Module 1: Introduction to Crypto Markets

Ethereum and Programmable Money

Chapter 4 of 15 · about 7 minutes

4.1 Bitcoin does one thing well

Bitcoin was designed to do one job: let people hold and send bitcoin without a middleman. It does that job very well, and its rules are deliberately simple and hard to change. That's a strength. A money system shouldn't be constantly experimenting.

But in 2013, a young programmer named Vitalik Buterin asked a bigger question. If a blockchain can keep track of who owns which coins, why can't it keep track of anything? Loans, agreements, games, digital collectibles, entire financial systems. What if a blockchain could run programs?

That question became Ethereum, which launched on 30 July 2015.

4.2 The vending machine

The best way to understand Ethereum is a vending machine.

When Mint buys a drink from a vending machine, there's no shopkeeper. Mint inserts money, presses a button, and the machine follows simple rules: if the payment is enough and the item is in stock, release the drink and give change. Nobody can argue with the machine or ask it to make an exception. It just follows its programming.

Ethereum lets anyone write these kinds of rules and place them on a blockchain. These programs are called smart contracts. Once deployed, a smart contract runs exactly as written, and because it lives on a blockchain, nobody can secretly change it or stop it from running.

"So it's a contract that enforces itself?" Mint asked.

"More or less," said Hash. "The name is a bit misleading. It's not a legal contract. It's code that automatically does what it says when certain conditions are met."

4.3 What smart contracts make possible

Here's a simple example. Mint and Node make a bet on a football match: each puts in $50, and the winner takes $100. Normally, they'd need a friend they both trust to hold the money. With a smart contract, the money is locked in code. When the result is published by a data source both agreed on, the contract automatically pays the winner. No one has to trust anyone to hand over the money.

Now scale that idea up. Smart contracts power almost everything people build on crypto beyond simple payments.

ApplicationWhat the smart contract does
TokensCreates new digital assets and tracks who owns them (Chapter 5)
Decentralised exchangesLets people swap tokens without a company in the middle (Chapter 8)
LendingLets people lend and borrow by locking up collateral, with automatic rules for repayment and liquidation
StablecoinsIssues tokens designed to stay at a fixed value, like one US dollar
NFTsRecords ownership of unique digital items
Prediction marketsLets people trade on the outcome of real-world events

Together, many of these applications are known as DeFi, short for decentralised finance, which has its own dedicated module later in this series.

4.4 Ether and gas

Running programs on thousands of computers isn't free. Every action on Ethereum, from sending tokens to executing a complex smart contract, requires computation, and the network charges for it.

That charge is called gas, and it's paid in Ethereum's native currency, ether (ETH). Think of gas like the fuel in a car: a short trip uses a little, a long trip uses a lot. A simple transfer uses a small amount of gas. A complicated smart contract interaction uses much more.

ActionRelative gas used
Sending ETH to someoneLow
Sending a tokenMedium
Swapping tokens on a decentralised exchangeHigher
Complex DeFi transactionsHighest

The price of gas rises and falls with demand. When many people are trying to use Ethereum at the same time, fees go up, a bit like surge pricing on a ride-hailing app. This is why we'll talk about Layer 2 networks, which are built on top of Ethereum to make transactions cheaper and faster, in Module 3.

Gas also protects the network. Since every computation costs money, nobody can write a program that runs forever and clogs the system.

4.5 From mining to staking

Ethereum originally used proof of work, like Bitcoin. In September 2022, it switched to proof of stake in an upgrade known as The Merge. This cut Ethereum's energy use dramatically, by over 99% according to most estimates.

Today, validators secure Ethereum by staking ETH. In return, they earn rewards, and if they misbehave, some of their stake can be taken away. This also means ETH holders can participate in securing the network and earn a yield, either directly or through staking services, which we'll cover in the DeFi module.

4.6 Bitcoin and Ethereum compared

"So Ethereum is a better Bitcoin?" Mint asked.

"No," said Hash. "They're trying to do different things. Comparing them is like comparing gold with a smartphone. Both are valuable, for completely different reasons."

BitcoinEthereum
Launched20092015
Main purposeDigital money and store of valuePlatform for running programs and applications
Native assetBTCETH
ConsensusProof of workProof of stake
SupplyCapped at 21 millionNo fixed cap; issuance offset partly by fees that are destroyed
Design philosophySimple, conservative, hard to changeFlexible, evolving, regular upgrades

Ethereum's supply works differently from Bitcoin's. New ETH is issued to validators, but part of every transaction fee is permanently destroyed, or "burned." Depending on how busy the network is, total supply can grow slowly or even shrink. We'll go deeper into supply mechanics in Chapter 10.

4.7 Ethereum wasn't the last

Ethereum's success inspired many other smart contract blockchains. Some aim to be faster or cheaper, some make different security tradeoffs, and some specialise in particular uses. Many of them are compatible with Ethereum's programming environment, called the Ethereum Virtual Machine (EVM), which means applications and wallets built for Ethereum can often work on them too.

We'll compare different blockchains properly in later modules. For now, the key idea is that Ethereum introduced programmable money, and much of the crypto world is built on that idea.

4.8 The risks of code

Node had been quiet, but now spoke up. "If a smart contract can't be changed, what happens if there's a mistake in the code?"

"Then the mistake is permanent too," said Hash. "And people will look for it."

This is one of the most important realities of crypto. Smart contracts can hold billions of dollars, and bugs in their code have led to some of the largest losses in crypto's history. One early example came in 2016, when a bug in a popular Ethereum project called The DAO let an attacker drain a large share of its funds. It was so serious that the Ethereum community controversially changed its own history to reverse it, splitting the network in two. The original, unchanged chain still exists as Ethereum Classic.

The lesson for us: "decentralised" and "automatic" don't mean "safe." Code is only as good as the people who wrote and reviewed it.

4.9 Try it yourself

Open an Ethereum block explorer and look up the current gas price, usually shown on the homepage in units called gwei (one billionth of an ETH). Then look at a recent block and compare a simple ETH transfer with a more complex transaction, such as a token swap. Notice how much more gas the complex one used.

If you're curious, search the explorer for a well-known token contract and open its "Contract" tab. You're looking at the actual code that runs the token, publicly visible to anyone.

Key takeaways from this chapter

  1. Ethereum, launched in 2015, extended the blockchain idea from tracking money to running programs.
  2. Smart contracts are programs on a blockchain that execute automatically, like a vending machine, without a middleman.
  3. Smart contracts power tokens, decentralised exchanges, lending, stablecoins, NFTs, and much of the crypto economy.
  4. Every action on Ethereum costs gas, paid in ETH, and gas prices rise when the network is busy.
  5. Ethereum moved from proof of work to proof of stake in 2022, reducing its energy use dramatically.
  6. Bitcoin and Ethereum have different goals: Bitcoin focuses on being sound money, Ethereum on being a programmable platform.
  7. Smart contract bugs can cause large, permanent losses. Automatic doesn't mean safe.