What Is Ethereum? Smart Contracts, Gas and ETH Explained Simply

A short history

Ethereum was proposed by programmer Vitalik Buterin in late 2013, and he soon teamed up with a group of co-founders to build it. The network launched on July 30, 2015. Its native currency is ether, usually written as ETH.

Bitcoin focuses mainly on being money. Ethereum was designed to be programmable. Developers can write code that lives on the blockchain and runs exactly as written, which opened the door to a whole range of applications.

What smart contracts are

A smart contract is a program stored on Ethereum. It follows simple if-this-then-that rules. A basic example: "If someone sends 1 ETH to this contract, send them 100 tokens in return." Once deployed, the contract runs automatically whenever someone interacts with it, and nobody can quietly change its rules unless the code allowed for changes from the start.

The name can be misleading. These are not legal documents, and "smart" does not mean clever. They are just code, and code can contain mistakes. A bug in a popular contract can be exploited by attackers, and funds lost that way are often impossible to recover.

ETH as fuel: understanding gas

Every action on Ethereum, from sending ETH to using an app, takes some computing work. That work is measured in units called gas, and you pay for it in ETH. Gas prices are usually shown in gwei, which is one-billionth of an ETH.

Your fee has two parts. The base fee is set by the network according to how busy recent blocks were, and it is burned, meaning it is permanently removed from circulation. The optional priority fee is a tip that goes to the validator who includes your transaction. When many people use Ethereum at the same time, fees rise.

You pay the fee even if a transaction fails, because the network still did the work. Gas also discourages spam: if every action costs something, flooding the network becomes expensive.

The move to proof of stake

Ethereum originally used proof of work, like Bitcoin. On September 15, 2022, it completed an upgrade called The Merge and switched to proof of stake. Instead of miners competing with powerful machines, validators lock up ETH as a deposit and take turns proposing and checking blocks.

Validators earn rewards for doing the job honestly. If they break the rules, part of their deposit can be taken away, a penalty called slashing. According to ethereum.org, The Merge cut the network's energy use by about 99.95%.

Unlike Bitcoin, Ethereum has no fixed maximum supply. New ETH is issued as rewards to validators, while burned base fees remove some ETH, so the total supply can rise or fall over time.

What runs on Ethereum

• Tokens. Thousands of other digital tokens, including many stablecoins, are built on Ethereum using shared standards.
• Decentralized finance (DeFi). Apps for swapping tokens, lending and borrowing that run on smart contracts rather than through a bank.
• NFTs. Unique tokens that record ownership of a digital item, such as a piece of art or an item in a game.
• Layer 2 networks. Separate networks built on top of Ethereum that bundle many transactions together to make them cheaper, then record the results on Ethereum.

You use these apps through a wallet, which signs each action you approve. Always read what you are signing, because one careless approval can give an app permission to move your tokens.

Risks to keep in mind

• Price volatility. ETH can rise or fall sharply, and its price depends heavily on how much people use, and expect to use, the network.
• Smart contract bugs. Even audited apps can be hacked. Using many apps and brand-new projects multiplies this risk.
• Fees and mistakes. Fees can jump when the network is busy, and sending tokens to the wrong address or network usually cannot be undone.
• Scams. Fake tokens, copycat websites and malicious approval requests are common. Double-check addresses and only use apps you have researched.