Ethereum explored

Key takeaways

• Ethereum is a digital asset network, and its token is the second largest cryptocurrency by market capitalization behind bitcoin.
• The Ethereum network has many similarities with the Bitcoin network.
• Ethereum differentiates with the Bitcoin network primarily by its programmability.

You've probably heard of bitcoin—the largest cryptocurrency by market capitalization. But do you know about ethereum? There are a lot of similarities between the 2 largest cryptocurrencies, and there are some key differences. If you are crypto curious, here's what you need to know about ethereum.

What is Ethereum?

If you want to understand ethereum, it helps to know a bit about bitcoin. Like the Bitcoin network, the Ethereum network is a digital asset network that offers a digital currency (ETH) and other uses. Whereas there is a finite supply of bitcoin, there is a potentially unlimited supply of ETH.

Essentially, the Ethereum network is a digital platform built on blockchain technology, where other applications can easily be built. Blockchain is a decentralized and distributed online database: Instead of the data being stored in one place on a computer or on a server maintained by one person or company, a network of unrelated computers maintain their own copy of the ledger.

Ethereum features an open-ended architecture (basically, a software that makes adding and upgrading components easier to continuously evolve). It's this programmability that's thought to be the big differentiator between the 2 largest cryptocurrency networks. Ethereum's programmability allows for the creation of smart contracts, or computer programs that reside on the Ethereum blockchain. These smart contracts are the building blocks of the different functions and applications that can be built on the Ethereum network.

Proponents of the Ethereum network think it is this programmability that is not only the primary differentiator from the Bitcoin network, but also its main advantage. They think that this feature may attract more developers to build useful applications to drive demand for use of the Ethereum network (and its token, ETH). Consequently, many cryptocurrency analysts believe ethereum may be viewed as having more room for evolution compared with bitcoin, given its programmability, but may also carry more risk.

It's worth noting that, despite the relatively significant differences between these 2 cryptocurrency networks, one is not necessarily viewed as being inherently better than the other. Rather, there can be different uses for each network—as well as other networks.

The table below summarizes some other differences between the Bitcoin and Ethereum networks.

In sum, the Bitcoin network may be best understood as the network for a monetary asset (i.e., a digital currency where payments can be made and received), and Ethereum may be best understood as a network with multiple use cases that also has digital currencies.

What is ETH's price?

The current price of ETH is hovering around $1,300, as of late September 2022. The price of ETH is influenced by many of the same factors that impact bitcoin's price, including investor and user sentiment, changes in global economic data and world events, acceptance as a form of payment, network factors, and regulatory developments, among others.

Tokens on Ethereum

Payment on the Ethereum network is always required to be made in ETH (its native token), regardless of whether you want to make peer-to-peer payments or execute more complex smart contract transactions. Ethereum transaction fees are often referred to as "gas fees." They are the required payment for ensuring a safe transaction—similar to fees paid on the Bitcoin network.

There are other tokens besides ETH on the Ethereum network—a key difference from Bitcoin. Indeed, it is not common on other digital currency networks to allow for non-native tokens. These non-ETH tokens on the Ethereum network can be fungible (meaning they can be exchanged for other tokens) or non-fungible tokens (NFTs). Fungible tokens (also known as ERC-20 tokens) are often used in the funding and development of decentralized applications on the Ethereum network.

NFTs represent unique assets that are not interchangeable. They are tokens that are digitally unique—no 2 NFTs are the same and each NFT has an owner. Regardless of what you think about these NFTs, some cryptocurrency analysts think the potentiality of these tokens represents some of the most dynamic opportunities for growth for the Ethereum network and, consequently, ETH.

Ethereum security

The Ethereum network has had 10 major upgrades throughout its history to make improvements, many of which were done via "hard forks." This is an alteration of the network's protocol that is not backward compatible with its previous ruleset. A hard fork requires all users to upgrade their software to access the new chain and ruleset.

For example, Ethereum recently did a hard fork shifting from a proof of work model to a proof of stake model in an event termed "The Merge." Essentially, proof of work is a competition among miners to solve cryptographic puzzles to earn rewards, while proof of stake uses randomly selected validators to verify that transactions are reliable. Before the shift, ethereum proponents believed that this shift to proof of stake would use 99% less energy, allow the network to scale, and potentially reach 100,000 transactions per second. Time will tell here. 

Even though upgrades have and may continue to be made, the Ethereum network has risks—as do all cryptocurrency networks. Like the Bitcoin network, it has been the victim of exploits, including one of the most well-known ones: The DAO exploit of 2016. In April of 2016, a DAO (see sidebar to learn about a DAO) raised funds for Ethereum's initial token sale. The DAO was exploited through a security vulnerability in June of that year. Approximately 3.6 million of the 11 million ETH raised by the group (worth over $50 million at the time) were stolen.

Bitcoin had a somewhat similar experience early in its existence. In 2010, 184 billion bitcoin (worth roughly 5 to 7 cents per bitcoin at the time) were minted as the result of an exploit. It would later be thwarted and rolled back via a soft fork.

It is believed by many blockchain and crypto analysts that these types of hacks are less likely to take place today due to evolving security measures. However, risks of this type remain.

Ethereum and DeFi

Proponents of Ethereum think that its tools optimize decentralized finance (commonly referred to as "DeFi") to a greater extent compared with other networks. Indeed, Ethereum's creation may be considered the beginning of decentralized finance.

DeFi can be thought of as traditional finance functions—such as payments, lending, borrowing, saving, trading, and insurance—on digital networks without the need for intermediaries like banks and other financial instutitions. Essentially, DeFi has come to represent a kind of catch-all for anything that is financial-related, but done on a blockchain and through decentralized applications.

Another feature of the Ethereum network that proponents point to are stablecoins, which are tokens that are pegged to a traditional currency, such as the US dollar. These stablecoins function like a traditional currency, like the US dollar, but have the capabilities of digital assets and can be moved and traded like other digital assets. This usage may be particularly attractive to those engaged in certain DeFi transactions.

However, stablecoins are tied to a central bank through the traditional currency and are thus subject to similar influences as traditional currencies. Stablecoins can also fail to maintain their peg to a traditional currency—notably evidenced by the TerraUSD collapse in June 2022.

Ethereum's evolution

Ethereum has come a long way in its development. However, many crypto analysts think the network is still far from what it might look like in the future.

Increasing use of the Ethereum network, for example, has caused large spikes in transaction fees for prolonged periods of time. Even moments that are generally accepted as being low volume and cheap can still result in transaction fees well in excess of $10 (see chart below).

The recent shift to proof of stake demonstrates Ethereum's potential to evolve over time. Proponents of the Ethereum network think this shift could reduce fees and increase speed. Regardless, the relative dynacism of Ethereum has led many analysts to view it as having more risk than Bitcoin: The benefits and tradeoffs carry both potential rewards and risks to each network.

Ethereum taxes

Sales or other dispositions of ETH (and other cryptocurrencies) are generally taxable events. Taxes on cryptocurrencies are similar in many respects to those of other capital assets like stocks and bonds—with short- and long-term holding period tax rules applying.

But beware that complexity can exist with cryptocurrency taxes, such as if you are actively trading and making many cryptocurrency trades. Also, there is no wash sale rule for cryptocurrencies. Consider consulting a tax professional if you have cryptocurrency tax questions.

Ethereum's future

Cryptocurrency's newness introduces an element of the unknown that presents both opportunity and risk. For example, the heightened uncertainty related to potential government regulation of the cryptocurrency industry is a huge risk factor. On the other hand, some industry observers think that regulation could actually help reduce some aspects of uncertainty and volatility.

Additionally, cryptocurrencies have been extremely volatile, as previously mentioned, with huge price swings occurring on a frequent basis. Investors would need to be comfortable with that level of volatility and risk of loss, and even then, cryptocurrencies may not be appropriate.

With that said, it is undeniable that the Ethereum network opened a world of new possibilities within the crypto network world by extending blockchain technology to include programmability and smart contracts. And Ethereum proponents believe we may have only just begun to realize its potential.

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