While Bitcoin targeted value transfer, the goal of Ethereum is to decentralize, well, everything else: the way we send and receive information, build businesses, pay for things, and more.
What is Ethereum?
Ethereum is a completely separate community from Bitcoin, and it has its own, separate blockchain. Unlike Bitcoin’s “ Satoshi Nakamoto”, we very much know who the founder of Ethereum is (Vitalik Buterin is his name), and he's still very much involved with the project.
Bitcoin allows users to transfer digital information (payments) to each other. Ethereum, on the other hand, allows users to run programs and decentralized Applications, or dApps.
Think about the applications or websites we use today. They all run on centralized servers. Facebook, a social media application, stores your data on Facebook servers. Your bank information, health information, all kinds of personal data, are stored on massive, privatized computers.
But it's more than that. All these middlemen, banks, social media applications, health record keepers, take a fee for the service they provide, whether storing your money, connecting you with friends, or keeping your records. Or worse yet–they sell your data for a profit (yeah, remember those massive terms and conditions you skipped through? Many of these companies sell your data...).
Ethereum imagines a world where we don't need middlemen. A world where services like these can be decentralized. Blockchains are run by decentralized networks of computers. Ethereum’s blockchain allows users to build whatever applications they want to.
Think of the Ethereum network as a plot of land, the bedrock on top of which anything can be built. Coders are architects, who can construct all kinds of applications on top of the Ethereum platform. Make sense? Ethereum is essentially a massive virtual computer for developers to build with and us to benefit from! Sound too good to be true? You're not alone. Vitalik Buterin once said, "When I came up with Ethereum, my first first thought was, 'Okay, this thing is too good to be true.' As it turned out, the core Ethereum idea was good - fundamentally, completely sound." And he was right, it is sound!
Ethereum is classified as a protocol. It's a set of rules, defining how the network operates. It does not suggest what to do with the network, it just IS the network. Kind of like the Internet itself.
How does it work?
Okay, so Ethereum is this decentralized computing system, and users can run programs on the network. Right. But for a decentralized protocol to work, there must be a decentralized network of individuals all around the world maintaining it. Sound familiar?
Ah, our good, neighborhood friends, the miners. Ethereum has its own miners, just like Bitcoin does. In the Bitcoin network, miners run computer software to verify and record transactions–in essence they process payments. On the Ethereum network, miners run computer software to execute various functions that allow all of the dApps to function correctly...oh, and they process payments too.
Does that seem broad to you? Well, it is broad. That’s because Bitcoin is really only good for payment processing. Ethereum is good for, well, a lot of different things.
Here's the thing: Ethereum (the protocol, the network) has its own cryptocurrency, called Ether. Many people call the cryptocurrency Ethereum but, technically, it's called Ether. Here's why Ether exists: there needs to be an incentive for miners to maintain the decentralized network of computers. When you run a program on Ethereum, you are using thousands of computers around the globe to do it, and you pay the owners of those computers a small fee in Ether for their trouble.
Ethereum: the decentralized computing network. Ether: the cryptocurrency used to pay miners for maintaining the Ethereum network. Alright, we've been tossing around terms like Ether, decentralized applications (dApps), global computing, and cronuts (tasty).
How does this actually work?
Smart Contracts
Smart contracts are what make Ethereum special.
Smart contracts collapse an agreement and the execution of that agreement into one thing. They do not automate it, combine it, attach it, transpose it, blend it, petrify it, sauté it, boil it, broil it, no. They collapse agreement and execution. Here's how.
A smart contract is a digital agreement that two (or more) people sign. It details the terms of the agreement, and has the power to automatically execute and transfer funds or information once the terms of the contract are met. It executes, automatically, and it runs on a blockchain. Sounds pretty smart.
Wondering how we'd ever use such a contract? Well here's an example in the wonderful world of sports betting. You and I make a bet for $100 on a basketball game. I say the Warriors are going to win, you say the Lakers are going to win. Your opinion is invalid. It's okay to be wrong. Don’t worry about it.
We write down the terms on a piece of paper and sign. The Warriors lose, somehow. You were right. Shoot! I'm a sore loser, and besides that I think the ref made a bad call during the game, so I refuse to pay you. That's not very nice of me, but what are you going to do?
Well, you certainly aren't going to sue me. Suing me would cost you far more than $100, not to mention the hassle. So, basically, you won, I won't pay, and there's very little you can do about it, because paper contracts separate the agreement from the execution. You and I can both agree on something, but nothing in a paper contract guarantees that we will follow through on our agreement (except legal action, but that's often far more trouble than it's worth).
Reverse the tape. Hop in the time machine. Imagine just before we sign the paper contract you go, "oh wait! We should use a smart contract!"
Here's how it would go down: Let's imagine a reputable source (like the NBA or ESPN) posts the score of the game on their website after the game. We write a contract on the Ethereum platform that says "check the score of the game at this website at this specified time. If the Warriors scored higher than the Lakers, transfer funds to Account A. If the Lakers scored higher than the Warriors, transfer funds to Account B."
Of course, the contract doesn't read like that. It would be written in a programming language called Solidity, and deployed to the Ethereum blockchain.
Anyway, we both sign, giving the contract the power to move funds, pay a small fee to the network, and send the contract off. Then, we wait. The game happens. The ref makes the bad call. The Warriors lose. I'm pissed. I lost. Rats!
The contract kicks into effect on thousands of computers all around the world. We can't change it or stop it from happening. The contract executes, sees the score of the game, and transfers Ether to your address. The smart contract collapsed the agreement and the execution into one step. Once we agree to the contract, it will execute.
This does not simplify the legal disputing process. This does away with the legal disputing process.
Ethereum and the future
That, in a nutshell, is how smart contracts work. They are digital agreements signed by multiple parties that have the power to automatically execute and even transfer funds (or information) between people. Bottom line? Bitcoin was the first cryptocurrency, and it changed the nature of money. Ethereum took things a step further, opening up decentralized networks to much more than value. And it has the power to change much, much more than money.
TLDR
What is Ethereum?
Ethereum is a protocol, a set of rules that defines how a decentralized network operates, kinda like Bitcoin.
It allows developers to build decentralized applications, or dApps, that utilize Ethereum’s distributed computing network.
How does it work?
Similar to Bitcoin, Ethereum has a network of miners that process both transactions of value and operations for decentralized applications
Miners are paid for their efforts in Ether, the native currency of the Ethereum blockchain.
What are smart contracts?
Smart contracts collapse agreement on a contract with execution of the terms of that contract.
They run on thousands of computers throughout the distributed network, making them impossible to stop once deployed.
What are Ethereum’s future implications?
Smart contracts cut out arbitration middlemen like escrow services.
Many industries could be made more efficient by implementing smart contracts.