From a technical perspective, our society “trusts” big companies with too much of our data. Apps like Facebook and Google serve millions of users a day, all while collecting and storing that data on their servers.
We call this process of trusting large corporations centralization, and it’s problematic because it creates single points of failure in the system that stores our user information. Systems with single points of failure are simply too risky to trust with our data. We are at the mercy of hackers and other no-good-doers who are looking to leverage technical exploits and social engineer their way to personal or professional gain.
Large, prominent companies aren’t invincible. In fact, it’s almost inevitable that hackers will find a weakness to exploit. In 2007, Eqiufax was hacked, and 147 million U.S. users (~44% of the U.S. population) had their information stolen because Equifax failed to renew an encryption certificate on one of their internal security tools.
Fortunately, Ethereum has started addressing the problem of centralization with blockchain technology.
Blockchain (and Bitcoin) Basics
A blockchain is like a linked list; each block in the chain has a unique hash, plus the hash of the previous block. This helps ensure that the chain cannot be tampered with.
Bitcoin’s blockchain is a distributed digital ledger recording every transaction that has ever occurred with the currency. Users are pseudonymous; instead of using names or social security numbers, user identities are protected with encryption keys. The assets in your digital wallet cannot be moved by anyone who doesn’t have your private key.
Bitcoin is often called “digital gold” because, just like you wouldn’t use gold to buy a pack of gum, Bitcoin isn’t meant to be used for small transactions. It’s meant to be a safe haven from inflation and third-party intervention. By rejecting government-controlled money and bank-controlled payments, Bitcoin is changing the way we view money.
Ethereum – Decentralized Everything
Inspired by Bitcoin, Vitalik Buterin and friends created Ethereum to change how the internet works. Ethereum aims to create a new protocol for building decentralized applications, with an emphasis on development, security, and scalability.
The Ethereum network is the infrastructure for running decentralized apps (dApps) worldwide, and the currency of the platform is called Ether (ETH). Strangers worldwide can now use applications and transfer value in a trustless manner.
Ether is used for interacting with smart contracts; it acts as a form of payment to the miners who are securing and processing the transactions. Smart contracts are much like written contracts because they contain the rules of enforcement, management, performance, and payment. They are deemed “smart” because they are written in code, self-executing, and (once deployed to the blockchain) cannot be changed.
Deployed smart contracts are immutable and available to every user. These transactions are considered trustless because there is no need to trust other individuals on the network. If the terms of the smart contract aren’t fully met, the transaction won’t occur. This is the beauty of Ethereum — no one in the community needs to know or trust anyone else for the system to work.
With decentralization comes inclusivity. No company or entity runs the system; instead, it’s a distributed network of independent, private computers worldwide. The platform itself is maintained and updated by developers all over the world. Information on this network is sent directly from person to person rather than from person to company to person. People of all beliefs and backgrounds can use it without approval or permission — anywhere, anytime.
Proof of Work vs. Proof of Stake
A blockchain system is composed of nodes that store and update a copy of the blockchain. Sending small bits of encrypted data across many computers makes the network more available and less exploitable. To protect against malicious changes to the network, at least half of all the nodes have to agree before any new addition is made to the blockchain. This means the more nodes in the network, the greater the accuracy.
Proof of Work
Exchanging Ether (Ethereum’s currency) includes a fee often referred to as “gas,” which is vital to the smart contract ecosystem because it pays the consensus nodes for validating the transaction. This process is called “mining,” and the gas incentivizes miners to confirm transactions. It’s part of a consensus protocol called Proof of Work (PoW) — a first-come, first-serve system, where the first miner that proves to have done the work receives the reward.
The transaction pool holds all the unconfirmed transactions on the network. Once a transaction is uploaded to the blockchain, it’s put into the transaction pool to await the necessary number of confirmations. One confirmation is not enough to be confident about the validity of the transaction; users have to wait for each new block to be created and verify the information.
All nodes on the network are connected to the transaction pool. The first miner who solves the mathematical equation and adds the block to the blockchain is the first to confirm the block. So far there isn’t an agreed-upon number of confirmations needed on the Ethereum blockchain; however, the Ethereum white paper suggests seven confirmations should be enough to confirm the transaction (which takes about two minutes).
PoW benefits miners with the largest hash rate and lowest electricity costs, so people often formed groups to pool their computing power together. The downside of PoW is that mining is relatively expensive because it takes a lot of electricity. Bitcoin uses PoW to verify transactions, and in 2019, Bitcoin’s energy consumption was around 64 terawatt-hours. That’s larger than the annual electricity consumption of Switzerland.
As the network continues to grow and mining becomes impractical for many, a select few mining farms will essentially control the network. This sounds a lot like centralization again, doesn’t it?
Additionally, miners often choose transactions with the highest fees so they can earn a higher bonus. This explains why not paying transaction fees can lead to your transaction getting stuck. This is a classic scalability issue. As more people join the network, the wait times could grow exponentially.
Proof of Stake
To address these concerns, Ethereum 2.0 will be using Proof of Stake (PoS). With PoS, miners are replaced with validators who are responsible for securing the network. Instead of being first-come, first-serve, PoS uses an election process where one node is randomly selected to validate the next block. To become a validator, you must run a node and deposit 32 ETH.
This is called “staking” and can be thought of like a security deposit. Any time there is an update to the blockchain, a validator node is selected. The economic incentive to act honestly comes from the staked ETH and the chance to lose money by acting dishonestly.
While both Bitcoin and Ethereum allow users access to digital money without a middleman, Ethereum is programmable and can be used for many different digital assets.
Bitcoin showed us the first use-case of blockchain technology. Ethereum will show us many more — a marketplace of financial services, games, and apps that can’t steal your data or censor you.