Ethereum: De-Fying Gravity
Remember when Eminem released the hit song ‘Can the real Ethereum, please stand up?’ Well… neither can I, but these lyrics are sure to echo in the back of your mind as we begin to delve deeper into the world of Ethereum.
ETHEREUM THE ‘APP STORE’
Ethereum, Ethereum Classic, Ethereum Max, and many more versions of these, are ironically not all related to the real Ethereum and may lead to quite a bit of confusion. Similar to what we’ve seen during meme stock rallies where retail investors ended up buying ‘similar’ hyped stock names.
So, Let’s unpack the ‘real’ Ethereum and how we got here, ready?
Ethereum is a decentralized (controlled by no one), open-source blockchain with a built-in fully fledged Turing-complete programming language (meaning with the right initial condition it can compute just about anything) and this enables the creation of smart contracts and decentralized applications, better known as DApps.
Ethereum’s architecture drew a lot of inspiration from Bitcoin however it aimed to create more and different use cases through the use of its smart contracts. Ethereum can be thought of as the ‘app store’ of the blockchain (Apple I-store if we to be exact because you know… levels). While Bitcoin is more like an application or to some, a ‘store of value’ and ‘digital gold’. Ethereum provides a platform for developers to build their applications (DApps) instead of having to build a fully decentralized blockchain to begin with. This guarantees them the same decentralization and security even for smaller and rarely used applications. There are more than 2,500 decentralized applications built on Ethereum with this figure growing daily.
The introductory whitepaper for Ethereum was released by Vitalik Buterin at the age of 19. In mid-2013, while most 19-year-olds were getting their bodies (and livers) summer-ready for Rage and Rocking the Daisies, The father of Ethereum was refining the introductory whitepaper intending to create a secure and sustainable blockchain that would become the go-to for building future applications.
The blockchain took off and developed into one of the biggest ecosystems with decentralized applications which use Ether, the digital native asset of the Ethereum blockchain, to run applications and transact. Ethereum officially launched in 2015, after one of the largest and most successful initial coin offerings (ICO) at the time, which raised $18.4 million for the project, and its native asset has since grown to become the second-largest cryptocurrency by market capitalization.
Speaking of being the platform for platforms and since the rally of mainstream adoption throughout 2020, it’s no surprise that Ethereum’s network activity is quickly catching up to the father of crypto.
ETHEREUM VS ETHEREUM CLASSIC
The cryptocurrency space has seen many projects become victims of hacks, rug-pulls, and scams. Most projects cease operations afterward and never truly recover with retail investors being the worst affected in each instance. The story of how Ethereum 'split up' into Ethereum and Ethereum Classic is a long, sad story that deserves a write-up of its own but to summarize, It was an event that split the community and shook the blockchain to its core only one year after its inception.
The Decentralized Autonomous Organization (DAO) attack of 2016 saw a hacker drain $60 million of Ether after he discovered a loophole in the code. The DAO was a blockchain-based cooperative that aimed to remove traditional centralized management structures and was collectively owned by its members, with rules set and executed through code. It was one of the earliest crowd-funding efforts and projects built on Ethereum with over 10% of the available supply at the time invested in the DAO contracts.
The solution to the attack was a hard fork.
A fork occurs when there is a change in protocol or the blockchain diverges into two potential paths forward after a majority vote on the network. While not everyone within the community agreed on amending the code of the blockchain, those who didn’t, ventured off to continue with their own competing blockchain named Ethereum classic.
Comparing the advancements made and the price of the two, it's not hard to tell who lost more in this divorce… that's a reminder to always sign the prenup!
GAS AND GWEI
Back to post-hard-fork (ed) Ethereum. As mentioned before, Ethereum has a built-in fully fledged Turing-complete programming language, and this allows for ‘loops’ in programming. Bitcoin, on the other hand, does not. This means that doing something 100 times requires copying the task and pasting it the exact same number of times, while on Ethereum it saves you the time and effort because of its ‘loops’.
That sure sounds great, but it does not come without its own drawbacks.. enter Gas. No, not what passes when your stomach starts tossing and turning after crypto crashes (again). It’s more like petrol, but for Americans, think of Ethereum like a car, it can get you where you want to be, but to move it (on the blockchain) you need gas and the unit of measurement for Ethereum gas is Gwei and one Gwei is equal to 0.000000001 ETH.
Ethereum gas and South African petrol price might actually be positively correlated, one moment it's almost near record lows, and then the next moment…
Here you are buying and HODLing Dogecoin when you should be buying and HODLing petrol.
Since Ethereum is Turing-complete with loops it could easily lead to a bad actor spamming the network or some code requiring millions of executions overloading the network. Therefore, the more executions, the more gas required and by introducing gas fees for each operation the spammer would need to be a pretty big whale.
Here’s a basic calculation on how gas fees are calculated from our boys at Ethereum:
The gas limit is usually a standard of 21,000 units but users are also able to manually set their own limitations which can be high or lower. Having a lower limit might not exactly be beneficial since Ethereum's miners operate in a similar way to Bitcoin miners considering they'll take as much of a 'bribe' as you'll give, to get your transaction into the next block for validation.
The higher the limit and the higher the price paid, the higher probability you have of being ‘next in line’. Normally, transactions are grouped into blocks by miners who then validate them, but miners will often prioritize the 'higher-paying customers'… psshht capitalism.
Complex operations such as calling a function on a smart contract or publishing a smart contract will require more gas to execute since more computation power is required to make it happen. Here’s a visual depiction on how gas prices have risen since 2016:
A smart contract is a program that essentially takes input from whoever/whatever is calling it, processes the information according to what the author has created and then setting the outputs to be stored on the blockchain. The contracts are automatically executed when predetermined conditions have been met.
The use of these contracts comes down to removing the ‘middleman’, I mean they do the exact same functions at a fraction of the cost and twice the speed. These contracts simply take in the data, process it, and output the result.
While smart contracts are currently associated mostly with decentralized finance (DeFi) but imagine for a second the possibilities for change in industries where there is much-needed transparency and trust such as within public procurement processes like electronic voting and grant disbursements, the possibilities are endless.
While we are a long way away from the change, it is impossible not to factor in the disruption smart contracts and DeFi will cause especially within the archaic systems still in place… cough, home affairs, cough. It will undoubtedly change decades of established processes and replace them with the new age of technology.
Given the lingering effect of the DAO attack at this point, you're probably wondering why smart contracts are even labeled 'smart' after all of the hacks which have happened across various projects. The name does seem to create a false sense of trust, but this trust is at times broken since the smart contracts are essentially only as smart as the person who wrote them.
Another problem with smart contracts on Ethereum is that storing code on the blockchain ends up contributing greatly to increasing gas prices and bloating the system. Fortunately, there has been major progress made by developers moving towards ‘lightening the load’ and making Ethereum not only less costly to transact but more scalable and even more secure. This upgrade to the network is known as ETH 2.0 but stay tuned, we will dive into that a bit later.
DECENTRALIZED FINANCE (DeFi)
Bitcoin was created as a way to stick it to the system by giving retail full control over their money and removing centralized control by institutions such as banks for payments, money, and storage… only to give that power to centralized mining pools… Bitcoin maxi triggered in 3…2..1!
Decentralized finance came in and took it all step further, attempting to change the entire financial system as we know it. Insurance, banking, trading, and everything that centralized institutions have controlled for centuries upon centuries.
The building blocks for decentralized finance are smart contracts and with more than 20% of ether supply held in smart contracts, the majority of DeFi applications are built on the Ethereum blockchain. It is one of the most developed ecosystems with the handy built-in Turing-complete programming language and more than 200,000 developers, that's more than five times the population of Monaco.
Some examples of DeFi applications :
MAKERDAO - THE CENTRAL BANK
We may never know if "1 ETH = 1 ETH" would ever happen but at least 1 DAI = 1 DAI, that surely counts for something?
The MakerDAO project was created in 2015 and was one of the first DeFi projects built on the Ethereum blockchain. Users would lock in collateral (ETH) to generate the cryptocurrency (DAI). This can then be used as the crypto equivalent of a dollar ($) hence, they’re commonly referred to as “stablecoins” for the DeFi system as they are pegged to the currency… Brrrr! Don’t worry though, it prints less than the FED!
COMPOUND - THE DEFI COMMERCIAL BANK
Forget about cutting coffee’s and Woolies avocado prices for a second, what about those ridiculous banking fees?
Fortunately, DeFi has also come to save us from costly banking fees and extremely slow services so we can all become billionaires while having bottomless coffee and avocados. Compound is one of the biggest DeFi projects with over $10 billion in total value. This platform allows users to supply assets such as Ethereum or Tether and gain interest. Supplied assets can also be used for borrowing. While they may not have a ‘very expensive paper’ to justify the valuation, they do have an accessible system of smart contracts and no YMCMB bank can compete with that.
These are only two examples of DeFi apps that make up a part of the growing ecosystem on Ethereum, flipping traditional systems of finance in insurance, margin trading and even in the exchanging of cryptocurrency.
So why do we still use traditional finance? There are definitely big risks in using DeFi, after all the technology is still in its infancy. The risks include bugs, protocol changes in smart contracts, the systematic risks of an asset price losing its value resulting in a cascade of liquidations and the fees especially on Ethereum when there is network congestion.
ETHEREUM 2.0 AND WHAT NEXT?
Fees, sustainability, and scalability have always been some of the biggest issues concerning Ethereum and its users. You could be trying to send money or execute an action and the next thing you know, gas fees have gone through the roof and your transactions have run out of gas, thanks Pudgy Penguins!
Fortunately, core developers have been constantly working on the blockchain and often propose changes known as Ethereum Improvement Proposals (EIP). These are implemented through hard forks and only when a majority consensus is reached.
The graph below is an interesting visual depiction of the price action after the previous hard forks including the highly anticipated EIP-1559 or better known as the ‘London’ fork.
Here’s how each of the events line up alongside each other. If anything the recent rally is very much following the trajectory of past upgrades.
The EIP-1559 proposal is part of the progress towards moving from proof-of-work (POW) consensus protocol towards a more sustainable proof-of-stake (POS) model, also known as Ethereum 2.0, Cue those Bitcoin maximalists having a stroke right now…
The Proof-of-stake model does not rely on miners with high computational power to solve complex algorithms to secure the blockchain, but rather validators that dedicate their Ether through staking and forge rather mine in validating transactions.
The use of staking and validators encourages further decentralization on the blockchain since you don't need a big mining pool or specialized hardware as in proof-of-work. Nodes are relatively easy to set up and one can begin to actively take part in the network.
The model is also more resistant to 51% attacks since one would need to accumulate at least 51% of the supply for an attack, furthermore, Ethereum will implement sharding. Sharding refers to splitting the network into multiple portions, meaning should nodes decide to collude, there is a high chance they will be split into multiple shards, making the attack more difficult.
The EIP-1559 proposal plays its part in these changes concerning the current Ethereum gas fees model. I don't have to mention another example of how people have been essentially choking on gas fees or the number of times users have experienced 'transaction is out of gas' or 'transaction fee too low'.
While EIP-1559 won’t actually lower fees on Ethereum it will certainly make them more predictable. The new model firstly increases block sizes by as much as double meaning more transactions can be processed. There will be a 'base fee' introduced which is the minimum amount of fees payable and users can opt to only pay base fees although this may result in waiting longer for transactions to be confirmed when there is a bidding war for some CryptoPunks. Skipping to the front of the line currently still means paying the miners a tip (for now) but the predictability comes since there is a fixed percentage increase in base fee price if the network is constantly congested.
Here’s a simplified, visual representation before and after EIP-1559 from The Daily Gwei:
Arguably the best part about EIP-1559 or at least the reason why there is a lot of noise surrounding it, is that it will make Ethereum 'deflationary’ since the base fee is burned in every transaction, which is true to an extent… but not really, for now. That will only be the case if the reward (paid to miners) and miner's tip together are lower than the base fee (deflationary) but when the network is congested this will not work so well since the miner tips will increase, so will the base fee (inflationary).
The bright side is that Ethereum 2.0 will bring lower fees, a blockchain that is more scalable with communities more involved through staking and less congestion in the network. The merge into the next phase is scheduled to happen closer to 2022 hopefully this will actually happen this time…
Crypto with DeFi in particular, is an exciting space that is rapidly growing with tons of life-changing stories but also tons of stories of people who have lost it all (the not-so-exciting part). As always remember never get caught as the last Diamond hand and in the face of Elon tweet volatility, never become the first paper hand.
To the moon!
This article is published in collaboration with Altvest, exploring different alternative investment classes.
Altvest is a disruptive platform democratising private equity by creating access for retail investors to own opportunities previously exclusive to high net worth individuals
To find out more about Altvest, have a look at their website: Altvest Capital