What is ETH, and how does it work?

Crypto 101

When you start getting into cryptocurrency, one of your first questions is sure to be, “What is ETH?” At a glance, the Ethereum token, Ether, or ETH stands out as the runner-up to BTC, the biggest crypto in terms of market cap. But ETH is more than just the token.

Like BTC, it’s a system for exchanging value with absolute transparency and privacy, but it’s also a coding-friendly, open-source platform. Many developers have used ETH to create innovative smart contracts and applications that provide peer-to-peer financial services.

From a tech and capability perspective, ETH has increased the potential of virtual currency more than BTC did and continues to go further. In fact, ETH is launching its version 2.0, which aims to make the platform more efficient and environmentally friendly. This capacity to change and undergo new development is another notable characteristic of ETH.

However, ETH faces a juncture. Despite its innovations, it hasn’t managed to unseat BTC, and it’s no longer the most cutting-edge digital asset available. Newer coins have successfully implemented many of the new technologies ETH is still working on. The future of the project depends on its leaders’ ability to innovate the platform and compete with the new generation of blockchains.

ETH mining: How does it work?

Understanding a cryptocurrency’s consensus mechanism is important. A blockchain is essentially a decentralized, anonymous ledger or set of data that people operate democratically. Everyone can see the records on the blockchain, which are both public and anonymous.

The consensus mechanism provides a way to ensure that each person’s version of the system is identical so that the blockchain only reports accurate data. The consensus mechanism also defines how people can earn rewards for contributing their hardware to power actions on the blockchain. This isn’t just processing transactions. It also applies to minting NFTs or powering smart contracts that facilitate peer-to-peer financial services. Mining ETH isn’t exclusively limited to those with powerful rigs. There are three different ways to go about mining ETH:

  1. Pool Mining: miners combine their collective computing power to create new blocks of ETH. This is the most cost-effective means of mining this crypto.
  2. Solo Mining: A costly mining method where miners have access to advanced rigs with high-end graphic cards, enabling them to solve complex blockchain puzzles in record time.
  3. Cloud Mining: An efficient mining approach that leverages the unlimited potential of cloud computing, where you hire someone with rig capacity to mine for you. While cloud mining helps you acquire freshly minted ETH without heavy-duty equipment, it’s the most vulnerable to online scams and fraudulent arrangements.

Proof-of-work versus proof-of-stake

ETH functions with the PoW consensus mechanism, which is typical of older cryptocurrencies. Miners compete with their hardware to complete complex mathematical equations, and the fastest miners can handle transactions on the network and receive payment via transaction fees. This is one way to enable a network to function as a completely decentralized, peer-to-peer system. It’s proven technology, but it also has drawbacks.

For one, the complex equations aren’t actually necessary to the process. Rather, they aim to make the cost of electricity a deterrent to attacks on the network. But, many people have become concerned about this waste of electricity, as well as the wear and tear on expensive computer parts. While ETH currently uses proof-of-work (PoW) for consensus and mining, it’s in the process of shifting to proof-of-stake (PoS) with the launch of ETH2.

With PoS systems, people power the system and earn rewards by participating in validator nodes. If you stake a certain amount of the token, you can operate a validator node and receive transaction rewards. On the other hand, those who don’t own enough can delegate their tokens to someone else to earn a portion of their validator rewards. This drastically reduces the cost of transactions and increases scalability, at the expense of being somewhat more centralized than PoW.

Significant changes in ETH’s evolution

Shifting to ETH 2.0 will be a major change, but change is already an element of the industry’s evolution. In the digital currency world, there’s a “hard fork” that only happens in rare situations. A hard fork means the community using the cryptocurrency has branched off to a new protocol for handling the blockchain. The old protocol still exists, and the two are often in competition.

Ethereum is particularly unusual because it has had two hard forks in recent years. The original hard fork produced Ethereum Classic, which uses the original rules and blockchain from Ethereum’s launch. It remains a popular asset and one of the larger cryptocurrencies, although it’s much smaller in terms of market cap, trading volume, and community size than the main ETH token.

More recently, the London hard fork accompanied the initial launch of the Beacon Chain in 2020. This new chain is the foundation for ETH2, which should launch in 2023. Among other things, it involved the move to a PoS model and otherwise laid the groundwork for more development in Ethereum.

How to Use Ethereum

There are numerous applications for ETH tokens, thanks to the blockchain’s support of smart contracts. As a digital currency, it works for any of the standard transactional purposes that you might use a currency for. These include:

  • Exchanging other currencies for ETH
  • Exchanging ETH for other currencies
  • Transferring ETH
  • Paying for goods and services
  • Receiving payment for goods and services

 

These aren’t the only applications for ETH. Much like BTC, ETH is considered by many to be a non-inflationary asset that should gain relative value against inflationary currencies over time. This gives it considerable appeal as a vehicle for investment and a store of value.

ETH isn’t just digital gold, though; it also stands out as a sort of digital oil. By holding Ether tokens, you can participate in the ecosystem of decentralized finance services (DeFi) that exist on the ETH blockchain. You can also use ETH to mint a non-fungible token (NFT). While standard ETH tokens are fungible, in that they’re interchangeable in the same way that $1 is always interchangeable with $1, NFTs are unique. They’re data stored on the blockchain, which has an association with a separate asset, such as real estate or artwork.

Before you can use ETH for any of these purposes, you must hold it. You hold ETH and other cryptocurrencies in digital wallets, and you can choose between hot and cold options. A hot crypto wallet is connected to the internet and might be a proprietary wallet at a centralized exchange. Alternatively, you can store your crypto in a cold wallet that’s not connected to the internet and is only accessible via a long, complex password. Cold wallets are the ultimate option security-wise, but they’re harder to use compared to hot wallets. Once you set up your wallet and deposit Ether in it, you can use that Ether for all the purposes listed above.

The Value of ETH

When you’re talking about the value of ETH, there are two main factors to keep in mind. On the one hand, there’s the use-value of the technology. This is hard to measure but also hard to understate, as ETH hosts a vast collection of DeFi apps that are changing finance as we know it. If ETH2 launches as planned in 2023, it will surely push its technological value even further.

While it might seem logical to say that improving technology will certainly lead to greater market cap and coin value, this isn’t always the case. Like other cryptocurrencies, ETH is extremely volatile and likely will continue to be.

From 2015 to spring 2017, the coin stayed below US$20 before leaping to US$350 in June over the course of three months, and then rose again to almost $1,400 in 2018 before crashing to a stable price of around $200-$300 in 2019. The 2021-2022 market has seen unprecedented adoption rates, with the coin leaping to almost $5,000 in November 2021. As of June 5, 2022, the Ether token is at $1,815.06. While the pathway here has been tumultuous, Ether is still worth more than 1,500x its early price of $1.

ETH Pros and Cons

While ETH has many benefits, it also has challenges to overcome as well as certain risks to consumers. The original blockchain wasn’t built to scale efficiently enough to keep up with its growth, which means transaction fees have risen steadily over the years.

Plus, while ETH has seen remarkable performances as an investment asset from 2015 to 2022, it suffers in this area due to price movements that closely correlate to BTC. Dated technology also means the ETH network consumes much more electricity than necessary.

But, many of these disadvantages come with caveats. While ETH’s technology has become dated, the rollout of ETH2 may well be the advance needed. It also stands as a decentralized, globally accessible currency that’s free of manipulation by central organizations, with non-inflationary qualities that protect the value you store via ETH. Many investors find ETH’s combination of past growth and future development inspires confidence, which has contributed to the rising adoption rates for this crypto.

The bottom line is that ETH has its share of benefits as well as problems. And no one can deny that it has a rich, innovative history that has led to its current position as the second most popular crypto.

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