How Does Ethereum Work?

Second only to Bitcoin, Ethereum is among the world’s most highly valued and well-known cryptocurrencies. According to data from CoinMarketCap, Ethereum has the 2nd-largest market capitalization in the cryptocurrency landscape, with a total token value of over $58 billion and a token value of over $516 at the time of writing. Ethereum is much more than a simple crypto coin, however, with underlying technology that greatly expands upon the framework laid out in place by Bitcoin.

As investors turn their eyes toward Ethereum and other tokens necessary to facilitate decentralized finance and applications, there are still many misunderstandings floating around about Ethereum. Our guide to Ethereum will help you understand why its token is valuable and how it is created. 

Ethereum Dictionary

Understanding a few of the most commonly-used terms used when discussing Ethereum can help you better understand the cryptocurrency market as a whole. Here are a few common terms you’re likely to run into.

• Cryptocurrency: A cryptocurrency is a digital currency in which transactions are verified using a decentralized network as opposed to a singular authority.
• Blockchain: A blockchain is a permanent public ledger that creates a record every time a wallet sends or receives a cryptocurrency like Bitcoin. Blockchain technology ensures that users aren’t able to “double-spend” or send a single Bitcoin to multiple addresses.
• Transactions: A transaction is a transfer of a cryptocurrency. In terms of Bitcoin or Ethereum, a transaction is a transfer of a token recorded on the blockchain.  
• Ether: Ether is the token used to power the Ethereum network. You can buy and sell Ether on major exchanges.
• Mining: Mining is a process that adds blocks to a decentralized cryptocurrency’s blockchain. Miners are rewarded in Ethereum for powering the blockchain. 

What is Ethereum?

Ethereum is an open-source platform that allows users to connect with others and create contracts and agreements without the use of a middleman server or software. Ethereum works using a global network of computers that connect together as a single supercomputer. Ethereum incentivizes programmers to dedicate their computers to the Ethereum network with its “Ether” token. Ether is the cryptocurrency built on top of the Ethereum network — when you invest in “Ethereum” through a cryptocurrency broker, you’re actually purchasing the Ether token.

Although compared to one another and available on the same trading platforms, Bitcoin and Ethereum are not the same, nor do they serve the same purpose. Bitcoin was the first cryptocurrency created, and it was originally invented to act as a secure and more anonymous payment method when compared to online fund transfer methods. Bitcoin is built upon technology called the “blockchain,” which is an unalterable ledger that records every transaction made between Bitcoin wallets.

Ethereum uses the basic technology behind Bitcoin to greatly expand user capabilities, allowing users on the Ethereum network to create applications on the Ethereum blockchain. Because Ethereum has no single centralized point of access, these applications are referred to as “decentralized applications.” These applications can enable direct monetary payments, launch collaborative projects, create contracts and more without the use of a middleman server or software. 

What is a Decentralized Application?

Most people are familiar with the term “application” and how it applies to software and smartphone technologies. The vast majority of these applications are “centralized applications,” which means that the application is controlled by a single entity. For example, when you use Uber to order a cab, Uber is the middleman that controls the application, connecting you with a driver.

A major point in centralized applications is that these apps have a single point of failure — hackers know exactly where to target when attempting to steal payment or personal data. Centralized applications can also face internal threats. For example, many users have concerns over Facebook’s data-sharing policies, which offer the social media network unfettered access to the personal data users provide when signing up for an account.

Decentralized applications (sometimes called “dapps”) is a fully autonomous network with no single point of entry. The Ethereum network is run by thousands of computer volunteers around the world, which verify transactions and communications directly between 2 or more users on the same network application. Programmers can use the Ethereum network to create decentralized applications that connect users to content, creators and other users while helping users retain full control over their own content and data.

How is Ethereum Created?

The Ethereum network relies on a series of tokens called “Ether.” Ether is a cryptocurrency provided to network operators who run the computers that execute code and programs necessary to operate decentralized applications on the network. Like Bitcoin miners are provided with Bitcoin in exchange for solving computational problems that add transactions to the blockchain, developers use Ether to pay operators who run applications on the Ethereum network.

Ether is created using a process called “mining.” Miners use computers to quickly guess the answer to computational problems until a final miner wins out. When the miner solves a problem, it adds a portion of a block to the blockchain, which is crucial in verifying transactions and ensuring that no user on the Ethereum network can send tokens that they do not have in their wallet. Ethereum’s tokens are created at a rate of 5 ether per mined block. 

How Does Ethereum Make Money?

As Ethereum is a network and not a business with an owner or operating strategy, Ethereum itself does not make money. However, it is possible to make money through Ethereum’s token, Ether, as an investor using these primary methods:

• Mining: As discussed, this solves computational problems in order to add blocks to the Ethereum blockchain. Unlike Bitcoin, there is an unlimited number of Ether that can be mined using the blockchain. Ether is mined at a rate of 5 per mined block. However, Ether is only awarded to the computer that finds the block. Even if you do set up a successful mining operation, there is no guaranteed rate of return on your investment.
• Investing: Like any cryptocurrency token, the Ether token always fluctuates in value. Ether is tradeable on almost every brokerage platform that supports cryptocurrency investing and is second only to Bitcoin in terms of availability. You can make money with Ethereum by strategically investing in the Ether token when you believe prices are low and holding your tokens in a wallet until the price of the token rises. You can then convert your Ether back to fiat currency.

Most cryptocurrency investors who earn money through Ethereum do so by buying and selling the token. 

How Long Does it Take to Mine an Ethereum?

According to CoinWarz’s data, the average time it would take to mine 1 Ether token is about 42 days at the current difficulty level. This is a profit of about $10.13 based on current Ethereum price data. Your hash rate, power consumption, electricity costs and miner can all play a role in your overall profit. 

Learning More About Ethereum

No matter if you decide to mine Ether, purchase tokens through a trading platform or invest in another type of cryptocurrency, remember that the cryptocurrency market is largely unregulated. This means that it’s possible to lose 100% of your initial investment if prices suddenly plummet. If you do decide to invest in Ethereum or another cryptocurrency, never invest more money than you can afford to lose.