A Crash Course on Ethereum
Web3 Musings: Edition 2
In my last post, I mentioned Ethereum. I will attempt to give an overview of the important components that make up the most widely used blockchain today. I have tried to keep this explanation as simple as possible by only including necessary details.
What is Ethereum?
According to the Ethereum homepage, “Ethereum is the community-run technology powering the cryptocurrency ether (ETH) and thousands of decentralized applications.”
What does this mean? Let’s break it down:
“community-run” — this means Ethereum is not controlled by one central entity. Anyone can build or contribute to the network.
“the cryptocurrency ether (ETH)” — ETH is the underlying currency that allows value to be exchanged across the network. ‘Ethereum’ refers to the network itself, ‘ether’ refers to its native currency. These two concepts cannot exist without each other. More on this later.
“decentralized applications” — Often referred to as dApps, these are programs that exist on Ethereum and are open to be viewed and interacted with by anyone. Their access cannot be restricted or controlled.
I won’t go into too much detail explaining how cryptocurrencies work, but for those curious, this is a great place to start. For now, let’s get into how Ethereum works.
How Ethereum works:
Ethereum works by hosting a virtual computer, known as the Ethereum Virtual Machine (EVM), on a blockchain maintained by nearly 5600 computers (called “nodes”) distributed all around the world. Each node keeps a copy of the Ethereum state on its computer.
A “block” refers to the data being stored in consecutive groups known as “blocks.” Every transaction made on Ethereum must be added to a block to be successful. “Chain” refers to the fact that each block references its parent block using a cryptographic process known as “hashing”.
Wallets:
I explained briefly in my last post that wallets are essential for interaction with Ethereum. Wallets are your profile on Ethereum and the home for managing and storing your digital assets. When you create a wallet, you are given a phrase of 12-24 words. This is often referred to as your “seed phrase” or “secret recovery phrase”. A seed phrase might look something like this:
never gonna give you up never gonna let you down never gonna
Your seed phrase is the only way to recover your funds if you lose access to your wallet—so it is important to never to share these with anyone. I would even recommend not keeping a digital copy of your seed phrase. Write it on paper instead.
Every wallet also has a public key, which looks something like this (yes, that is my public key):
0xF2Bc5807145f624aBde79ff35F41E54018b9AccBPublic keys (wallet addresses) are used to transfer assets between wallets and are the only key you can safely share. Private keys, on the other hand, are much different. To each public key, there is a matching private key which works similarly to a seed phrase. Private keys are not meant to be shared with anyone and also grant access to the wallet of the matching public key.
There are two main types of wallets to choose from—custodial, and non-custodial.
With custodial wallets, your assets are controlled by another party, such as a centralised exchange like Coinbase. This option is typically fine for users just getting started with buying and selling Ether, as they are easier to set up and require less knowledge of wallet security.
Non-custodial wallets such as Metamask give users full control and responsibility for their own assets. They are often in the form of a browser extension or a mobile app. With the freedom of having full control comes the requirement for users to take precautions to protect their assets. Non-custodial wallets also allow for interaction with dApps on Ethereum.
Gas:
When a transaction is created, it is sent to a node with a small fee (”gas”) consisting of a “base fee” and a “tip”. Gas is used to incentivise miners to process transactions and to prevent malicious transactions that can slow down the network by requiring too much computational power, such as infinite loops. Higher gas tip paid = higher priority for miners = faster transaction processing. Fluctuations in gas prices are common—spikes often occur if there is heavy traffic on the network as users compete with others to get their transactions processed earlier.
Mining:
Every computer in the network must agree upon each new block, once a block is approved, the state of the network is publicly updated. This is achieved through a consensus mechanism known as “Proof-of-Work” (PoW). Essentially how this works is by making each node compete to solve a computationally difficult puzzle. Doing so proves they have done the work by using computational resources, and so they can add the transaction to a block and update the state of the network. This process is known as “mining”. Nodes who successfully mine a transaction are rewarded with the gas tip, while the base fee is burned. Ethereum is switching from Proof-of-Work to Proof-of-Stake consensus later in 2022 (more on this in a later post). What this means is that the network as a whole will become more energy efficient as there is no longer a requirement for nodes to process increasingly difficult puzzles.
Smart Contracts:
A smart contract is a program whose code is executed only when certain conditions are met. Once they are uploaded to the EVM, they can be reused. Anyone can create and deploy a smart contract for a fee paid to the network, and anyone can then use functions of the smart contract (again, for a fee). A key characteristic of smart contract is that they are deterministic, meaning they will always provide the same output if inputs are the same. There is no randomness in smart contracts.
Smart contracts eliminate the need for a third-party in processing transactions such as transfers of digital assets.
When transacting face-to-face in the physical world, a third-party is rarely needed as the two participants would often trust each other before engaging in the transaction. This is different in the digital world. Transferring physical assets using digital means requires a platform to facilitate the transaction, which then usually takes a fee. Consider buying a clothing item from an online marketplace. It would be risky to communicate with and pay the seller directly as they could simply take the payment and not ship the item. The reverse is also true for sellers—they risk shipping an item and never receiving payment. This is where a neutral third-party is often used to ensure both parties can be trusted before completing the sale.
Smart contracts act in a similar way to the online marketplace in the above example, although their code is open for anyone to see and verify, and they are not controlled by anyone. For example, a simple smart contract could enable the secure sale of a digital asset such as an NFT (more on those in a later post) by not executing the transfer of the assets until it has received to correct payment from the buyer, and the correct asset from the seller. If these conditions are not met, the assets are returned to their owners.
Decentralised Applications:
DApps are applications built on Ethereum that consist of a smart contract (or multiple), and a front-end such as a website that provides an interface for users to interact with the contract. The front-end can also be decentralised if it is hosted on a platform like IPFS, which is a peer-to-peer network for online storage and hosting.
Some benefits of having decentralised applications:
No owners—once deployed to Ethereum, the program code cannot be taken down and anyone can use the code—even if the application’s developers abandon the project.
Anonymity—with most dApps, all you need to log in is your wallet, which is anonymous and does not usually link to your real-world identity.
Censorship free—usage of a dApp or submitting transactions cannot be blocked by a government or other entity.
Cryptographically secure—attackers are not able to forge transactions or dApp interactions on someone else’s behalf. DApp interactions are authorised with your wallet so that your credentials are safe.
The possibilities of dApps are limitless, with categories ranging from financial services (DeFi) to collectibles (like NFTs) and gaming.
Interesting Content from this Week:
On dealing with bear markets in crypto:
Key takeaways:
Feeling anxious/stressed about market declines is a sign you have over-invested.
Healthy portfolio management is often overlooked.
The goal of a healthy portfolio is to reduce the impact of market declines on your overall portfolio. If one asset goes down, at least the others are steady.
Never invest more than you can afford to lose.
Portfolio management is an ongoing process rather than a one-off setup.
A few useful Web3 terms and their meanings:
Terms relevant to this article:
DeFi: “Decentralised finance (DeFi) is an emerging financial technology based on blockchain. The system removes the control banks and organisations have on financtial services, assets & money.”
NFT: “NFT stands for non-fungible token. NFTs represent a digital asset on the blockchain which are unique and represents ownership by someone.”
On the importance of networking in Crypto:
Key takeaways:
Being able to process information and separate signal from the noise is a useful skill.
People are generally happy to share information with others. This is still a new field—we are all learning together.
Networking is not only important for people seeking to capitalise on the latest trends, but also for founders who want to launch their own product.
“The longer you spend in this space, being a good human, a helpful member of our society, the more goodwill you will accrue.”
Networking in Web3 is different to the old methods of taking someone to a fancy dinner, meetings in conference rooms, etc. Networking is sharing things on Twitter, joining discords and interacting with people who share similar interests, and supporting projects/people you believe in.
There is no such thing as stupid questions—ask them! Be humble and be prepared to learn.
Pay it forward. Share your knowledge.
That’s all for this edition of Web3 Musings, I hope you’ve enjoyed reading.