Ethereum is a type of digital currency or cryptocurrency, a medium of exchange that exists exclusively online. Ethereum is one of the most popular cryptocurrencies and ranks second in terms of overall size (as of October 2021), behind Bitcoin, a coin that has become synonymous with crypto.
Cryptocurrency has created a lot of controversy, from those who call it the world’s next payment system to those who see it as a mere speculative bubble. Here’s what Ethereum is and how it works.
What is ethereum
Ethereum is one of literally thousands of cryptocurrencies that have emerged in recent years. As an idea of 8 co-founders, Ethereum debuted in 2015. The cryptocurrency or platform is called Ethereum, while the single unit is ether (2 ethers, 17 ethers, etc.)
Ethereum operates on a decentralized computer network, or distributed ledger known as a blockchain, which manages and tracks the currency. It can be useful to think of a blockchain as a running receipt of every transaction that has ever taken place in the cryptocurrency. Computers on the network verify the transactions and ensure the integrity of the data.
This decentralized network is part of the appeal of Ethereum and other cryptocurrencies. Users can change money without the need for a central intermediary such as a bank, and the lack of a central bank means the currency is nearly autonomous. Ethereum also allows users to conduct transactions almost anonymously, even if the transaction is publicly available on the blockchain.
While referring to the entire field in relation to currency, it may make more sense to think of crypto as a token that can be issued for a specific purpose made possible by the Ethereum platform. For example, sending money or buying and selling goods are functions that the coin enables. But Ethereum can do a lot more and can also form the basis for smart contracts and other apps.
What is Ethereum doing?
Ethereum can run a number of applications that offer a wide range of features:
- Currency: A cryptocurrency wallet allows you to send and receive ethers, or pay for goods and services when the digital currency is accepted as a form of payment. Some platforms like Coinbase even allow you to keep your coins in a digital wallet so you are theoretically less exposed to hackers.
- Smart contracts: Smart contracts are a type of permissionless app that runs automatically when the terms of the contract are met.
- Digital apps or dapps: Ethereum supports digital apps that allow users to play games, invest, send money, track an investment portfolio, follow social media, and more.
- Not fungible tokens: These tokens can be operated by Ethereum and allow artists or others to sell art or other items directly to buyers using smart contracts.
- Decentralized financing: By using Ethereum, some people may be able to avoid centralized (state) control over the movement of money or other assets.
Again, it might be more accurate to think of Ethereum as a token that powers various apps, rather than just a cryptocurrency that users can use to send money to one another.
Where do ether coins come from?
There were about 118 million ethers in October 2021. And although new coins could be “mined”, the total annual issue is limited. This is in stark contrast to Bitcoin, where a maximum of 21 million coins can be mined and reissuing becomes more difficult every year. And it’s even further in contrast to Dogecoin, where the spending is completely unlimited.
Ether coins and those of other crypto currencies are “mined” by the computers in the network. You will perform math calculations that will effectively unlock coins or fractions of coins.
However, this setup changes. Both the Bitcoin and Ethereum blockchains use a so-called “Proof of Work” to mine new coins and validate transactions. It’s an expensive, energy-intensive, and time-consuming process that can clog the network. Therefore, the minds behind Ethereum decided to change their system to a “Proof of Stake” system, nicknamed Ethereum 2.0.
The new system makes it difficult for miners to generate new coins. Instead, those who own the currency are basically “pinning” their own crypto holdings and validating transactions. Stakers could lose their investment if they review transactions that do not comply with Ethereum’s rules.
It is expected that the changeover and the “burning” of transaction fees – destroyed forever – will result in less ether existing and a deflationary spiral emerging that will send crypto soaring.
Is Ethereum a Good Investment?
Ethereum has grown significantly in recent years, so those who bought and held years ago did well. But instead of looking at yesterday’s price movements and being afraid of missing out, understanding what you are investing in is important. And on that basis, those who buy Ethereum are buying a cryptocurrency that is not backed by hard assets or cash flow.
This may sound trivial, but it is the main difference between stocks and cryptocurrency. A stock is a fraction of the ownership of a company, so its performance over time is due to that company’s continued success. As the company grows its earnings, its stock will likely follow that growth over time. Shareholders have a legal interest in the assets and cash flow of this company.
In contrast, Ethereum – and most other popular cryptocurrencies – are not backed by anything. The only thing that holds the price is the optimism of other investors, who all believe that they can later sell the crypto coin to someone else for more money – the so-called “bigger fool theory” of investing. Speculation is the only thing that drives Ethereum and other cryptos up.
For this reason, among other things, the investment legend Warren Buffett will not touch the cryptocurrency and will even refer to it on record as “rat poison squared”. Buffett’s approach is a good indication of the enduring value of cryptocurrencies.
Should you buy or mine Ethereum?
If you want to speculate with Ethereum, it is easy to buy and trade the cryptocurrency on a popular trading platform like Robinhood or Binance.US. You have access to the market 24 hours a day and you have good liquidity, which means that you can make trades without moving the price too much. The calculation of profits is also simple: you profit when you sell coins for more than you paid for.
When you think about mining Ethereum, you have to think like a business owner. You have to invest significant amounts of money in mining rigs in order to produce the cryptocurrency and then you have to use expensive electricity to mine it. You need to run the numbers out to see if it makes financial sense for you to make the initial investment and keep your operation going. That said, you want to earn coins that are worth more than you paid to mine. As Ethereum’s validation system changes, potential miners need to be sure that the profit is still there.
In the end, it is easier to buy Ethereum than it is to mine and requires less effort. There may be potential for profit in mining cryptocurrency, but you need to see if the numbers work.
Bottom line
Speculators can invest directly in cryptocurrencies like Ethereum, but they can also invest in companies that could benefit from a switch to digital currencies.
Whether you are trading Ethereum, Bitcoin, or any other cryptocurrency company, it is important to understand the risks, including the potential for loss of your entire investment. Investors should take a measured approach to cryptocurrency given its volatility and many risks. If you want to get a taste of the action, you shouldn’t invest more than you can afford to lose.
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Editorial disclaimer: We recommend that all investors conduct their own independent research on investment strategies before making an investment decision. In addition, investors are advised that the past performance of investment products is no guarantee of future price increases.
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