Ethereum, most people know it as the cryptocurrency that sits behind Bitcoin by market cap ranking, but it’s much more than just another coin.
In this post we explain what Ethereum is, how Gas works, current issues and what is being done to fix these and cement Ethereum as the leading blockchain network.
What is Ethereum?
The Ethereum network is an open source, programmable blockchain that allows the creation of Smart Contracts, or mini software programs, with fixed rules to govern user interaction. Examples may be a payment on a set date every week, a reward for completing a task, or a payout for winning a game.
The maintenance and security of the Ethereum blockchain is powered by the incentive to earn a cryptocurrency, also called Ethereum (AKA ETH or Ether).
Ethereum Isn’t Just Ethereum
Ethereum isn’t just the Ethereum Network and ETH. It also allows users to create their own cryptocurrencies, known as tokens, each with their own rules and uses (smart contracts).
Most tokens created on Ethereum follow a certain standard referred to as an ERC-20 (“ERC-20 Tokens”). They have to obey the basic rules set by the Ethereum blockchain, and by doing so offer greater interoperability. Beyond that, the rules and uses are up to the creator.
Anyone can make an ERC-20 token and many do; in fact, at the time of writing there are over 200,000 different ERC-20 tokens.
The Top 10 ERC-20 tokens at the time of writing are;
- US Dollar Tether (USDT)
- Chainlink (LINK)
- USD Coin (USDC)
- AAVE (AAVE)
- Uniswap (UNI)
- WrappedBitcoin (WBTC)
- Theta Token (THETA)
- Maker (MKR)
- Synthetix (SNX)
- Compound (COMP)
A full list of ERC-20 tokens can be found on the etherscan block explorer
While Ethereum allows complicated sets of rules to be created, simple transactions, or the transfer of wealth from one person to another, is the core use case.
Centralised services from companies such as Coinbase, Binance, and Cash App are custodial services. They make purchasing and transacting with cryptocurrencies easy. You simply give them your identification documents, attach a bank account and off you go.
This ease of use comes at a price. Not only do you pay multiple layers of fees to the provider, but the service holding the keys to your account has full control. They can move, freeze and lose your money and you can’t do anything about it. As the old crypto adage goes — Not Your Keys, Not Your Crypto.
Of course these centralised services have their place, but they aren’t really in keeping with the original ethos of cryptocurrency, as envisioned by Satoshi when he created Bitcoin.
“bitcoin, a new electronic cash system that’s fully peer-to-peer, with no trusted third party.” — Satoshi Nakamoto
We are now heading back towards Satoshis vision with the rise of what is referred to as Decentralised Finance (DeFi) — putting the power back in the hands of the individual — with the goal to help democratise financial applications.
At the core of DeFi are non-custodial wallets which, simply put, are wallets where you hold your own private keys. Examples of non-custodial wallets include MetaMask, Numio, and Ledger.
With a non-custodial wallet you are in full control of your cryptocurrency.
So What Is Gas?
So that’s Ethereum in a nutshell, but what is Gas?
Gas is “… the fee, or pricing value, required to successfully conduct a transaction or execute a contract on the Ethereum blockchain platform” — Investopedia
When making an Ethereum transaction there is always a fee, called Gas, which must be paid in ETH. It can’t be paid in the cryptocurrency you are sending.
This isn’t a problem with a centralised service as they will work it out for you and take the fee from whatever token you have- at a premium of course. The problem comes with non-custodial wallets where you always need enough ETH to cover the Gas fee.
On top of that, if you want to send an ERC-20 token you have to have ETH in that same wallet to cover the fee.
How does this work when you want to send a transaction from your non-custodial wallet that only holds an ERC-20 token and no ETH?
Simply put, you will need to transfer ETH to your wallet to get the token out.
If you don’t have ETH in another wallet then you might need to open up a centralised service, buy enough ETH to cover the fee plus any fee they charge, and send that to your wallet.
You also have to factor in that the Ethereum network transfer fee fluctuates constantly so, by the time it reaches your wallet, enough Ethereum remains to make the original transaction.
On the other hand, you might also end up sending too much and have some small amounts of ETH stuck in your account that you may never use — or be priced out of sending because of Gas fees.
It’s not a simple process.
So Ethereum Is Slow and Expensive?
The recent DeFi explosion has highlighted Ethereums major weakness as a day to day payments system. Namely, that it’s slow and expensive — but why?
Ethereum is currently based on what is known as a Proof of Work (PoW) consensus mechanism*. In the case of Ethereum this takes the form of a huge network (~11,000) of decentralised nodes (computers) which verify each transaction individually. Anyone running a node gets paid a fee (in Gas).
So, it’s simple, you want to make a transaction and want priority over everyone else so you pay a higher fee. Job done.
Well… it’s a bit more complicated than that.
Ethereum’s settlement layer can only cope with 15 transactions per second (tps) and there isn’t one set fee structure, instead it’s a variable price based on how busy the Ethereum network is at any time.
When the Ethereum network is quiet, the 15tps limit isn’t an issue and Gas fees are cheap. The problem arises when everyone wants to use the network. It gets busy and the network bottlenecks, so you can pay a higher Gas fee for priority, but everyone wants priority, so everyone outbids one another and the Gas fee continues to increase.
Currently Gas fees are around $5–20 per wallet-to-wallet transaction, regardless of the amount you are sending. And when interacting with smart contracts, such as on Uniswap, the fees can reach more than ten times that.
*this is changing to Proof of Stake but will take at least another 24 months.
So How Can We Make It Faster, Cheaper and More User Friendly?
The Gas fee issue isn’t a new one. It was a problem in the 2017 bull run, and it’s a problem now. The fact is that until it gets fixed we won’t see full adoption of Ethereum as a payment system. It needs what is called scaling.
The launch of Ethereum 2.0 will be the biggest upgrade to Etherum to date. The scalability improvements offered by Ethereum 2.0 should result in faster transaction speeds and lower fees for users — there is one big problem however… it’s not ready.
That’s where Layer 2 comes in, moving transactions off the Ethereum blockchain (Layer 1).
Luckily there are a number of Layer 2 scalability solutions available right now.
- State Channels
- Optimistic Rollups
- Validium (zkSTARKS)
- zkRollups (zkSnarks)
You can read up on each of the solutions in the links above or get a full comparison on the Matter Labs Blog.
In summary what these solution bring to the table are;
- an increase in transactions per second (TPS)
- a reduction in fees
- the ability to pay Gas in the token you are sending*
These Layer 2 solutions all have their pros and cons but the one that is really making waves at the moment are zkRollups. The creator of Ethereum, Vitalik Buterin has been quite vocal in his support of zkRollups and it seems that they are here to stay.
The main players building zkRollup infrastructure at present are, zkSync and Loopring, with some fantastic products being built by the likes of Numio, Gitcoin, Curve and Argent.
*not in every instance but this functionality is built into various Layer 2 solutions.
In summary Ethereum is a huge, ever growing, ecosystem and it can change the world, but it won’t while Gas remains an issue. So for mass adoption Layer 2 technologies are essential.
If you want to go deeper down the Ethereum rabbit hole there is a myriad of documentation for Ethereum and the various projects, products and scaling solutions out there — you’d better start reading now if you want to make a dent in it.
What Is Ethereum and Why Does It Have a Gas Problem? was originally published in Data Driven Investor on Medium, where people are continuing the conversation by highlighting and responding to this story.