Published: Mon 24th July 2017
Read Time: 10 minutes
Ethereum - A Beginners Guide
What Is Ethereum?
Most services that you use today have one thing in common: they’re centralised. For example, you trust your bank to keep your money safe, to be independently audited and to be honest. The same is true with Facebook when you upload a photograph or go to a medical practice and provide them with your personal medical information.
History has proven time and time again that this method is flawed but necessary as so-called trust-less operations have so far been both unprofitable and too complex to implement. Everything that is centralised is easy to attack because it offers a single point of failure, such as the firewall of a website. Applications built on Ethereum do not require their users to trust the developers with personal information or funds, so your personal information, funds and content remain secure.
How Does It Work?
At the core of Ethereum is blockchain technology. If you look at centralised applications you’ll find they reach trust by being closed; using firewalls and security teams that you must trust to do their jobs well. Blockchain technology on the other hand uses a different model, one by which trust can be reached in an open network. Bitcoin was the first and currently best-known application of blockchain technology. Ethereum makes this technology applicable to just about anything else.
On Ethereum, developers write business logic into what they call contracts. Contracts are programmes that follow a series of steps every time they receive a message called a transaction. They can store data, send and receive transactions and even interact with other contracts, independently of any control. These contracts are maintained by the network and are written in a programming language that will be instantly familiar to any developer.
Because the interfaces to the contracts that live on the Ethereum network are also decentralised, as an application developer you need zero infrastructure to deploy and distribute your applications. In fact, because an incentivising framework is inherent to the protocol, your applications will also be impervious to denial-of-service attacks. You can think of Ethereum as a programmable, distributed network. The fact that Ethereum is by its very design both fraud and tempering resistant, means that it offers a new range of solutions to everyday problems that are currently solved at great expense.
Voting machines, registration of legal documents, medical software and financial derivatives: these applications can all be built on a network where users stay in control of their funds and their personal information at all times. Ultimately, Ethereum is not here to undermine or to strengthen any existing system, it’s an entirely new way of operating.
- Individual Currencies
Imagine you’re an artist and want to support yourself by issuing a brand-new currency. If you want to support this artist you’d purchase that currency, technically investing in their own personal IPO. As those millions of currencies are traded on a decentralised exchange, the currency itself becomes a representation of your value and not just a means of exchange. Ethereum makes it straightforward to issue your own token of value, so you can reward your users for actions that they take even outside of the network – such as participating in a grid computing project.
Imagine how the relationship between consumers and retailers would change if instead of issuing loyalty points, retailers would issue crypto tokens of value that could then be exchanged for goods and services on decentralised markets, or even other tokens of value such as air miles. It’s a brand-new revenue model that’s never been seen before and it could completely revolutionise the way we think about revenue on the internet today.
- Middleman Applications
Users are tired of paying exorbitant fees to companies such as eBay, Kickstarter or Airbnb. On a peer-to-peer network, the existence of a middleman is limited to bringing true value such as insurance, rather than just putting two people in contact with each other.
And for a decentralised Kickstarter, instead of receiving a pre-ordered product that quickly becomes obsolete, users could be rewarded with tokens of value into the start-ups that they invest in.
- Financial Applications
Take the concept of a village where if you were to take a loan and default on it, you’d be banished. In short, you’re backing loans with reputations rather than physical assets. This is a successful concept in the developing world where microfinance companies have experienced very low default rates but it’s not new and has never been scaled beyond a small group of individuals. With Ethereum, you can scale reputation to millions of individuals so they can foresee disruption, not just in the developing world but also much closer to home.
This wouldn’t be limited to credit, as on Ethereum any user can issue and trade stocks, bonds, derivatives and even contracts for differences. Furthermore, J.P. Morgan Chase is developing a blockchain, atop Ethereum. The system, dubbed "Quorum," is designed to toe the line between private and public in the realm of shuffling derivatives and payments. The idea is to satisfy regulators who need seamless access to financial transactions, while protecting the privacy of parties that don’t wish to reveal their identities nor the details of their transactions to the public. In addition, Royal Bank of Scotland has announced that it has built a Clearing and Settlement Mechanism (CSM) based on the Ethereum distributed ledger and smart contract platform.
Overall, it may even be that the Ethereum applications that will have the most impact on the world haven’t been invented yet, just like it took 4 years for social networks to appear on the web and even longer to see them diversify, and invent novel applications such as micro blogging.
The value token of the Ethereum blockchain is called ether. It is listed under the diminutive ETH and traded on cryptocurrency exchanges. It is also used to pay for transaction fees and computational services on the Ethereum network.
Ether is a necessary element (a fuel) for operating the distributed application platform Ethereum. It is a form of payment made by the clients of the platform to the machines executing the requested operations. To put it another way, ether is the incentive ensuring that developers write quality applications (wasteful code costs more), and that the network remains healthy (people are compensated for their contributed resources).
How Are Ethers Created?
The total supply of ether and its rate of issuance was decided by the donations gathered on the 2014 presale. The results were roughly:
- 60 million Ether created to contributors of the presale.
- 12 Million were created to the development fund, most of it going to early contributors and developers and the remaining to the Ethereum Foundation.
- 5 ethers are created every block (roughly 15-17 seconds) to the miner of the block.
- 2-3 ethers are sometimes sent to another miner if they were also able to find a solution but his block wasn't included (called uncle/aunt reward).
The Value Of Ether
Even though Bitcoin has more than doubled in price this year alone, Ether is up over 2300%. This is shown in the graph below:
Reasons For The Rally?
While bitcoin has been gaining support from certain investors and governments, Ethereum has been backed by corporates wishing to use the technology for smart contract applications. A group called the Enterprise Ethereum Alliance (EEA) was recently founded to connect large companies to technology vendors, to work on projects using Ether. Companies involved in the launch include Microsoft, J.P. Morgan and Intel. More recently, the EEA announced that another 86 firms have joined the alliance, which is growing the legitimacy of the crypto currency.
At the same time, the rally in bitcoin has seen investors turn to alternative crypto currencies. A year ago, over 83% of ether buying occurred with bitcoin (data from CryptoCompare), showing it was the main crypto currency investors were interested in. But more recently, Bitcoin accounted for just over 32%.
Towards the end of June, GDAX, the digital currency exchange run by Coinbase, experienced a flash crash in its USD – Ethereum market. Within seconds, the price of ETH crashed from $320 to as low as $0.10!
While the price recovered quickly, the rapid price movement caused many traders to experience margin calls or stop loss orders, resulting in potentially severe losses. While many initially thought the flash crash was the result of nefarious work, GDAX eventually confirmed that there was no indication of wrongdoing or account takeover.
Instead, the flash crash was the result of someone placing a multi-million Dollar sell order at market price, meaning ETH would change hands at whatever price bidders were currently offering until the entire order was filled – no matter how much lower the price was than the current price of ETH. Filling this order caused ETH prices to instantly slip 30% to $224 – which in turn caused 800 stop loss orders and margin liquidations, which further drove the price down, to as low at $0.10. Originally GDAX said that they would be honouring these orders, since the trades were legitimate and in accordance with their trading rules.
However, recently they announced that the exchange will be using company funds to reimburse customers who suffered losses as the result of a margin call or stop loss order executed. If anything, this should be a reminder to traders how risky it can be to trade on margin, and that cryptocurrency markets can be just as unforgiving (and sometimes more) as other equity markets.
Because of the infancy of the platform, Ether has experienced sharp price fluctuations. While this volatility might make the currency look less valid in the eyes of some, these gyrations provide opportunities for some traders.
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