How Does Ethereum Work? An Introduction to ETH

A comprehensive guide to the Ethereum network, from smart contracts to dapps and gas fees, we explain it all.

Key Takeaways:

• Conceived and co-created by Vitalik Buterin, Ethereum is a platform that supports digital currency, smart contracts, and decentralised applications (dapps).

• Ether (ETH) is the native cryptocurrency of Ethereum, used to fuel the network. Gas fees are transaction costs on the Ethereum network, determined by supply, demand, and network capacity.

• Unlike Bitcoin, which is primarily a digital currency, Ethereum allows for more complex applications, including smart contracts and dapps.

• Using a Proof of Stake (PoS) consensus mechanism, where validators (rather than miners) are responsible for creating and validating blocks, Ethereum is an energy-efficient system compared to Proof of Work (PoW) blockchains.

• Ethereum’s switch from PoW to PoS in 2022 reduced its energy consumption by 99.95%, lowered ETH issuance, and improved security and scalability.

• Ethereum’s continuous development, including The Merge, Shapella, and Dencun upgrades, positions it as a versatile platform with broad applications across multiple industries.

Introduction

Co-created by Vitalik Buterin, Ethereum has caused a revolution in how we think about digital transactions and the potential of blockchain technology. In this guide, we break down the Ethereum blockchain, explain its consensus mechanism, and shed light on smart contracts and the Ethereum Virtual Machine (EVM).

Learn how Ethereum works, explore its key components and features, and gain insight into decentralised applications (dapps) and the role of Ether (ETH) in fuelling the network.

The Ethereum Blockchain: A Decentralised Network

What Is a Blockchain?

At its core, a blockchain is a distributed database or ledger shared amongst a computer network’s nodes. This blockchain stores data in blocks linked together via cryptography, creating a chain of information that’s transparent and secure. Blockchain makes data immutable, meaning it cannot be altered — a feature that has application in many industries.

The Role of Nodes

Nodes, individual computers or servers that participate in the network, play a crucial role in maintaining Ethereum’s decentralised nature. These maintain a synchronised copy of the blockchain and adhere to the network’s rules. Ethereum nodes have several key responsibilities:

• Transaction verification: Nodes verify all transactions against the consensus rules of the Ethereum protocol.
  
  
• Block validation: Nodes participate in the validation of new blocks proposed by validators.
  
  
• Smart contract execution: Nodes execute smart contracts by interpreting and processing the code within them.
  
  
• Data synchronisation: Nodes maintain a synchronised copy of the blockchain, ensuring they are up to date with the latest state of the network.
  
  
• Interaction: Each node runs client software that enables it to communicate with other nodes and interact with the Ethereum blockchain.

In Ethereum’s Proof of Stake (PoS) system, which replaced the earlier Proof of Work (PoW) mechanism, validator nodes play a crucial role. Based on their stake (locked-up ETH), validators propose and add new blocks to the blockchain. This process is more energy-efficient than the mining-based approach used in Bitcoin.

The interconnected network of nodes ensures that Ethereum remains decentralised, transparent, and secure. By working together to verify transactions and maintain the blockchain’s integrity, these nodes form the backbone of Ethereum’s ecosystem, enabling its wide range of applications in decentralised finance (DeFi), non-fungible tokens (NFTs), and the emerging Web3 infrastructure.

How Ethereum Differs From Bitcoin

While both Ethereum and Bitcoin use blockchain technology, they have distinct purposes and capabilities.

Purpose

Designed primarily as a digital currency, Bitcoin is a medium of exchange and store of value. Ethereum, on the other hand, was developed as a versatile platform for smart contracts and dapps. While it also functions as a cryptocurrency, Ethereum’s primary focus is on enabling developers to create applications that run on its blockchain, which is seen as foundational for the emerging Web3 ecosystem.

Consensus Mechanism

Bitcoin utilises PoW, requiring miners to solve complex mathematical problems to validate transactions and create new blocks. Ethereum transitioned from PoW to PoS in 2022, which allows validators to create new blocks based on their stake in ETH, improving energy efficiency.

Smart Contracts

Bitcoin has limited scripting capabilities, primarily focused on simple transactions. Ethereum was built with a robust programming language that supports complex smart contracts and dapps.

Consensus Mechanisms: From PoW to PoS

Ethereum Proof of Work Explained

PoW was the original consensus mechanism used by Ethereum to create new blocks, where miners competed to solve complex mathematical puzzles, expending significant computational power and energy. 

While PoW provides a high level of security and decentralisation, it has its drawbacks. Ethereum’s annual energy consumption under PoW was estimated at 21 terawatt-hours (TWh), comparable to Google’s electricity usage. 

Ethereum’s Transition to Proof of Stake

On 15 September 2022, Ethereum successfully transitioned from PoW to PoS in an event known as ‘The Merge’. This transition was a significant milestone in Ethereum’s development, addressing several challenges associated with PoW.

In the PoS system, validators have replaced miners, and instead of solving complex puzzles, validators stake their ETH to create new blocks and validate transactions. This process involves locking up a certain amount of ETH in a smart contract, which serves as a security deposit.

To learn more about PoS, read our guide here.

The switch to PoS has brought several advantages to the Ethereum network, mainly energy efficiency and improved security:

• Energy efficiency: PoS has drastically reduced Ethereum’s energy consumption by approximately 99.95%, making it more environmentally friendly.

• Lower issuance: Yearly ETH issuance has decreased from about 5.4 million under PoW to around 816,000 under PoS, potentially leading to deflationary pressure on ETH.

• Improved security: PoS introduced block finalisation, making it extremely costly and difficult for bad players to alter or remove finalised blocks.

• Scalability: The transition has led to consistent 12-second blocks, slightly improving Ethereum’s scalability.

• Accessibility: PoS has lowered the entry barrier for participation in network validation, as it doesn’t require specialised hardware to mine anymore.

While PoS has significantly upgraded Ethereum’s network, it’s not without challenges. The rise of liquid staking providers like Lido has raised concerns about potential centralisation. As of writing, Lido controls around 28.12% of staked ETH, which could potentially impact Ethereum’s governance in the future.

Smart Contracts: The Heart of Ethereum

Smart contracts are self-executing programmes stored on the Ethereum blockchain. These contracts automatically execute when predetermined conditions are met, eliminating the need for intermediaries. As a core feature of Ethereum, smart contracts have caused a revolution in how we think about digital transactions and blockchain technology.

How Ethereum’s Smart Contracts Work

Smart contracts operate on a simple ‘if-this-then-that’ logic. When users interact with a smart contract, they submit a transaction that executes a function defined in the contract. The contract then automatically enforces the rules and conditions set within its code.

Think of smart contracts like a vending machine: With the right inputs (money + snack selection), a certain output is guaranteed (snack dispensed). This logic is programmed into the blockchain that cannot be changed once created. Smart contracts are written in specific languages, with Solidity the most common for Ethereum. Once written, they’re deployed to the Ethereum network, where they become immutable and publicly visible.

Real-World Applications

Smart contracts have a wide range of potential applications across various industries, including supply chain management and arts.

• Decentralised Finance (DeFi): Smart contracts enable decentralised lending, exchanges, and the creation of stablecoins.
  
  
• Supply Chain Management: They can automate tracking of items, increasing efficiency and transparency.
  
  
• Voting Systems: Smart contracts could create a secure environment for voting, reducing the risk of manipulation.
  
  
• Arts: They can ensure fairer distribution of royalties and easier management of copyrights.

By automating processes, reducing intermediaries, and increasing transparency, smart contracts have the potential to transform numerous sectors. As the technology continues to evolve, we can expect to see even more innovative applications emerge in the future.

Ethereum Virtual Machine (EVM)

What Is EVM?

Ethereum Virtual Machine (EVM) is the heart of the Ethereum network, serving as a decentralised, Turing-complete virtual machine. It functions as the runtime environment for smart contracts on the Ethereum blockchain and operates as a global, distributed computer that executes code consistently and securely across all Ethereum nodes.

As a stack-based virtual machine, the EVM processes bytecode compiled from high-level programming languages like Solidity and Vyper. It maintains a stack with a maximum of 1,024 items, each with a 256-bit word. This design simplifies function calls and execution contexts, which is particularly beneficial in Ethereum’s distributed system.

How the EVM Processes Smart Contracts

The EVM processes smart contracts through a series of steps, as described below:

1. Transaction Initiation: An external account or another contract initiates a transaction, specifying the contract address, input data, and gas limit.
   
   
2. Transaction Verification: The EVM first verifies the validity of a transaction. If valid, it establishes an execution context incorporating the current state of the network.
   
   
3. Opcode Execution: The EVM reads and executes opcodes (low-level instructions) from the smart contract’s bytecode. These opcodes dictate actions like updating the world state, consuming gas, or reverting the state if an error occurs.
   
   
4. Gas Management: Each operation in the EVM has an associated gas cost, which reflects the computational resources required for execution. If gas specified by users runs out, the transaction fails, reverting the state.
   
   
5. State Changes: Successful execution results in state changes on the blockchain, such as updates to account balances.
   
   
6. Finalisation: After processing, the new state resulting from the smart contract execution is propagated across all nodes in the network, which update their copies of the blockchain to reflect these changes, ensuring consensus is maintained throughout the network.

Dapps on Ethereum

Dapps are software programmes that operate on blockchain networks or a peer-to-peer (P2P) network of computers. They are self-executing and powered by smart contracts that enforce predefined rules, enabling direct interactions between users without intermediaries.

Unlike traditional apps that run on a centralised server, dapps distribute the programme across many nodes, ensuring no single entity has complete control. This decentralised nature makes dapps resistant to censorship and interference from a single authority. By leveraging blockchain technology, dapps aim to provide enhanced security, transparency, and autonomy compared to traditional applications.

Popular Ethereum-Based Dapps

Ethereum has become a hub for dapp development across various sectors. Below are some notable examples:

• Uniswap: A leading decentralised exchange (DEX) that allows users to directly trade cryptocurrencies without intermediaries. In 2024, Uniswap was handling billions of dollars in trades monthly.
  
  
• Aave: An open-source DeFi lending platform that enables users to lend and borrow cryptocurrencies. By September 2024, Aave had $12.6 billion locked in its system.

Ether and Gas: Fuelling the Ethereum Network

Understanding Ether (ETH)

Ether (ETH) is the native cryptocurrency of the Ethereum blockchain, serving as the fuel that powers the entire network. ETH plays a crucial role in the Ethereum ecosystem, enabling all operations on the blockchain and facilitating the execution of smart contracts and dapps. Traders can acquire and hold ETH as a long-term investment, similar to Bitcoin.

Gas Fees Explained

Gas fees are transaction fees that users pay on the Ethereum blockchain to conduct transactions and execute smart contracts. These fees are priced in tiny fractions of ETH called Gwei, where 1 ETH equals 1 billion Gwei (or 1 Gwei = 10^-9 ETH). In essence, gas fees are the costs associated with computational work needed to process transactions.

The price of gas is determined by supply, demand, and network capacity at the time of the transaction and can vary from a few cents to over $100. Gas fees are calculated using the formula:

Gas fee = units of gas used * (base fee + priority fee)

The base fee is set by the protocol — users have to pay at least this amount for their transaction to be considered valid. The priority fee is a tip users add to the base fee to make their transaction attractive to validators so they choose it for inclusion in the next block.

How to Buy ETH

To interact with the Ethereum network, users need to acquire Ether (ETH), which is listed in the Crypto.com App along with a growing list of 250-plus supported cryptocurrencies and stablecoins, including Bitcoin (BTC), Polkadot (DOT), USD Coin (USDC), and Cronos (CRO). 

Crypto.com App users can buy ETH with USD, EUR, GBP, and 20-plus other fiat currencies and spend it at over 80 million merchants globally using the Crypto.com Visa Card.

Alternatively, users can also buy Ether on the Crypto.com Exchange. To start buying ETH today, download the Crypto.com App.

Conclusion

Ethereum has truly reshaped the landscape of blockchain technology, offering a versatile platform that goes beyond simple digital transactions. Its ability to support smart contracts and dapps has opened up a world of possibilities, from DeFi to digital art and beyond. The transition to the Proof of Stake mechanism has further enhanced Ethereum’s efficiency and sustainability, making it a more accessible and environmentally friendly network.

As Ethereum continues to evolve, its impact on various industries is likely to grow. The platform’s ongoing development and the increase in adoption of blockchain technology suggest a future where dapps can become more commonplace in our daily lives. 

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