What is Ethereum and how does it work

When people talk about cryptocurrencies, Bitcoin is usually the first reference. Ethereum comes right after, but with a different purpose: instead of being mainly a payment system, it was designed to run programs.

This article explains what Ethereum is, how its pieces work (accounts, virtual machine, contracts, fees and consensus), how the network has changed since launch and which risks you should know about. For a comparison with Bitcoin, see also the guide on what Bitcoin is.

Ethereum in one sentence

Ethereum is a programmable blockchain: a shared ledger, maintained by a network of computers, that stores not only balances but also programs and their data.

Its native currency is ether (ETH). Ether was introduced in 2015, alongside the network’s launch, and is used to pay fees and for staking, the deposit that secures the network (ethereum.org, ether). The first production release, called Frontier, went live on July 30, 2015, aimed mainly at developers (ethereum.org, upgrade history).

“Ethereum” and “ether” are often used interchangeably. In this article, Ethereum is the network and ether is the currency.

Where the idea came from

The Ethereum whitepaper, from 2014, proposed a blockchain with a built-in “Turing-complete” programming language. In practice, that means a language capable of expressing any computable logic, so that anyone could write their own rules for transferring value (Ethereum whitepaper).

The paper starts from the limitations of Bitcoin’s scripting language. Among them: the absence of general loops, the difficulty of controlling partial amounts, the lack of persistent state between steps and the inability to read data from the blockchain itself, such as a block’s timestamp.

ethereum.org itself warns that the whitepaper is a historical document. It does not reflect today’s Ethereum, which moved to proof of stake in 2022 and came to rely on layer 2 networks.

The formal technical specification is in another document, the Yellow Paper, by Gavin Wood. It describes Ethereum as a transaction-based machine with shared state (Yellow Paper, Shanghai version). The version consulted by the editorial team is from February 2025.

Accounts: who holds what

Everything on Ethereum revolves around accounts. There are two types (ethereum.org, accounts):

• Externally owned account. Controlled by whoever holds the private key, the cryptographic secret that authorizes transactions. Creating one is free, and only this type can initiate a transaction.
• Contract account. Controlled by code, not by a person. Creating one costs a fee, because it uses storage on the network, and it only acts in response to a transaction it receives.

Each account has a balance, measured in wei (1 ETH equals 10¹⁸ wei), and a transaction counter called the nonce, which prevents the same transaction from being replayed. Contract accounts also store the program’s code and storage.

A useful distinction: an account is not a wallet. The wallet is the app you use to manage the account. Whoever holds the private key controls the account, whatever the app.

The Ethereum Virtual Machine

ethereum.org describes Ethereum as a distributed state machine, not just a ledger. The “state” is the snapshot of all accounts, balances and program data at a given moment (ethereum.org, EVM).

With each block, a set of valid transactions moves the previous state to a new state deterministically: given the same inputs, every computer on the network reaches the same result. The rules for this transition are defined by the Ethereum Virtual Machine (EVM).

Programs are written in languages such as Solidity, compiled into bytecode (low-level instructions) and stored in the contract account. When someone calls the contract, each node on the network executes that bytecode on its copy of the EVM. There are several independent EVM implementations, and all of them must follow the Yellow Paper specification.

Smart contracts

A smart contract is a program that lives at a blockchain address, with its own functions and data (ethereum.org, smart contracts). The classic analogy, attributed to Nick Szabo, is a vending machine: with the right input, the outcome is guaranteed by the rules built into the machine.

Three characteristics help explain why they matter:

• Permissionless publishing. Anyone with enough ether for the fee can publish a contract.
• Composability. Contracts are public and can call one another, like building blocks. That is where financial, token and governance applications built on top of each other come from.
• Immutable by default. A published contract cannot be deleted by default, and interactions with it are irreversible.

There are limits. A contract cannot directly access real-world information, such as a price quote or the result of a game. This is intentional, because external data could break consensus. That is what oracles are for: services that bring external data to the blockchain and add their own layer of trust.

Gas: the price of using the network

Every operation on the EVM consumes an amount of gas, the unit that measures computational work. You pay for this gas in ether. The charge exists to prevent abuse, such as programs stuck in infinite loops, and applies even if the transaction fails (ethereum.org, gas).

The fee is calculated as: gas used × (base fee + tip).

• Base fee. Set by the protocol for each block. It rises when the previous block was above the target fill level and falls when it was below, by at most 12.5% per block. This part is burned, that is, removed from circulation.
• Tip. Goes to the validator that includes the transaction and signals urgency.

Prices are usually expressed in gwei, one billionth of an ether. In the documentation’s own example, a simple ETH transfer uses 21,000 gas; with a base fee of 10 gwei and a tip of 2 gwei, it costs 0.000252 ETH. The value in reais, or in any other currency, depends on the price of ether and on demand for the network at that moment, and changes all the time.

This base-fee-and-burn model was introduced in the London upgrade, on August 5, 2021, through proposal EIP-1559 (ethereum.org, upgrade history).

Proof of stake and The Merge

A blockchain needs a method for the network to agree on the next block, the so-called consensus mechanism. Ethereum was born using proof of work, like Bitcoin, with miners spending energy.

On September 15, 2022, with the event called The Merge, the network switched to proof of stake. The consensus layer that took over block production, the Beacon Chain, had already been running in parallel since December 1, 2020. ethereum.org estimates the change reduced the network’s energy consumption by about 99.95% (ethereum.org, The Merge).

Under proof of stake, according to the documentation (ethereum.org, proof of stake):

• Validators deposit 32 ETH as collateral and run software that checks and proposes blocks.
• Time is divided into slots of 12 seconds, and 32 slots make up an epoch. In each slot, a validator is randomly selected to propose the block.
• A block becomes final, that is, practically irreversible, when validators representing at least two thirds of the staked ETH vote in favor. Reverting a finalized block would require destroying at least one third of all staked ETH.
• Anyone who acts maliciously, for example by voting for two conflicting versions, is slashed: they lose part of their deposit and are removed. Being offline incurs smaller penalties.

The Merge also has limits that are often misunderstood. It did not lower fees, because it did not increase the network’s capacity, nor did it meaningfully speed up transactions. Staking withdrawals were only enabled later, in the Shapella upgrade, in April 2023.

How much ether exists

Here is a central difference from Bitcoin. Bitcoin has scheduled issuance that is cut in half every 210,000 blocks, the Bitcoin halving, and approaches a total of 21 million. Ethereum has no such fixed cap. ethereum.org speaks of “dynamic supply mechanics” (ethereum.org, ether).

Two forces act in opposite directions (ethereum.org, issuance after The Merge):

• Issuance. New ETH is created as a reward for validators.
• Burn. The base fee of each transaction is destroyed.

When network usage is high, the burn can exceed issuance and supply shrinks. When usage is low, supply grows. There is no way to know in advance which effect will prevail, because it depends on demand for the network.

Layer 2 and recent upgrades

Directly increasing the main network’s capacity would require more powerful computers to run a node, which would reduce the number of participants. The chosen strategy was different: make Ethereum a good settlement layer and leave much of the activity to layer 2 (L2) networks built on top of it (ethereum.org, layer 2).

L2s that publish their data on the main network are usually called rollups. They bundle many transactions and record the result on Ethereum, which lowers the cost per transaction. There is no “official” L2: anyone can create one, and designs vary.

Upgrades in recent years have followed this direction, according to ethereum.org’s history:

• Dencun (March 13, 2024): introduced cheaper data space for rollups (EIP-4844).
• Pectra (May 7, 2025): changed staking rules and allowed regular accounts to execute contract-like code (EIP-7702).
• Fusaka (December 3, 2025): brought PeerDAS, which, according to the layer 2 page, helps L2s publish and retrieve data on the network more efficiently.

The next planned upgrade is called Glamsterdam. As of the last update of the page consulted, it had no set date.

Risks you need to know

Ethereum carries risks that go beyond price swings:

• Volatility and total loss. Ether can lose much of its value, or all of it, in a short time.
• Contract bugs. Code published with errors can be exploited, and transactions cannot be reversed. ethereum.org recalls the attack on The DAO, in which 3.6 million ETH were drained, and a Parity wallet case in which more than US$ 300 million in ETH was permanently locked. The documentation estimates losses from smart contract security failures at “easily over $1 billion” (ethereum.org, smart contract security).
• Third-party staking. Validating on your own exposes you to penalties and slashing. Delegating to a provider, using a pool or leaving your ETH on an exchange adds counterparty risk and, in the case of exchanges, hands custody to them. ethereum.org rates exchanges as the option with the strongest trust assumptions (ethereum.org, staking).
• Layer 2 networks. The security of each L2 depends on the technology, the quality of the contracts and the maturity of the project. ethereum.org itself recommends doing research first and starting with small amounts.
• Unpredictable cost. At times of high demand, the base fee rises block by block, and an operation can become much more expensive than you expected. If the transaction fails, the gas consumed is not refunded.
• Private key. Whoever holds the key controls the account. If it is lost or stolen, there is no help desk that can undo the problem.

Key takeaways

• Ethereum is a programmable blockchain. The EVM runs smart contracts the same way on every node, and ether pays for using the network.
• Every operation consumes gas. The base fee is burned and the tip goes to the validator.
• Since The Merge, on September 15, 2022, security comes from validators who deposit ETH and can lose it if they misbehave.
• There is no fixed supply cap: issuance and burn compete for the balance, depending on network usage.
• The risks include irreversible code failures, intermediaries in staking, uneven maturity of L2s and lost keys, on top of price volatility.