What is Ethereum (Smart Contracts)?

Ethereum explained

Ethereum is a decentralized, blockchain-based, cryptocurrency platform created by Vitalik Buterin. Currently, it is only second to Bitcoin in terms of market capitalization. It has redefined much of the crypto industry with the introduction of smart contracts. The best way to understand Ethereum is by first comparing it to Bitcoin.

Ethereum VS Bitcoin

Although Ethereum and Bitcoin share many similarities, ultimately these are two separate projects with distinct goals. Nevertheless, let’s first examine the characteristics they do have in common. Both are decentralized systems, meaning that there is no single entity that controls them. Instead, their systems run on a global network of computers volunteered by willing participants called nodes. In other words, both rely on blockchain technology to record data or transactions in a safe and public manner. However, their differences become apparent in terms of the long-term objectives they each have for this technology.

Bitcoin stands as the first cryptocurrency or money transfer system recorded on a distributed public ledger, whereas Ethereum is a multipurpose platform. Although it does have its own digital currency, ether (ETH), this is only one component of its overall system. Ethereum significantly expanded on Bitcoin’s core technology to offer a network that allows for the creation and deployment of other decentralized applications (DApps). These applications can be entirely new concepts or new versions of existing ones. For example, decentralized finance or DeFi is one of the most popular fields currently being developed on the Ethereum network. These are traditional financial services reimagined and reconstructed without the need of third-party intermediaries. Picture the ability to lend or borrow money on a global scale but without a bank or company collecting a large percentage in fees. Instead, all generated interest and transaction fees go straight to the lenders. It is a true peer-to-peer system in which every interaction happens directly between users.

Even if we compare just Ethereum’s cryptocurrency component to Bitcoin, there are still some significant differences. The total maximum supply of bitcoins is capped at 21 million. Ether, on the other hand, has no limit. Ethereum also aims to have its blocks mined at an average of 12 seconds per block, much faster than the 10 minutes Bitcoin takes. Finally, bitcoin mining is much more resource-intensive, requiring custom dedicated machines that few can afford. In contrast, it is much easier for the general public to participate in the mining of ETH, thereby encouraging more decentralization.

Smart Contracts    

Smart contracts are the singular new feature introduced by Ethereum that has become a catalyst for the development of countless new decentralized applications. Like their physical counterparts, these can be understood as binding agreements between two parties. However, in the physical world, signing a contract does not guarantee an expected result. In fact, contracts are broken or ignored all the time. These paper documents are often merely deterrents whose strength is dependent on the enforcement capabilities of the legal and governmental institutions that back them. A smart contract does not have such weaknesses. It is represented by computer code that runs exactly as intended on the Ethereum blockchain. Once deployed, it is automatic and cannot be censored or tampered with. It facilitates transactions or exchanges of money, data, content, or anything of value. Smart contracts are self-operating, meaning that their code is designed to execute specific actions once certain conditions are met.

Let’s illustrate the power of smart contracts with a simple example. Imagine you want to buy a digital book from someone on the other side of the world. Your main issue will be trust. If you first wire the money to this person, what guarantee do you have that the seller will actually send you the product? Conversely, the seller also risks not receiving any payment if they send you the book first. One solution is an intermediary or trusted escrow service that holds the payment and only releases it upon proof that the product has been delivered. Of course, the escrow company will likely charge fees in exchange for their service. Yet, even in this situation you must still trust and hope that the intermediary will act in good faith as they too could choose to keep your money and run. Employing a smart contract on the Ethereum network eliminates all of these concerns. A code that automatically sends you a copy of the book once a specified amount of funds has been transferred to a target account is a much more effective solution. Besides the buyer and the seller, no additional parties are required, no extra fees are collected, and everything happens automatically with public transaction records verifiable on the blockchain.

Developers can leverage these smart contracts to create much more complex applications limited only by their imaginations. These new services would all share the traits of decentralization, automation, and transparency and this is exactly what is happening with the current DeFi boom. All different types of traditional financial and banking services are being recreated on the Ethereum network with the use of smart contracts. However, finance is not the only industry that can be decentralized. Voting systems, social networks, and even gaming all have the potential to be revolutionized.

Disadvantages

Although it shows a lot of promise, Ethereum’s smart contract feature does have one potential critical flaw, human error. The uneditable code of a smart contract is only as good as the person who wrote it. If a mistake was made or an oversight left an exploitable bug, it’s only a matter of time before a malicious actor takes advantage of it. Once they do, there is virtually nothing that can be done to reverse the damage. Of course, a new and improved version of the contract can be written, but whatever transaction happened using the previous contract has already been recorded and made permanent on the blockchain. The only way to change this would be through general consensus to reverse the transaction and rewrite the underlying code, a move that goes against the core philosophy of an immutable ledger.  Whenever such mistakes happen, and they certainly have, trust in the Ethereum network gets eroded and the value of ETH drops significantly. Despite this, this exciting field is still young, and so far, it has managed to pick itself up and regain the confidence of investors multiple times.


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