stop once it starts running.
So to reverse the hack, the Ethereum community voted to “hardfork” Ethereum. A hardfork is a software update to the entire network that results in a permanent divergence of the Blockchain.
This created a “new history” of the Blockchain, which to the purist, went against everything Ethereum stood for to begin with.
Hacking or no hacking, Blockchain transactions are supposed to be irrevocable and immutable, and not to be controlled by any single authority!
In the end however, the majority (99%) of the Ethereum network disagreed with the purists (1%) resulting in two separate Blockchains:
1) The “new” Ethereum, which erased the hacked transactions (considered the official Ethereum)
2) The original Ethereum (renamed Ethereum Classic) which maintained the hacked transactions
DAOs Are Still In Their Infancy
The DAO fiasco underscores one key point – we have still have a long way to go before DAOs become globally viable.
Consider some of these questions:
• How is an entity with no geographic location regulated?
• With no managers or board of directors, who would be legally responsible for such a company?
• As for Ethereum, what will happen when the next big smart contract goes south? Another hard fork?
Food for thought.
Recapping The Basics
So far, we’ve determined that Ethereum is a free, open source, public, and decentralized platform – a Blockchain – for building smart contracts, Dapps, and DAOs.
We’ve also defined each of these components. Now, how does Ethereum actually work?
The Ethereum Blockchain – An Overview
Bitcoin was the first and most successful implementation of Blockchain Technology
Vitalik was an early, hardcore Bitcoin enthusiast. He contributed to several Bitcoin open source projects.
Most notably, he co-founded one of the first serious publications dedicated to cryptocurrencies – Bitcoin Magazine, which he worked on between 2011 and 2014.
In late 2013, he began to conceptualize a new Blockchain platform that would address some of Bitcoin’s shortcomings, namely:
- Inconvenient software updates that interrupt the network
- Limited programming functionality
He went on to distill his concept in the now famous 2013 Ethereum white paper – and thus, Ethereum was born.
After being introduced to Vitalik by a mutual friend, Dr. Gavin Wood, a computer scientist, wrote a more technical breakdown of the concept in the Ethereum yellow paper.
In August of 2014, the Ethereum project reached a critical milestone when it raised $18 million (60 million Ether) in only one month, via a crowdsale to a bevy of hardcore fans.
A year later, on July 30th, 2015, the Ethereum Blockchain went live.
Today, Ethereum is the second most successful application of Blockchain Technology (by market capitalization), the first being Bitcoin.
Just like Bitcoin, no one entity controls the Ethereum Blockchain. It’s public, free, and can be accessed and used by anyone.
Ethereum – The World Computer
When a smart contract on the Ethereum Blockchain triggers a transaction, all 6,000 nodes on the network execute that transaction almost simultaneously.
This is why Ethereum is often referred to as ‘The World Computer.’
Ethereum – ‘The World Computer’
For illustrative purposes only
The transaction is then validated by each node. A system called proof-of-work (also used on the Bitcoin network), is used to ensure consistency of transactions across the entire network.
Proof-of-work (PoW) has several pros and cons that I won’t get into right now. Just understand that its major drawback is the gargantuan amount of electricity it requires. For this reason, Ethereum is in the process of switching to a different system called proof-of-stake (read more about these two approaches here.)
After all transactions have been timestamped and validated, they are included (most of the time) in the latest ‘block’ of transactions on the Ethereum Blockchain as public, permanent, immutable records.
Like a virtual heartbeat, one block is created like this every 14 seconds (check the current block time here).
In short, Ethereum advanced Bitcoin’s concept of a decentralized global payment network, to a global computational network.
Ether (symbol: ETH) is the name of Ethereum’s native cryptocurrency. At the time of this writing, Ether’s global market capitalization is approximately $1 billion – second only to the king of digital currencies – Bitcoin (about $16 billion).
Official Ethereum logo
Courtesy of the Ethereum Foundation
All transactions on the Ethereum Blockchain incur fees, and those fees are paid for in Ether.
Ethereum also allows the use of any digital currency (you can even create your own), but converts that currency into Ether for execution on its network.
If you’re familiar with the more popular Bitcoin (symbol: BTC), you probably already know that Bitcoin’s global money supply is capped at 21 million BTC.
Ether is handled a bit differently. Current global supply is just shy of 90 million ETH. Annual supply is capped at 18 million ETH per year, at least until the Ethereum Blockchain switches from PoW to PoS (proof-of-stake).
Popular Ether Wallets
If you decide to go out and buy yourself some Ether, make sure you have a decent digital wallet to store it in. As with Bitcoin, it’s possible to permanently lose your Ether whenever you move it around.
Here are some options recommended by IBM’s Henning Diedrich:
- Mist (official Ethereum wallet)
- MyEtherWallet (web application)
- Jaxx (most user-friendly, best for newbies)
- Icebox (for cold/offline storage, by Consensys)
At the end of the day, the power of Ethereum is in its smart contracts, not in Ether.
I’m a big fan of the Pareto Principle (the 80/20 rule) and I’ve used it with this article. If you’re a novice, I’ve gone over what I consider to be the fundamental attributes of Ethereum – at a very high level of course.
If you really want to see how deep the rabbit hole goes:
- Read the Ethereum white paper
- Read the Ethereum yellow paper (super technical)
- Read the Ethereum Foundation’s blog
- Stay current with ongoing developments – Ethereum is in its infancy, and it’s changing very quickly
My question to you: Does Ethereum make sense now? Let me know in the comments section below.
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