Chapter 3: Decentralized Layer: Ethereum
What is Ethereum?
As mentioned in the first chapter, most DeFi Dapps are currently built on the Ethereum blockchain. But what exactly is Ethereum? Ethereum is a global open-source platform for decentralized applications. You can think of it as a world computer that never stops running. On Ethereum, software developers can write smart contracts, which control digital value through a set of standards and can be accessed from anywhere in the world.
In this book, we will specifically explore those decentralized applications (Dapps) that provide so-called DeFi financial services. The smart contracts written by software engineers are the components of these Dapps. These smart contracts are deployed to the Ethereum network and run 24/7. The network continuously maintains a digital value ledger and tracks its latest state.
What is a Smart Contract?
A smart contract is a programmable contract that allows counterparties to set transaction conditions, with the execution of the transaction not requiring trust in a third party.
For example, if Alice wants to establish a trust fund that pays Bob $100 at the beginning of each month for the next 12 months, Alice can write a smart contract like this:
- Check the current date
- Automatically send Bob $100 at the beginning of each month
- Repeat until the funds in the smart contract are exhausted
By using a smart contract, Alice bypasses trusted third-party intermediaries (lawyers, custodians, etc.) to send the trust funds to Bob, making the entire process transparent for all parties involved.
Smart contracts operate on the principle of "if this, then that." When a certain condition is met, the smart contract executes actions as pre-set.
To complete more complex processes and calculations, multiple smart contracts can be combined to interact with each other, which is referred to as decentralized applications (Dapps).
What is Ether (ETH)?
Ether is the native digital currency of the Ethereum blockchain.
Ether functions like currency and is similar to Bitcoin, used for everyday transactions. You can send Ether to another person and purchase goods and services based on the current market price. The Ethereum blockchain records these transactions and ensures their immutability.
In addition, Ether is used to pay for the fees associated with running smart contracts and Dapps on the Ethereum network. You can think of executing a smart contract on the Ethereum network as driving a car. To drive a car, you need fuel. To execute a smart contract on Ethereum, you need to pay a fee known as Gas with Ether.
Ether is slowly evolving into Ethereum's unique reserve currency and store of value. Currently, in the DeFi ecosystem, Ether is the preferred asset for many DeFi Dapp collateral. It provides security and transparency for this financial system. If you find this confusing, don't worry; we will explore this topic in more depth later in the book.
What is Gas?
On Ethereum, all transactions and contract executions require a small fee, known as Gas. Technically, Gas refers to a unit of measurement for the computational resources required to execute an operation or a smart contract. The more complex the operation being executed, the more Gas is required. Gas fees are paid entirely in ETH.
Gas prices fluctuate based on current network demand. Since computational resources on the network are limited, if more people are interacting on the Ethereum blockchain, such as transferring ETH or executing smart contracts, Gas prices will rise. Conversely, if the network is underutilized, the market price of Gas will decrease.
Gas fees can be set manually. In cases of network congestion due to high utilization, transactions with the highest Gas fees will be prioritized for validation. Validated transactions will be finalized and added to the blockchain. If the Gas fee is set too low, the transaction will enter a waiting queue and take some time to be packaged.
Therefore, transactions with Gas fees below the average will take longer to complete. 
Example of Gas fee calculation
What is a Decentralized Application (Dapp)?
On the Ethereum network, Dapps are interfaces that interact with the blockchain using smart contracts. From the front end, Dapps look and operate similarly to conventional web applications and mobile applications, but they interact with the blockchain in a different way.
What are the Advantages of Dapps?
Dapps built on decentralized blockchain networks (like Ethereum) typically have the following advantages:
- Immutability: Once information is stored on the blockchain, it cannot be changed by anyone;
- Tamper-proof: Smart contracts published on the blockchain cannot be altered without the knowledge of other participants on the blockchain;
- Transparency: Smart contract-driven Dapps are publicly auditable;
- Availability: As long as the Ethereum network remains active, Dapps built on it will remain active and available.
What are the Disadvantages of Dapps?
While blockchain brings many benefits, it also comes with several drawbacks:
- Immutability: Smart contracts are written by humans, so human errors are inevitable, and immutable smart contracts can amplify mistakes;
- Transparency: Publicly auditable smart contracts can also become a medium for hacker attacks, as hackers can discover vulnerabilities by examining the code;
- Scalability: In most cases, the bandwidth of Dapps is limited by the blockchain they are built on.
What Else Can Ethereum Do?
In addition to creating Dapps, Ethereum has two other functionalities: creating Decentralized Autonomous Organizations (DAOs) or issuing other cryptocurrencies.
A DAO is a fully autonomous organization that is not managed by individuals but is governed by code. The code runs on smart contracts, allowing DAOs to replace the typical operational models of traditional institutions. Since it operates on code, it is immune to human intervention and runs transparently without external influence. Management decisions or rulings within a DAO will be determined by voting with DAO tokens.
Speaking of tokens, Ethereum can serve as a platform for creating other cryptocurrencies. Currently, there are two popular token protocols on the Ethereum network: ERC-20 and ERC-721. ERC-20 is a protocol standard that defines the rules and standards for issuing tokens on Ethereum. ERC-20 tokens are fungible tokens, meaning they are interchangeable and have the same value. On the other hand, ERC-721 tokens are non-fungible tokens, meaning they are unique and not interchangeable. A simple analogy is to think of ERC-20 as currency and ERC-721 as collectibles like figurines or baseball cards.
That concludes the introduction to Ethereum. If you want to own your first cryptocurrency or try your first Dapp, we will introduce several interesting DeFi products, including their overviews and step-by-step guides. But before starting your journey, you need an Ethereum wallet!
Recommended Reading
What is Ethereum? [The Most Updated Step-by-Step-Guide!] (Ameer Rosic) https://blockgeeks.com/guides/ethereum/
Smart Contracts: The Blockchain Technology That Will Replace Lawyers (Ameer Rosic) https://blockgeeks.com/guides/smart-contracts/
What is Ethereum Gas? [The Most Comprehensive Step-By-Step Guide Ever!] (Ameer Rosic) https://blockgeeks.com/guides/ethereum-gas/
The trillion-dollar case for ETH (Lucas Campbell)
https://bankless.substack.com/p/the-trillion-dollar-case-for-eth-eb6
- Ethereum: The Digital Finance Stack (David Hoffman)
https://medium.com/pov-crypto/ethereum-the-digital-finance-stack-4ba988c6c14b
- Ether: A New Model for Money (David Hoffman)
https://medium.com/pov-crypto/ether-a-new-model-for-money-17365b5535ba
