Introduction to the Ethereum framework, and its cryptocurrency Ether, for beginners. Ethereum substantially differs from Bitcoin due to its much broader use case, being essentially a platform to execute smart contracts.
Part of a analysis of Seeking Alpha:
The BTC blockchain basically just vets bitcoins passing from one owner to another, a ‘state transition’ in computer science speak, and a very specific one. Ethereum proposes a decentralized architecture that could handle much a much broader class of, including much more complex, state transitions. That might sound very abstract, so let us just review a couple of examples.
Actually, let just start by reviewing the simple state transition on the BTC blockchain: when the BTC network receives a new instruction (“transaction” in Ethereum speak) to pass 1 BTC from party A to party B, then execute this state transition IF (I) party A actually has (at least) 1 BTC and (ii) the cryptography checks out.
Now let us complicate that basic scenario: the transaction now is to pass 1 Ether from party A to party B IF (I) party A actually has (at least) 1 Ether, (ii) it rained in Zurich today and (III) the cryptography checks out. Congratulations, you just invented a weather derivative on Ethereum.
In example 2, the transaction is to pass 1 Ether from party A to party B for every hour that party A uses a specific car owned by party B. Congratulations, you are well on your way to having put a car sharing service (like Zipcar) onto Ethereum.
By now you probably have a grasp of what is going on and may think of other examples. In fact, it is testament to the attractiveness of the Ethereum platform that people have already thought about a whole lot of things that could be done on it, including e.g. from file storage all the way to “DAOs”, decentralized autonomous organizations.
Before going on, we have to circle back to two questions that should have come up by now.
First, why do we simply not do all of these things on the existing BTC blockchain? The simple answer is that the BTC blockchain was never designed to handle anything much more complex than passing BTC around, it lacks basic computational flexibility – in computer science speak, it is not “Turing complete.” However, some relatively simple things can be done on the BTC blockchain and, in fact, there are some simple crypto assets that can run on the BTC blockchain, notably colored coins.
Second, looking at the two above examples, how does the Ethereum network know whether it rained in Zurich or whether party A is using one of party B’s cars? The answer is, as you probably imagined via internet-connected sensors. Yes, that is right – the “internet of things” (IOT). So, in this way, Ethereum is also a major play on IoT. Strictly speaking, one could also use human input to the state transition function, but that would introduce subjectivity and thereby lower safety. As an example, imagine an Airbnb on Ethereum: after the guests of a rented apartment leave, usually a human goes in to check the state of the apartment, including to see whether anything is missing or broken. That could probably in theory be done by a large enough array of specific sensors (like hotels that do now often use sensors to check the contents of the minibar rather than humans) but it just does not seem very practical for now. From my experience, most investors in Ethereum-based businesses prefer business models that can be run without human inference.
A key feature of the Ethereum framework is that the computations necessary to perform the transactions are NOT free. One has to pay for them in, you guessed it, Ether. One pays a defined price (the “gas price”) per computational step.