Ethereum has Become a Platform to Launch ICOs
Note: This article was written in 2015 and describes what Ethereum might look like post launch. Obviously, Ethereum was a massive success. If you are looking to buy Ethereum, check out our picks for the best altcoin exchanges, although most mainstream exchanges carry Ethereum as well. Read on for a time capsule, which is anyway interesting to remember the ideology behind the protocol.
There is currently a debate raging in the cryptocurrency market as to the best method for rolling out new applications of blockchain technology. Brian Armstrong, CEO of leading bitcoin exchange coinbase, presents the “bitcoin first” view: “Ripple, Stellar, and Altcoins are all a distraction. Bitcoin is way too far ahead. We should be focused on bitcoin and sidechains”.
Vitalik Buterin, lead developer of Ethereum, takes the opposing view. He argues that limitations in the bitcoin protocol frustrate attempts to utilize the underlying blockchain technology for building 2.0 applications. In his words, Bitcoin is “a revolutionary invention; as a protocol for storing and transferring value, Bitcoin is excellent. However, as far as being an effective low level protocol is concerned, Bitcoin is less effective…it is not particularly good as a foundation for anything else.”
Ethereum is a platform with a robust, built-in programming language with an integrated blockchain. If something can be built, it can be built on Ethereum. And when built, any application is infused with the ethereum blockchain in its very DNA.
It could very well result in the replacement of many single-function coins that, while perhaps useful, clutter and fragment the market. Many of these coins can be replicated in the ethereum ecosystem with just a few lines of code. And it might just offer the environment required for developers to create the dream applications that Bitcoin has as yet not been successful in facilitating.
And what does this mean for users? Ethereum helps give people a new level of independence in personal and business finance, estate planning, trust fund management, in fundraising and investment. It removes the middleman from most any commercial interaction, facilitates person-to-person marketplaces in an environment in which trust is guaranteed. It places power back in the hands of the individuals that has been diffused amongst many different interlocutors such as banks, lawyers and agents. If it takes off, it has the chance to be truly liberating.
Ethereum the platform
The applications built upon the platform are called Decentralized Applications, or Dapps. Any Dapp written in the Ethereum programming language described above will work in the Ethereum network, where it will live on the blockchain.
Dapps are frontend applications that interact with contracts located directly on the Ethereum blockchain. The contract acts as an autonomous agent with a specific function or code executed when called on – or in other words, when sent a transaction. Dapps are open source, acting as templates to the ethereum development community – got an idea for a dapp? Grab the code of the closest current approximation, and make your changes. Below are a few of the different types of apps that are either in the process of being built or will feature within Ethereum 1.0.
Contracts can determine in advance how and when funds can be withdrawn. For instance, a petty cash wallet might have certain permission requirements depending on withdrawal amount. One out of five signatures, for instance, could allow a limit of $100 per day, three of five for $1000, and all signatures required for cashing out the entire amount. These signatures would be sent as transactions to the contract, which would be governed by its preexisting encoded mandate.
The same principles could serve as the foundation for a family trust. A husband and wife could create jointly an account meant for an heir after a particular life event or, heaven forbid, in case of the death of the parents. The contract would be activated only by the holder of a private key – which would be safely stored for the intended heir. In the event that the private key sends a message to the contract, the fund might be released in one sum, or according to some predetermined schedule.
Businesses could automate payroll activity in which funds are sent to employees on the first of every month. In the event of a new hire, the contract could either be updated, if such allowances were programmable, or could be cloned and updated in a few simple steps.
Ethereum is a useful tool for fundraising, whether for charity or raising equity for new or expanding businesses. In the former scenario, funds are pooled in escrow by contributors to a worthy project, released only in relation to predetermined and provable milestones. In the case of a public offering, businesses could write a contract in which a certain percentage of the business is available for sale, at a certain cost. Dividend distribution can be automated by the contract as well, so that regular payments are made to investors according to a preannounced formula.
Anonymous and cryptographically secured voting could easily be facilitated. Addresses are set corresponding with each particular choice, and eligible participants could exercise their vote simply by transferring the token to one address of another. The most immediate use case for such a system would be in a corporate environment, but the advantages in establishing such a system for political votes are intriguing.
The same concept could be applied to establish predictive markets, a current hot topic in the crypto community. Prediction markets allow people to “bet” on future events. For instance, let’s imagine there is a prediction market for the 2016 Republican primaries in the United States. Bets are created by casting a token with a certain value behind one or another candidate, and all losing tokens are divided between the winners. This is not only a fun thing to do, but it provides interesting market data on the likelihood of future events.
In his famous “we are not an altcoin” (1:18) speech to New Finance in November, Ethereum COO Stephen Taub outlines an interesting method by which predictive markets could one day be used as a mechanism for peer to peer insurance (12:02). He uses the example of earthquake insurance in California, which could be used as a hedge against damage done. (Alice: Oh Bob, we’ve lost everything! Bob: Yeah, but I won!)
Peer to peer
There are a many ways in which Ethereum can compliment non-financial peer-to-peer ecologies. Dapps can be written that matches buyers and sellers of hard drive space to store encrypted files, with micropayments automatically distributed to the sellers from the buyers. Not only is this a great method of monetizing unused hard drive space, it is cheaper and most likely more secure, as files are encrypted and decentralized throughout a wide network.
This also provides a method incentivizing the sharing of torrent files. In the current bittorrent market, it is never an issue to find the most popular films, which are always loaded with “peers” to ensure quick download. However, for more obscure films, it is difficult to find the content or adequate liquidity necessary for download. In offering payment incentive – both to the original provider of the content as well as to those serving as peers – a wider variety of content, as well as a greater number of peers are encouraged.
We’ve covered the blockchain and contract system, and how this is used to create Dapps. There are a few other building blocks of ethereum to review before moving on to a discussion of the client developed for the network, Mist.
The bittorrent concept described above is the motivation for ethereum’s storage and distribution protocol, called Swarm. Swarm is a p2p method utilizing spare hard-drive space and processing power to power a bittorent-esque method of transferring files and displaying web pages or dapps. In other words, rather than focus on centralized servers to host published materials, they are supported by the decentralized ethereum community, who is incentivized to participate. This drives down server costs, removes single point of failure – i.e. large centralized servers- and contributes to the development of a truly decentralized network. (Sidenote: Ethereum has developed a Namecoin-like decentralized DNS solution utilizing the blockchain. In combination with Swarm, this should create a truly censorship, control free and anonymous network).
Complimenting Swarm is a secure messaging protocol named “Whisper”. Whisper is a low level protocol, meaning that it is meant to be utilized by all subsequent applications built in ethereum. It facilitates the sending of broadcasts to the entire network and the sending of encrypted messages unreadable by any but the intended reader. Whisper does not divulge any information as to the IP address of the sender or the recipient, ensuring that communications may not be geotracked.
One is tempted to describe Mist as a browser for Ethereum, but in his video presentation, UX designer Alex Van de Sande pretty emphatically objects to such a designation. “Throw in a url bar and the first thing the user will do is type in google, and by then they are lost.” Rather, Mist should be considered a tool kit which packages all the technologies described above in an intuitive and unintimidating fashion. Mist is the bridge between the worlds of crypto-development and the mainstream.
After downloading Mist, a new user is directed to a catalogue page with a number of the most popular and useful dapps listed, organized within categories. As a user begins to interact with different dapps they appear on a bespoke dashboard, alongside contacts within the network and any other information – like particular prediction markets – that have been selected by the user.
Each user has the opportunity to create a number of profiles that can be used for different functions. Someone might want to set up their true identity when dealing with personal finance and friends, a second identity when dealing with matters on behalf of their small business, and perhaps a third anonymous identity for whatever reason. These profiles are used when sending messages, and can have corresponding wallets. For instance, a personal wallet or trust fund would be assigned to someone’s true identity, while perhaps payroll or checking account wallet would be assigned to the business identity.
Each wallet might be governed by a different contract logic so, for instance, a child’s trust fund could not be bet in the prediction markets, or employee payroll funds could not be put towards a crowdfunder. Perhaps the trust fund wallet requires the signature of a spouse or next of kin in order to withdraw some or all of the amount contained within.
Speaking of the trust fund, this is a good example of how mist has simplified an extremely complex technical process. The trust can be held on behalf of the recipient by the parents or guardians, who designate themselves and the heir in just a few clicks. Once the trust has been created, a contract is generated. The contract contains the actual code written so that the salient details can be understood by the non-technical, as well as how to alter dynamic fields in order to customize the specifics of how, when and under what circumstances the trust should vest. There is community support available in the forums, where common customizations are described and discussed.
In his video, Mr. Van de Sande makes an interesting point. Your most intimate relationships in the real world might not be early adopters of technology like ethereum. How can someone utilize technology such as this, when his or her immediate family is not yet engaged with the product?
Let’s imagine that a trust is being set up for a child. An invitation token can be created which is a temporary transaction redeemable only once, allowing an heir into the trust. The token contains a QR code-type image/private key, and a special question and answer passphrase. The image can be printed or sent to the user or a guardian by email, and never expires. When the time comes, the heir simply must scan or drag and drop the image into its place on the trust screen, and type in the answer to the question.
Similar invitations can be made for any particular functionality. It creates a method for ethereum users to act as ambassadors, to widen the network not in some spammy tell-a-friend way, but with actual information that can be seen as valuable and helpful, that has tons of different functionalities that can be used in everyday life.
Ether – powering the ethereum engine
Ether is the native currency to the ethereum network, described as the fuel or gas powering the ethereum engine. It is used for a number of different purposes.
Contracts require this gas in order to run, and for each and every operation executed, a small amount of gas is burned – or passed off as service fees to miners, responsible for processing and authenticating the operations executed by the contracts. The size of the fee depends on the amount of network resource required to support any particular transaction or action. Most actions required for standard operations will be exceedingly cheap.
Ether is also the method of payment allowing usage of any particular service. For instance, establishing a family trust would require payment of some nominal amount to the developers. And of course, each subsequent transaction – like for instance an automatically executed payment – will require some small additional fee.
The fees not only compensate developers and miners but protect against “infinite loops” or other abusive transactions. Were transactions entirely free, there would be nothing to stop a baddie from clogging the blockchain with thousands of worthless recurring transactions, ethereum’s own brand of spam.
If Ethereum reaches it’s potential, the demand f will grow accordingly, and thus it represents a very interesting speculative opportunity in its own right. Below, we outline how ether will be introduced into the ethereum ecology.
Ethereum was the third highest-funded crowdfunding project in history. 60.1m ETH was sold, raising $18,441,000 worth of bitcoin in September 2014. 76.5% of funds are meant to be used to boost development of the platform and corresponding tools; 13.5% was allocated to community outreach and marketing, with the additional 10% or so going to preexisting expenses and a legal contingency fund.
Ether supply and rewards
The mining reward is meant to be approximately 15m ether per year, or 40,000 per day. This is a standard release schedule, meaning that the annual amount will never be reduced. Being a constant rate of release into an ever growing supply, deflationary pressure should grow as the years pass, gradually moving towards 0.
For instance, after the first year newly-mined ETH will have added 25% to the initial crowdfunded supply. After 10 years, the 15m injection will account for a 7.5% increase, after 20 4.3%, and so on. This is compounded by an estimated 1% of the ether base that will be removed permanently from the network, due to loss, death, or what have you. This would serve to increase deflationary pressure as the years pass and newly-minted coins account for a smaller and smaller percentage of the overall money supply.
Ether mining will initially work according to the “dagger hashimoto” method, a variation of litecoin’s scrypt. While blocks are mined using traditional proof of work – i.e. solve a puzzle whose answer is a random number chain which only can be guessed through trial and error at blazing computer speeds – unlike bitcoin their is an additional aspect called “memory hardness”. A memory-hard problem is one in which a large amount of memory is also needed to solve the puzzle. This additional twist is meant to make mining more resistant to specialized hardware, as memory is more difficult and costly to scale than simple computational power. Mining thus remains more accessible, although still extremely competitive, to a more decentralized network of individuals, theoretically using home computing equipment.
In ethereum’s mining algorithm, a miner is required to grab random transactions from previously hashed blocks which must be used in the proof of work hashing function. This requires each miner to operate as a full node, meaning that they must run the client locally. This helps decentralize the network and discourages mining pools. Additionally, dagger hashimoto is meant to allow efficient “memory-light” verification, which would allow anyone running the ethereum client to participate in verifying that the blocks are correctly mined, without overburdening their personal computer.
Mr. Buterin has outlined an additional proof of stake mining function called “Slasher” that some believe will replace dagger hashimoto. Proof of stake essentially distributes a “chance of mining” to each coin held by all the users in the network. When a user’s coin is picked, the user gets to mine the block and receive the awards. Many consider proof of stake mining to be superior to proof of work as it minimizes waste – in the form of energy consumption – and is thus a green alternative. However, the threat of centralization coming from proof of work super asics is replaced by the largest holders of the coin. However, if a fork in the blockchain were to occur, it would be in the best interest of miners to continue mining both blocks, as their chances of successfully mining would double.
In Slasher, Mr. Buterin attempts to mitigate this risk through a PoW/PoS hybrid that vastly decreases the amount of computational effort required to mine a block, but tweaks how signing privileges are determined by PoS to ensure miners would not be incentivized to double mine were there ever a blockchain fork. In Slasher, the chain is “aware” of other chains, and miners are incentivized to rat out double miners, with an algorithm devised by Mr. Buterin offering an easy method of discovery. In the event that a user catches a double miner, he receives the block reward, and the double miner is penalized.
Blocks will be mined at a one minute target.
Security and stability
Way back in the summary, Mr. Buterin was quoted as saying effectively that bitcoin is fantastic in doing what it does – transferring its native currency bitcoin – but sort of lousy in accommodating alternative applications of its blockchain technology. This is not because of any lack of technical expertise on the part of the bitcoin core developers, it was a deliberate choice. The expansion of the core focus of bitcoin would introduce a number of additional complications and unintended consequences that could damage the network.
Perhaps Ethereum, in that it restricts itself to being only the platform and language allowing third-party development, can lay claim to some of the same simplicity. However, it does seem to be a massive undertaking, and one can only hope that it does not fall into the same over-complicated trap into which its peer, bitshares, seems to have fallen.
Closely related to the above is the mining dynamic. Bitcoin benefits from a massive amount of computational power dedicated to ensuring the validity and stability of the network. Can something even close be replicated on ethereum? How long will it take to establish enough ether value to attract massive mining interest?
And of course, perhaps the biggest obstacle to ethereum’s success is the stability of its underlying currency, ether. While all the different dapps described above are truly innovative and should have mainstream appeal, that appeal quickly leaves the building when the detail that family trusts, for instance, cannot be denominated in dollars, but must be stored in something called ether.
The derivatives trap
Mr. Buterin, in his speech to the Texas Bitcoin Conference, outlined two methods of establishing a crypto-asset pegged to real world currency or commodity. This concept, in our view, is vital for the long term success of ethereum.
His first solution was actually just an description of Tether, in which a token is backed and redeemable in the real world for one dollar. In the case of Tether, the corresponding currency is located in a reserve account which can be “viewed and verified”. Mr. Buterin seemed to dismiss this alternative due to the centralized nature of the solution. From the view of someone dedicating his life to replacing outmoded central trust models, this is perhaps a no-go zone.
His second solution was the establishment a hedging contract, meant to serve not only as a value hedge but a price indicator. In broad strokes, two counterparties contribute say, $100 into escrow. After a predetermined amount of time, counterparty 1 would receive $100 worth of ether, with the remaining amount going to counterparty 2 – worth more or less than it initially was worth.
This seems to be a variation on the bitasset concept which we believe will eventually collapse. The problem is that collateralization of such contracts with the same underlying asset does not account for either a massive drops in its price or dried up demand for the coin. All it takes is one black swan, and the whole house of cards falls.
We feel there are two alternatives that can help ethereum (and bitshares) avoid this derivatives trap. The first is the Tether solution, described above. Of course, Mr. Buterin is right about the centralized nature of the solution, but if such institutions were, say, FDIC insured, we would feel much more comfortable.
The second solution, and one which we hope is established quickly after launch, is the development of a Dapp allowing the two-way pegging of bitcoin, effectively establishing ethereum as an incredibly robust sidechain. While bitcoin itself is extremely volatile, it has established value, and there is progress towards regulation and mainstream financial inclusion (on Wall Street, etc) which should lead to greater adoption rates and decreased volatility over time. At least, there is a much better chance of this happening in the short term than is the case with Ether.
If there will ever be a successful alternative to bitcoin, ethereum is it. The technology promises to be amazing. There is a large amount of interest, reflected both in a sizable community and a massively successful crowdfunding. An incredible team of developers is led by Vitalik Buterin, who himself offers an incredibly intriguing story. He is young, he is a genius and, forgive me if you are reading Vitalik, he is nerdy in a very endearing and charismatic way. People want him to succeed. We want him to succeed.
This could be the beginning of something special. If it turns out not to be, perhaps it is some consolation that a number of the best minds in the industry gave it a proper go.