An Investor’s Guide To Ethereum And Ether

Ethereum is the second biggest digital asset behind bitcoin – and for good reason. In this guide, I’ll explain what Ethereum is, how it works, and why ether (ETH) belongs in most crypto portfolios. 

How did Ethereum start?

Vitalik Buterin wrote the Ethereum White Paper in 2013 when he was just 19 years old. As the legend goes, his distrust of centralization started from an early age. That’s because Blizzard Entertainment lowered the damage specs of his World of Warcraft character without his consent. 

Years later, Vitalik took the stage at the 2014 Miami Beach Bitcoin Conference, where he introduced Ethereum to a room full of early crypto adopters and investors. Of course, they were very impressed with what Vitalik had to say.

What is Ethereum?

The best way to understand Ethereum is to first understand Bitcoin (you can read our Bitcoin guide here). But for this guide, just know that Bitcoin allows you to send funds across the blockchain – without needing a bank or payment company. In other words, it’s decentralized. 

Now, if Bitcoin were a telephone, Ethereum would be a smartphone with all the apps. With a telephone, you can send information (your voice) to the person on the other line. You can do that with a smartphone too, but you can also use different mobile apps. These apps let you tweet, listen to music, trade the markets, and even play Angry Birds.

Sticking with this analogy, Bitcoin uses blockchain for “simple” financial transactions – sending crypto from point A to point B. Ethereum does that too, but coders can also build dapps (decentralized apps) on its blockchain. Technically, it’s possible to build dapps on Bitcoin, but it’s not so easy. And yet, Ethereum was designed for it. We’ll cover dapps later, but first, let’s learn about what makes them possible: smart contracts.

What are smart contracts?

There are two kinds of Ethereum transactions:

• Simple transactions, where the sender sends tokens to the receiver.
• Programmable transactions, where transactions have conditions attached to them.

Programmable transactions use smart contracts, which is what gives Ethereum its true dapp power. Like senders and receivers, smart contracts have their own wallet addresses and they can transact on the blockchain. 

Smart contracts are lines of code that developers can program into Ethereum, using a programming language called Solidity. You can think of them as automated agents that direct transactions according to a set of rules. For example, if this happens, send tokens here. If that happens, send tokens there. 

If you were in crypto in 2017, you might remember the thrill of initial coin offerings (ICOs). Well, ICOs were one of the first examples of smart contracts at work. A team of developers would build a project on the Ethereum blockchain with its own ERC-20 token (more on that later).

To raise money for the project, the developers would create a smart contract for the ICO. You could invest in the project by sending ether to that smart contract before the ICO launch. And once the project went live, the smart contract would send you back a specific amount of the project’s tokens – based on the rules the developers programmed into it.

What else can you do with Ethereum smart contracts?

Today you can do all kinds of things on Ethereum, and it’s all thanks to smart contracts. Here are a few examples:

Decentralized Finance (DeFi): 

Think of DeFi like a big investment bank with different options for savers and investors – except it’s all on the blockchain. With smart contracts, you can use Ethereum for complicated financial transactions, like lending, borrowing, and trading. Since Ethereum is a base layer blockchain, developers can build different DeFi protocols on top of it. A DeFi protocol is a set of smart contracts that can run automated transactions on the blockchain. And developers can integrate different dapps with those protocols to make them more user-friendly.

Here are two examples of popular DeFi platforms on Ethereum:

Aave (token AAVE) focuses on lending and borrowing services. Its smart contracts let users deposit assets on its platform, which they can use as collateral for borrowing, or to lend out and earn crypto interest. The Aave protocol integrates with many DeFi dapps, including its official Aave dapp, and others like DeFi Saver and Zapper. 

Uniswap (token UNI) is a fully decentralized crypto exchange (DEX). You can use it to earn trading fees from other traders by providing the exchange with tokens. Essentially, you “lock up” your crypto into a pool of capital that’s used as trading liquidity on the exchange. Centralized exchanges usually have a few big market makers that do this. But with Uniswap, anyone can be a market maker. You can also trade crypto through the Uniswap dapp.

Non-fungible tokens (NFTs):

You can mint and trade NFTs on Ethereum. These unique (non-fungible) tokens can collect value like rare baseball cards: the rarer the features, the better. Some NFTs, like Bored Apes (below), can go for a lot of cash.

Most people think of NFTs as jpeg images – and it’s true a lot of them are. But you can also have NFT land and other items that live inside blockchain games and virtual metaverse worlds…

Blockchain games:

As the first smart contract blockchain, Ethereum is home to many blockchain games. These are just computer games that run on the blockchain. They can have their own in-game currencies (fungible ERC-20 tokens) and unique in-game NFTs (non-fungible ERC-721 tokens). The games are all different, but the general idea is to acquire in-game currencies and/or NFTs. 

And here’s the best part: you can usually trade those tokens for real-world currencies through crypto exchanges and NFT marketplaces. So not only are blockchain games fun to play, but they can be financially rewarding too.

Here are a few examples of popular blockchain games that run on Ethereum:

Sorare Fantasy Football: In this game, you can collect, trade, and manage a team of digital player cards (in the form of NFTs).

Axie Infinity: This game allows you to collect, breed, and battle “Axie” monsters (in-game NFTs). You can also earn in-game currencies like AXS (Axie Infinity Shards) and SLP (Smooth Love Potion), which trade on regular crypto exchanges.

Decentraland: This is a virtual world that runs entirely on the Ethereum blockchain. You can buy NFT land and monetize it through various business ventures. You can also create and customize your own 3D avatars to represent you in its virtual world.  

Does Ethereum have miners, like Bitcoin?

For most of its life, Ethereum was a proof-of-work (PoW) blockchain like Bitcoin – meaning miners processed transactions and kept the network secure. But that all changed in September 2022 after its big “merge” event. At that point, Ethereum became a proof-of-stake (PoS) blockchain – meaning the miners packed up their machines and validators took over. 

Now, instead of miners solving complex cryptographic puzzles with their computers, validators confirm transactions by staking ether. In other words, they put up their own funds as collateral to keep the blockchain moving. In return, validators earn interest (in ether). And the more they stake, the more interest they can earn. 

Is Ethereum’s switch to PoS good for ether investors?

PoS does have some advantages for investors who want to buy and hold ether for the long run:

PoS is greener. Ethereum’s PoS model uses about 99.99% less electricity than mining, which makes it better for the planet. That could also help bring in more institutional investors, with green ESG (environmental, social, and governance) mandates. 

PoS makes it easier to earn a yield on ether. If there’s one thing institutional investors like more than ESG, it’s earning a yield on their investments. But not many institutional investors are going to set up a mining operation to do that. On the other hand, validating makes a lot of sense to them – because it’s a bit like buying a bond. And with Ethereum’s recent Shanghai upgrade, validators can stake and un-stake as they please. Institutions like flexibility, too.

PoS makes ether scarcer. Miners have big expenses: mining hardware, cooling systems, and an electricity bill that would make your jaw drop. But validators have none of that, making it a lot cheaper than mining. Since miners pay their bills in fiat currencies, they need to sell some of their ether revenue to pay them. Validators do that too, but their bills are lower, so they don’t need to sell as much ether. Validators also don’t need to mint as many new ethers to stay profitable. So not only does PoS mean new ethers are created slower, but it also means fewer ethers are being sold.

PoS could make Ethereum cheaper and faster. Validators don’t need to solve complex puzzles like miners, which means they can get the job done quicker, with fewer resources.

PoS could make Ethereum more secure. Validators stand to lose their entire stake if they break the rules, so they’re incentivized to keep the blockchain secure.

So is ether a good long-term investment?

The bigger the Ethereum network gets, the greater the demand for ether. That’s because ether is essentially “digital oil”: the fuel that powers the Ethereum blockchain. And while Ethereum does have its fair share of rivals, it’s still got a big lead over the competition in terms of market share. For example, more than half the value of the entire DeFi market still runs on Ethereum. 

There may be other smart contract blockchains with better tech than Ethereum. But like Bitcoin, Ethereum is already a very well-established and trusted blockchain compared to its newer rivals. That suggests there’s less “venture risk” holding ether than other digital assets. So while the upside might not be as high as with some other digital assets, the lower venture risk could make ether a more stable long-term investment.

Key points

• Vitalik Buterin came up with Ethereum in 2013. It was the first blockchain to use smart contracts for programmable transactions.
• Smart contracts make all kinds of things possible on Ethereum, including NFTs, DeFi, and blockchain games.
• Ethereum switched to proof-of-stake in 2022. Now, validators (rather than miners) secure it. This could make Ethereum greener, scarcer, faster, and more secure.

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