Complete Guide to Ethereum and ETH: How do they Work?

ethereum

Can you imagine a world where all applications are supported by the same technology? And what if that technology allowed for quick and secure payments to any part of the world? That would be fantastic, right? In the case that this technology wasn’t directed by any entity or government but was 100% decentralized, it would become unparalleled. Well, we’ve just described Ethereum.

This blockchain has brought several of the most significant innovations to the crypto ecosystem and still has much to offer. In fact, the evolution of Distributed Ledger Technologies (DLT) has continuously surprised us since the emergence of Bitcoin in 2009. Currently, Ethereum is the world’s second most important cryptocurrency by market capitalization, with only Bitcoin ahead. However, Ethereum’s strength goes beyond its value as a means of payment. Let me tell you what it is and how it works.

History of Ethereum

Ethereum is a public and decentralized blockchain that operates according to its namesake protocol. Ether (ETH) is the cryptocurrency supported on this network, designed not only for transactions but also for working with Smart Contracts and Decentralized Applications (DApps) deployed on it.

Therefore, Ethereum is not just the blockchain of a new payment method; its protocol allows for the execution of smart contracts and the launch of numerous blockchain projects, all while maintaining their independence within the network.

That’s why Ethereum isn’t so much about replacing fiat money; it aims to become the main platform for deploying decentralized applications for any company, enabling the universalization of its protocol while maintaining the independence and security of each hosted project.

ethereum

The Migration from Ethereum to ETH 2.0

Since its launch in 2015, Ethereum has faced multiple challenges, most of which are common to other blockchain networks. However, Ethereum has consistently positioned itself as one of the most innovative networks in solving these issues. As part of this innovation, they decided to launch a second version of their protocol. This new version, known as ETH 2.0, is Ethereum’s solution to achieve greater scalability, enhanced security, and an improved user experience.

In the development of this new protocol, the developers designed a roadmap for the upcoming years. With this roadmap, their aim is to implement incremental protocol variations, gradually optimizing the network’s functionality. All of this is done without jeopardizing or halting the network’s operation. Let’s now take a look at the main solutions outlined in their roadmap for the years ahead.

Security improvements

In the realm of security, the primary change Ethereum has undertaken is the implementation of Proof of Stake (PoS) as a replacement for Proof of Work (PoW). As we’ve seen in previous discussions, Proof of Work is highly secure but comes with a substantial energy cost. Additionally, its tendency towards increasing centralization among more powerful nodes makes it less desirable in the long term. This effect is further exacerbated by the algorithm’s low scalability. For these reasons, the network’s developers have chosen to alter the network’s consensus algorithm.

pow vs pos

With the new consensus algorithm, the barriers to entry for new nodes are lower. This allows for a higher level of decentralization, which reinforces the network’s security against 51% attacks. Additionally, Ethereum is working on small implementations that enhance the network’s security against other types of attacks.

One of these solutions includes reducing the block finality time. Currently, the time Ethereum takes to finalize a block (set at 15 seconds) can be exploited by attackers to reorganize recent blocks and gain an advantage. By reducing this time period to 0 seconds, this possibility is eliminated.

Furthermore, ETH 2.0 encourages the organization of validators into groups. This way, the network’s operation is maintained while the individual power of each node is reduced. Lastly, Ethereum proposes to keep the selection of nodes that create blocks secret. This eliminates the possibility of suffering from “Denial of Service” (DoS) attacks.

Scalability improvements

Furthermore, the new version of the protocol also introduces “Sharding” as one of its significant innovations. This essentially involves subdividing the network into small portions called “Shards.” This approach alleviates the need for validator nodes to download all available information (which is more resource-intensive). Instead, each node can work with one or several Shards or continue to connect to the main network.

This offers two major benefits. Firstly, it greatly enhances scalability—there’s talk that Ethereum, with this change, could process more than 10,000 transactions per second. Secondly, it requires more communication among nodes to ensure that the information in each Shard remains consistent with that stored on the main network. This approach ensures the security of the network while distributing the load among participating nodes.

sharding

This solution applies to Ethereum’s main layer, which is considered “Layer 1.” However, there are other solutions currently in development that focus on improvements to Ethereum’s Layer 2. These types of solutions, known as “rollups,” involve executing transactions off the Ethereum network and only communicating the outcome of these transactions. This approach helps alleviate congestion on the Ethereum network, making Layer 2 transactions much cheaper. As a result, these solutions also contribute to enhancing the network’s scalability.

User experience and overall ecosystem improvements

Lastly, Ethereum’s developers are exploring various ways to optimize the network’s functionality for users. As part of this optimization, there are two ongoing solutions: on one hand, the elimination of the double-key system to access the network. This can be achieved through the use of Smart Contracts that allow for key recovery, direct account management, etc. This reduces dependence on an external entity. On the other hand, Ethereum aims to make node creation more accessible to create a more universal network. With lighter nodes, entry barriers are lowered, and decentralization is improved.

Additionally, there are two initiatives aimed at making Ethereum a resilient network in the long term. Firstly, work is being done on the possibility of developing cryptography that is compatible with quantum computers. While such computers are not yet a reality, it is expected that they could pose a threat to Ethereum’s current code in a few years. Hence, work is already underway on an alternative. Secondly, Ethereum’s developers are striving to “clean up” the network’s code, making it more efficient by removing obsolete or duplicated components. This makes it easier to maintain for the future and ensures better functionality.

Nodes

Nodes are among the most crucial components in any blockchain network. A node is a piece of software that downloads network information and performs specific functions. These functions include transaction validation, block generation, and more.

Therefore, nodes ensure the stability and security of the network. The more nodes there are, the more secure and resilient the blockchain can be. In the case of Ethereum, based on the current structure of ETH 2.0, we can identify three types of nodes:

  • 1. Validator Nodes: These nodes participate in the Proof of Stake consensus mechanism. Validators are responsible for proposing and validating new blocks. They are required to lock up a certain amount of Ether as collateral to ensure their honest behavior. Validator nodes play a key role in maintaining the network’s security and integrity.
  • 2. Beacon Nodes: Beacon nodes are responsible for managing the Beacon Chain, which coordinates the PoS protocol and manages validator assignments. The Beacon Chain is a central component of Ethereum 2.0 and helps ensure the consensus mechanism’s proper functioning.
  • 3. Execution Nodes: These nodes handle the execution of smart contracts and transactions. They are responsible for processing user interactions and implementing the logic of decentralized applications. Execution nodes contribute to the overall functionality of the Ethereum network.

These three types of nodes work in harmony to maintain the Ethereum network’s operations, security, and functionality, contributing to its status as a decentralized and robust blockchain platform.

Transactions

Transactions in Ethereum are essentially actions initiated by an Ethereum account that update the entire network’s state. The “state” of the network refers to the collective situation of all the accounts, nodes, contracts, and blocks that compose it. Whenever a transaction occurs, and that transaction is validated and the block is added to the network, the state of the network changes. This is why nodes monitor and store information about these states, allowing them to maintain the traceability of transactions.

state change

In this context, the basic transaction involves sending money from one account to another (see image). These transactions are always initiated by an account, which can be a personal account or belong to a Smart Contract. Let’s explore the difference between these two types of accounts:

  1. Personal Account: A personal account in Ethereum is owned by an individual user and is associated with a private key, which acts as a digital signature for transaction authorization. Personal accounts are primarily used for transactions involving the transfer of Ether (ETH) from one user to another. They can also participate in interactions with smart contracts and decentralized applications.
  2. Smart Contract Account: A smart contract is a self-executing contract with the terms of the agreement directly written into code. A smart contract account on the Ethereum network holds the code and data required to execute specific functions when certain conditions are met. These accounts have their own addresses and can hold Ether like personal accounts, but they can also perform automated actions based on predefined rules. They are often used for various purposes such as decentralized applications, automated agreements, token issuance, and more.

Blocks generation

In Ethereum, the number of operations that can be processed in a minute depends on a unique concept of this network, known as the “Gas Limit” or “GasLimit.” Gas essentially represents the computational effort a user needs to pay to the network for processing a transaction. Therefore, in each transaction, the Gas Limit (GL), which indicates the amount of Gas the user is willing to pay to include that transaction, must be specified.

Additionally, a BaseFee is established, which is the minimum price per unit of Gas required to include that block. This fee is calculated based on the block’s space requirement. Lastly, users define a tip, which is directly paid to the block miner. All transaction costs are expressed in Gwei (which is 1×10^-9 ETH). In this way, if User A wants to transfer 1 ETH to User B, assuming Gas Limit = 21,000, Base Fee = 100, and Tip = 10, the cost of that transaction would be calculated as follows:

1 ETH + (GL*(BaseFee+Tip)*(1×10-9)) = 1 + 0.00231 = 1.00231 ETH

From the aforementioned amount, 1 ETH will go to User B’s account, and 0.00021 ETH will go to the miner’s account. The remaining 0.0021 ETH is considered the base fee, and this money is “burned,” meaning it is taken out of circulation.

Regarding the size of blocks, Ethereum has an expected size of 15,000,000 Gas. This size is calculated as the sum of the Gas Limits of all transactions in that block. When the actual size exceeds the expected size, the base fee increases, thus raising the transaction’s cost. This way, the network adapts to demand spikes, accommodating a greater number of transactions. The maximum block size is currently set at 30,000,000 Gas.

Conclusion

We’ve analyzed the fundamental components of the Ethereum network and observed that it aspires to be more than just a payment medium. Technologically, Ethereum has developed several innovative elements. These elements are geared towards enhancing its platform for deploying decentralized applications (DApps).

Furthermore, with the introduction of Smart Contracts and DApps, Ethereum enables the creation of numerous external projects on its blockchain. Ultimately, its transition to Proof of Stake (PoS), coupled with the incorporation of “Sharding,” makes scalability easier and demonstrates its commitment to adding value to the blockchain ecosystem.

Ethereum’s multifaceted approach showcases its versatility and adaptability, making it not only a digital currency but a robust infrastructure for a wide range of decentralized innovations and projects. The ongoing evolution of Ethereum continues to shape the blockchain landscape and drive innovation in the field.

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