Ethereum: What It Is and How It Works
ETH is more than a cryptocurrency: It powers a crypto-centric ecosystem.
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Ethereum is a blockchain network on which decentralized applications, contracts and other cryptocurrency-based services are built. Its native token, Ether (ETH), is the second-most valuable cryptocurrency by market capitalization. While they are distinct concepts, “Ether” and “Ethereum” are often used interchangeably as the name of the token.
Ethereum’s platform is not just used to record transactions. It also:
Supports decentralized finance, or DeFi, in which services that traditionally need an intermediary from the traditional banking or legal system can be performed by the network instead. It does this by supporting smart contracts, which are financial agreements between two or more parties that are stored on the network and are automatically executed when the contract’s conditions are met.
Hosts decentralized applications, or Dapps, which are made by developers using the network's programmable language.
Is used to build other cryptocurrencies, like Binance coin (BNB) and Tether (USDT).
Is home to popular non-fungible tokens, or NFTs, which are one-of-a-kind digital assets that you can buy and trade with others.
Ethereum: Key facts
Market cap | High. Ethereum has been the second-most-valuable cryptocurrency for years. In March 2024, its market cap was over $400 billion. |
Max supply | No max supply. There isn’t a cap on the total number of ETH that will go into circulation, but its current supply of about 120 million is expected to remain relatively stable. |
Network speed | Medium to high. Ethereum’s network approves new blocks every 12 seconds, on average. |
Fees | Medium to high. Users bid to get their transaction requests picked up. This supply-and-demand approach means that prices vary. During times of high network use, prices have surged over $50. |
Security | High. In 2016, Ethereum underwent a controversial hard fork to escape a serious hack, called the DAO hack, that took place on the network. Nothing as serious has occurred since then on this heavily-trafficked network. The merge, like any technology, still needs to develop a track record before it can be adequately judged . |
Pros of Ethereum
It already has an extensive user base
Ethereum is among a few projects with high levels of adoption. There are routinely more than 1 million transactions per day on the Ethereum network. For comparison, Cardano transactions have recently remained under 100,000 per day. Some of the most popular consumer-oriented crypto projects, such as games and NFTs, are built on Ethereum.
Recent upgrades could lead to better performance
Ethereum’s merge may convince skeptics that blockchain technologies can work without a huge environmental cost. Ethereum, like Bitcoin, had historically used a “proof-of-work” system to ensure that transactions on the network are recorded correctly. Ethereum has now moved to a “proof-of-stake” system, which instead uses a process known as staking. Proof-of-stake systems use much less energy.
» Ready to invest? Here’s how to buy Ethereum.
Cons of Ethereum
It’s not cheap to use
The cost of a single transaction on the Ethereum network has at times exceeded $50. And while that may not be a considerable amount for a trade worth thousands of dollars, the fees for small transactions can sometimes be higher than the value of Ethereum changing hands.
These transaction costs may not matter if you’re simply holding ETH, but they could be a roadblock to the growth of the Ethereum network as a whole. See the section below on gas fees for more info.
Mediocre speed
Ethereum processes somewhere around a dozen transactions per second. That is dramatically slower than some other blockchains, and far slower from legacy technologies such as the Visa network, which can carry out 24,000 transactions per second.
Ethereum vs. Bitcoin: Notable differences and price history
Ethereum and Bitcoin, which have the two biggest market capitalizations among cryptocurrencies, have notable differences.
Founder involvement. Vitalik Buterin, Ethereum cofounder, is still involved in its development. Bitcoin’s pseudonymous founder, Satoshi Nakamoto, has been silent for over a decade.
Technology. In Sept. 2022, Ethereum started using a technology called proof-of-stake to approve blocks of new transactions. Using a process called staking, users post their own ETH as collateral. In contrast, Bitcoin uses proof-of-work, in which miners run resource-hungry computers to confirm new blocks.
Function. Bitcoin’s design is focused almost exclusively on recording transactions. In contrast, Ethereum can be used to write applications, execute smart contracts, host NFTs and more. Many other cryptocurrencies are built and run on Ethereum’s network.
How do Ethereum gas fees work?
Ethereum gas fees are the transaction fees charged when moving funds on the Ethereum blockchain network. “Gas” refers to the amount of computational power it takes to process a transaction on the Ethereum network. Similar to the gas you put in your car, you might think of this digital gas as the fuel needed for the Ethereum blockchain engine to run successfully.
Most blockchain networks carry transaction fees for their users, and the fee assessed may be higher or lower than Ethereum. Gas fees are specific to Ethereum, and users pay for each transaction using Ethereum’s native Ether coin.
There is a formula you can use to calculate gas fees for each transaction, but there are a few key terms to understand before we use the formula.
Gwei: Gas fees usually cost much less than the price of ETH. In order to simplify the calculation, gas fees are measured in gwei. 1 ETH cryptocurrency coin is equal to 1 billion gwei (1 ETH = 1,000,000,000 gwei).
Gas units: The amount of energy, or computational power, that is consumed for each transaction. Each gas unit represents 1 gwei.
Gas limit: The maximum amount of gas you are willing to spend on a given transaction, which is later multiplied by the base fee plus tip. Gas limits are typically set at a fixed amount depending on the type of transaction. You must be careful to ensure the gas limit meets the amount required for the transaction you are trying to execute. A simple transaction, like transferring ETH from one user to another, would require a gas limit of 21,000 gwei. If you set your gas limit at 30,000, you get 9,000 gwei back after the transaction is completed. However, if you had set the gas limit at 10,000 gwei, the network would consume the 10,000 as it attempts to validate the transaction. Not only will the transaction fail, but you’ll lose the gwei that was consumed during the attempt. Generally, your wallet should indicate the gas limit for the transaction you want to make.
Base fee: The minimum amount of gas required to perform a transaction on the Ethereum network. Base fees are determined by supply and demand, and are adjusted based on the number of transactions happening on the network in real time.
Priority fee (tip): An extra fee that users can choose to pay so that miners are incentivized to validate their transaction requests sooner.
The formula to calculate your total fee is:
Total fee = Gas Limit x (Base Fee + Tip)
For example, say you wanted to send a friend 1 ETH on the Ethereum network and the gas limit was 21,000 gwei, and the base fee required to request the transaction is 100 gwei. In order to try to get this transaction expedited, you add a tip of 2 gwei. After making sure your limit is set for at least 21,000, you can request the transfer.
If we plug that into the formula, it looks like this: 21,000 x (100 + 2) = 2,142,000 gwei. The price of ETH fluctuates, but for this example, let’s say 1 ETH = $2,000 USD. That means:
When converted to ETH, your total gas fee would be 0.002142 ETH.
Your total gas fee for this transaction expressed in USD would be about $4.28.
The author did not own Ethereum at the time of publication.
