The two most arguably popular digital currencies, Bitcoin and Ethereum, bear many similarities. They’re both decentralized, they both utilize the blockchain, and both are fungible between different users. Despite these similarities, however, Bitcoin and Ethereum are born out of substantially different constructs.
Bitcoin was created in 2009 by an anonymous figure or team known as Satoshi Nakamoto. Ethereum, on the other hand, was founded by a team of disparate developers who rallied together behind Vitalik Buterin in 2014. The project was crowdfunded in Q3 of 2014 and the network went live on July 30, 2015.
How does Bitcoin work?
Bitcoin relies on a peer-to-peer network that consists of many nodes. Nodes on the Bitcoin network check over each transaction and ensure that funds are not spent more than once, which is a major concern with traditional currencies that are transferred digitally. Some nodes take on the role of miners, which perform computations to solve a specific puzzle. Only through mining can new Bitcoins come into circulation.
The first miner to find a solution to a given puzzle can mine the next block and also receives a predetermined amount of Bitcoin (BTC) in return for their resources and effort. This is called a block reward or block bounty. Every 210,000 blocks (roughly four years), the block reward is cut in half for subsequent blocks. Initially, 50 BTC was the block reward, but an event known as “The Halving” has occurred twice since Bitcoin went live. Block rewards are currently worth 12.5 BTC.
There will only ever be a maximum of 21 million Bitcoins in circulation, which prevents an inflation endemic of centralized agencies flooding the market with more currency units. The estimated year the last Bitcoin will be mined is 2140, at which time miners will transition to receiving rewards only through transaction fees.
Bitcoin also enables users to post transactions using cryptographic “keys.” Each Bitcoin wallet has two “keys”; a public one and a private one. Private keys are generated using a 12-word seed phrase, which is run through a one-way encryption algorithm. Public keys go through a similar process, but they initiate with the private key, as opposed to a seed phrase.
It’s theoretically impossible to reverse the encryption on the public key to derive the private key. However, the Large Bitcoin Collider has managed to find about twenty private keys out of the more than 8 quadrillion (8,000 trillion) attempts that have been made thus far by alternative methods of discovery known as encryption collision. In short, guessing keys is next to impossible, and they keep Bitcoin and Bitcoin wallets extremely safe and secure.
After the keys have been generated, BTC can be added to a wallet by purchasing it from a local Bitcoin seller, from another individual, or through an exchange. This is typically accomplished by providing services for BTC, mining BTC, or exchanging fiat currency. The incoming transaction is signed with a private key and displays the public key of the wallet used to send it. Many Bitcoin security experts recommend not reusing wallets in order to maintain absolute security of funds. That’s because some wallets, as mentioned above, have been cracked by using a published public key.
What was Bitcoin created to do?
Bitcoin was created to allow people to send money without paying an intermediary for proof that the individual on the other end of the transaction is trustworthy. Removing the need for centralized trustees allows transactions to be carried out with lower costs, speedier finalization, and greater privacy.
Transactions are not totally private, however. Many exchanges collect Know Your Customer (KYC) information from their users in order to comply with governmental requirements. Pseudonyms known as wallet addresses can be assigned to users each time they want to create a new wallet to keep track of users.
While less personal than a given name, pseudonyms can still be tracked according to transaction history and any involvement with exchanges. There are a few open-source projects working to analyze the Bitcoin blockchain, like Chainalysis. Not all blockchains stop at pseudo-anonymity, though. One currency, Monero, strives for complete anonymity, and its success has given rise to several other anonymous coins.
Bitcoin was not designed to provide fully anonymous transactions. It was designed to prevent theft, remove the need to have a trusted intermediary, and to lower the barriers to participation in finance.
What challenges does Bitcoin face?
The systems that make up the Bitcoin ecosystem have faced friction, with most issues stemming from their resistance to change—in particular, resistance to scaling, which is necessary to support more users and higher transaction volumes. Proposed solutions include Segregated Witness (SegWit), SegWit2x, and Lightning. Lightning faced a few obstacles to implementation, such as the requirement of SegWit activation.
Following SegWit activation in August 2017, a second-layer growth of the Bitcoin network was made possible. Some examples of second-layer growth are Lightning and Merkelized Abstract Syntax Trees (MAST).
Because of the low volume of transactions that can be published in any given block, network users have been faced with few options. Transactions can be sent with a normal, low transaction fee, but may not be published. They can also be sent with a higher fee and published within the next few blocks, or users can pay for a priority transaction fee, which will enable the transaction to be picked up and placed into the next block.
The technology that underpins Bitcoin, known as blockchain, has been applied to several new concepts since Bitcoin’s inception. Ethereum, Ripple, Zcash, Dash, and Monero are just a few examples.
Some of these other networks have managed to achieve results similar to Satoshi’s original intentions for Bitcoin. In fact, some function with greater ease and have even proven to be testing grounds for new scaling solutions for Bitcoin. LiteCoin, for example, deployed SegWit and Lightning before they were activated on the Bitcoin network.
How does Ethereum work?
Ethereum operates similarly to Bitcoin in the way the network determines who will find the next block. However, Ethereum is planning to change to a new system called proof of stake, in which validators stake ether (ETH), or save it in a special wallet, to determine which block is found next. Validators are similar to Bitcoin miners.
Once the network has placed their stakes, the set of transactions with the largest backing is deemed to be the next block. If the transaction validators choose the wrong chain, they lose money. This means that it is in their best interest to choose the correct block, instead of just backing the most valuable.
What was Ethereum designed to do?
Ethereum was designed to allow for applications to be built on the network. These applications are commonly referred to as decentralized applications, or DApps. DApps have been developed in the form of games, such as CryptoKitties, and even decentralized game development platforms, such as Xaya and PlayKey. Another common use of DApps is time tracking. A large list of DApps can be found on State of the DApps.
Ethereum has a more advanced infrastructure than Bitcoin, which allows developers to implement code templates called smart contracts. These code implementations allow users to create autonomous organizations, run corporations, create new tokens, transfer value, and virtually anything else that comes to mind, using a script that executes itself once it is sent to the network.
Smart contracts have numerous forms, ranging from custom-made scripts to community adopted standards, such as the ERC-20 format, which many ICOs and token sales have adopted.
How are the two networks alike?
Bitcoin and Ethereum are currently both proof of work networks, so they rely on the network to solve a computational puzzle in order to find the next block. Each allows for transactions at a basic level, and each is backed by a vibrant ecosystem of developers, users, and supporters.
Both have pushed the envelope for regulators and traditional companies to revamp and evaluate their methods of doing business. Both have allowed for economic changes in countries worldwide. Each currency has its own unique applications, and these different use cases are why both have retained so much value.
How are the two networks different?
Bitcoin is used exclusively as a financial instrument. Value store, electronic currency, virtual gold, and many other terms are used to describe BTC. Unlike BTC, ETH is used to fuel network development, governance initiatives, DApp usage, and much more.
Bitcoin offers users a fluctuating store of value and payment method, which requires the cost of transacting on the network to be paid in its native unit of currency (BTC). ETH provides value to users not just by offering them a speculative virtual currency, but also by enabling its community to build applications and platforms on top of the network.
When considering how to get involved in the digital currency world, it’s helpful to keep in mind where both BTC and ETH are headed, and which best suits your main objective with digital currency. For those interested in digital currency as a monetary or transactional vehicle, Bitcoin is probably the right choice. But if you’re interested in app development and building out organizations on the blockchain, Ethereum may suit you best.