The Bitcoin's smarter brother: an Octa's guide to Ethereum

In the week ending on 26 May, the price of Ethereum (ETH) gained nearly 25%, rising as high as 3,900 USD. The 4,000 USD price mark, crossed last in March, is clearly in sight after the US Securities and Exchange Commission approved the listing and trading of spot Ethereum exchange-traded funds (ETFs). In the long-term perspective, the situation also looks highly promising for the ETH ecosystem as its prospects are buoyed by the growing adoption in various sectors and the strong developer community. Since becoming the second-largest cryptocurrency behind Bitcoin in 2018, ETH has maintained this position. But what makes it so successful in the highly volatile cryptocurrency market?

A new era of blockchain technology

The idea of Ethereum was born in the mind of Vitalik Buterin, a visionary entrepreneur and cryptocurrency enthusiast. He first became engrossed in blockchain technology in 2011 and two years later proposed his own blockchain platform, Ethereum, as a new type of digital environment that can go beyond financial transactions.

The Ethereum project was crowdfunded in 2014, raising over 18 million USD in Bitcoin, and the network went live on 30 July 2015. While Bitcoin was created as a decentralised digital currency to serve as an alternative to traditional currencies, ETH aimed to extend the capabilities of blockchain technology.

In comparison to Bitcoin, Ethereum offers a more versatile blockchain capable of supporting smart contracts, which are self-executing contracts with the terms directly written into code. The new blockchain allowed for revolutionary possibilities: users could build new cryptocurrencies based on Ethereum by creating an ERC-20 token, which is a technical standard for establishing fungible assets on the Ethereum blockchain. Many altcoins were created based this way, allowing for a wide range of applications. For example, one of the top Ethereum-based altcoins is Chainlink, or LINK — a decentralised Oracle network that allows smart contracts on Ethereum to securely interact with real-world data, APIs, and other external sources.

The new versatile framework facilitated the development of various decentralised solutions. The existing practical applications of Ethereum include:

• decentralised finance: Ethereum-based applications aim to recreate traditional financial systems with blockchain technology. They provide services such as lending and borrowing cryptocurrencies without intermediaries, decentralised peer-to-peer exchange, and stablecoins (cryptocurrencies that are pegged to another asset to maintain a stable price, for example, USDT.)
• non-fungible tokens (NFTs): NFTs are unique digital assets that represent ownership of a specific item or piece of content. They are often used for creating and selling digital art. NFTs are also popular in gaming, where they are used to represent in-game items, characters, and virtual land. Some tokens, including ‘Pudgy Penguins’ and ‘Mutant Ape Yacht Club’ collections, even gained worldwide notoriety and were widely discussed in media.
• decentralised applications (dApps): Ethereum supports a wide range of applications across various industries, including gaming, social media, and digital marketplaces. The most popular dApps include MakerDAO and Brave browser.
• identity and authentication: Decentralised identity solutions leverage Ethereum to give users control over their personal data.

Ethereum 2.0: a leap into the unknown

On 15 September 2022, Ethereum introduced a new phase in the development and evolution of its blockchain by transitioning to Ethereum 2.0. The upgraded platform boasted the following advantages:

• new consensus mechanism. A consensus mechanism is a protocol that ensures that a transaction is reflected in the blockchain as soon as it gets validated. With Ethereum 2.0, the ETH ecosystem switched from the proof-of-work (PoW) to the proof-of-stake (PoS) mechanism. Among other advantages, PoS is more secure, less energy-intensive, and better for implementing new scaling solutions compared to the previous architecture.
• significant improvement in scalability and performance. Ethereum 1.0 had scalability limitations, handling about 15 transactions per second. That could lead to network congestion, resulting in high gas (fees required to successfully conduct a transaction or execute a contract) and slow transaction times. Ethereum 2.0 significantly increased scalability through the introduction of shard chains. Sharding divides the network into multiple smaller chains (shards), each capable of processing transactions and smart contracts independently, potentially increasing the network's capacity to handle thousands of transactions per second.
• increased overall efficiency of the network structure. While Ethereum 1.0 operates as a single blockchain where all transactions and smart contracts are processed by every node in the network, Ethereum 2.0 implemented shard chains alongside a central beacon chain. The beacon chain coordinates the network and manages validators, while the shard chains process transactions and smart contracts, distributing the load and increasing overall efficiency.
• better security and sustainability. By switching to PoS, the ETH ecosystem reduced energy consumption by approximately 99.95%, making it a more sustainable and eco-friendly network.

The Ethereum ecosystem can expand almost indefinitely with various new applications mushrooming in different sectors. However, in practice, some significant bottlenecks impede this progress. The main concerns that Ethereum 2.0 might have to address include:

• accessibility limitations. Based on the proof-of-stake consensus mechanism, the Ethereum 2.0 blockchain requires interested users to own the native cryptocurrency before becoming validators, so they must buy ETH tokens using fiat currency or exchanging tokens from cryptocurrency exchanges. Users interested in becoming validators have to raise at least 32 ETH, which translates to about 50,000 USD, which is hardly affordable to most users.
• lack of decentralisation. The PoS mechanism can also lead to a lack of decentralisation. Since it relies on delegates chosen to validate transactions, it's always possible for larger nodes to overpower smaller ones. The large nodes could potentially control the process of selecting delegates and prevent smaller ones from participating, eventually making the PoS less decentralised. Some ecosystem users are concerned about the possible centralisation of power in case a small number of influential delegates or validators gain control over the authority to approve and validate transactions.
• hidden dangers. The PoS mechanism has a lot to offer compared to its predecessor, PoW, but it is still relatively new and untested. No one can tell if any yet-to-be-identified security challenges could arise in the future. With the relatively low entry cost, personalised attacks against eminent players can potentially decrease the blockchain’s overall security.

Ethereum’s commitment to innovation is not limited to the PoS switch. The network is also exploring layer-2 scaling solutions and other upgrades to enhance its performance and user experience. This continuous evolution makes Ethereum an attractive platform for developers and investors, ensuring its continued relevance and growth.

Some experts predict ETH will pass its current record peak as a response to the launch of spot ETF products in the US. This much-anticipated event is also expected to trigger price changes in the currency exchange market. With that in mind, those trading in Ethereum CFDs on investment platforms such as Octa may be able to capitalise on the predicted market movements.

Octa is an international broker that has been providing online trading services worldwide since 2011. It offers commission-free access to financial markets and a variety of services already utilised by clients from 180 countries with more than 42 million trading accounts. Octa's free educational webinars, articles, and analytical tools help clients reach their investment goals. The company is involved in a comprehensive network of charitable and humanitarian initiatives, including the improvement of educational infrastructure and short-notice relief projects supporting local communities. Octa has won more than 60 awards since its foundation, including the ‘Best Online Broker Global 2022’ award from World Business Outlook and the ‘Best Global Broker Asia 2022’ award from International Business Magazine.