Is Ethereum secure?

ETH is currently secured by the Ethereum blockchain in much the same way Bitcoin is secured by its blockchain. A huge amount of computing power — contributed by all the computers on the network — verifies and secures every transaction, making it virtually impossible for any third party to interfere. 

The fundamental ideas behind cryptocurrencies help make them safe: the systems are permissionless and the core software is open-source, meaning countless computer scientists and cryptographers have been able to examine all aspects of the networks and their security. 

Apps running on the Ethereum blockchain, however, are only guaranteed to be as secure as their developers have made them. For example, code can sometimes contain bugs that could result in loss of funds. While their source code is also visible to all, the user bases of each individual app are much smaller than Ethereum’s as a whole, and so fewer eyes are on them. It’s important to do research on any decentralized app you plan to use. 

The Ethereum protocol is currently being updated in ways that are intended to make it faster and even more secure. See the Ethereum 2.0 section below for more.

How does Ethereum work?

You might have heard that the Bitcoin blockchain is a lot like a bank’s ledger, or even a checkbook. It’s a running tally of every transaction made on the network going back to the very beginning — and all the computers on the network contribute their computing power towards the work of ensuring that the tally is accurate and secure. 

The Ethereum blockchain, on the other hand, is more like a computer: while it also does the work of documenting and securing transactions, it’s much more flexible than the Bitcoin blockchain. Developers can use the Ethereum blockchain to build a huge variety of tools — everything from logistics management software to games to the entire universe of DeFi applications (which span lending, borrowing, trading, and more).

• Ethereum uses a ‘virtual machine’ to achieve all this, which is like a giant, global computer made up of many individual computers running the Ethereum software. Keeping all of those computers running involves investment in both hardware and electricity by participants. To cover those costs, the network uses its own Bitcoin-like cryptocurrency called Ether (or, more commonly, ETH).
• ETH keeps the whole thing running. You interact with the Ethereum network by using ETH to pay the network to execute smart contracts. As a result, the fees paid in ETH are called “gas.”
• Gas rates vary depending on how busy the network is. A new version of the Ethereum blockchain called Ethereum 2.0, which aims to increase efficiency, began rolling out in December 2020. (The transition to the new blockchain is scheduled to happen over the next two years.)

What is Ethereum 2.0?

Ethereum 2.0 (often referred to as ETH2) is a major upgrade to the Ethereum network. It’s designed to allow the Ethereum network to grow while increasing security, speed, and efficiency. 

As of early 2021, Ethereum 2.0 and Ethereum 1.0 exist side by side — but the original blockchain will eventually merge with ETH2 blockchain. (If you’re an ETH holder you won’t have to do anything — your holdings on the ETH 1.0 blockchain will automatically migrate to the ETH2 blockchain.) The transition to ETH2 began in December of 2020, and is scheduled to take two years.

Why is Ethereum 2.0 necessary? Moving a popular cryptoasset to a new platform is a complex endeavor, but for Ethereum to scale and evolve, it needs to happen. That’s because the “Proof of Work” method used by the ETH 1.0 blockchain to verify transactions causes bottlenecks, increases fees, and consumes substantial resources (particularly electricity).

What is Proof of Work?  How do cryptocurrency networks make sure that nobody spends the same money twice without a central authority like Visa or Paypal in the middle? They use a consensus mechanism. When ETH 1.0 launched, it adopted the consensus mechanism pioneered by Bitcoin: the aptly named Proof of Work. 

• Proof of Work requires a huge amount of processing power, which is contributed by virtual “miners” around the world who compete to be the first to solve a time-consuming math puzzle. 
• The winner gets to update the blockchain with the latest verified transactions, and is rewarded with a predetermined amount of ETH.  
• This process happens every 30 seconds (compared to Bitcoin’s approximately 10-minute cadence). As traffic on the network has increased, the limitations of Proof of Work have caused bottlenecks during which fees spike unpredictably.

What is staking?

Ethereum’s founders were aware of Proof of Work’s limitations. So a very different solution was devised for Ethereum 2.0. — one that will ultimately allow the network to efficiently process thousands of Ethereum transactions a second.

Ethereum 2.0 uses a consensus mechanism called Proof of Stake, which is faster, less resource-intensive, and (at least theoretically) more secure. The end result is similar to Proof of Work’s, in that a network participant is chosen to verify the latest transactions, update the blockchain, and earn some ETH. 

• Rather than requiring a network of miners racing to solve a puzzle, Proof of Stake requires a robust network of participants who are literally invested in the success of the enterprise.
• These stakeholders are called validators. Instead of contributing processing power as miners do, validators contribute ETH to a “staking pool.” 
• The act of contributing ETH to the pool is called staking. If you choose to stake some of your ETH, you will earn rewards in proportion to the size of your stake. For most users, staking will function much like an interest-bearing savings account. 
•  The network selects a winner based on the amount of ETH each validator has in the pool and the length of time they’ve had it there — literally rewarding the most invested participants. 
• Once the winner has validated the latest block of transactions, other validators can attest that the block is accurate. When a threshold number of these attestations have been made, the network updates the blockchain. 
• All participating validators receive a reward in ETH, which is distributed by the network in proportion to each validator’s stake. 

How does Ethereum have value?

There are a few ways of thinking about the answer to this question. On one level, Ethereum’s value is set by markets like any other asset. People buy it with Bitcoin, dollars, euros, yen, and other currencies 24 hours a day. Depending on demand, the price can fluctuate from day to day. (Ethereum’s value tends to be volatile compared to currencies such as the US dollar or equities like Fortune 500 stocks because it is still an emerging technology.)

But why the market prices it the way it does is a much more complicated question. To many investors Ethereum’s value is based on its flexibility as a platform for issuing stablecoins and running DeFi applications — resulting in a growing user base and growing transaction fees. 

What’s next for Ethereum?

As of early 2021, Ethereum is host to the vast majority of blockchain applications and has a market cap of just under $200 billion, with over $55 billion locked into tokens on the blockchain. Popular stablecoins such as USDC and USDT mostly live on Ethereum today due to its network effects.

But a variety of new smart contract blockchains are beginning to compete in the space. So while Ethereum is the dominant market leader today, there is growing pressure for it to successfully execute the transition to Ethereum 2.0.