What is Ethereum? How it works and how it differs from Bitcoin

Overview: cryptocurrencies, networks and native tokens

Qué es Ethereum — introducción en una frase

Blockchains are public, shared ledgers maintained by many participants. Each blockchain defines its own data model, rules for adding new blocks, and a native asset used inside the protocol. Ethereum is a blockchain designed to host a global programmable state machine: it stores accounts and program code and accepts transactions that change that state. Bitcoin is a blockchain designed primarily to record transfers of value on a tamper-evident ledger.

Unlike a simple token ledger, Ethereum provides a runtime environment for code—the Ethereum Virtual Machine (EVM)—so participants can deploy and call programs (smart contracts) that become part of the shared state. These differences shape what each network is used for and how users interact with it. The technical descriptions in this guide are based on the Ethereum Foundation’s developer documentation and the Bitcoin developer summary on bitcoin.org.

• Ethereum is a blockchain that combines a shared ledger with a global virtual computer (the EVM) to run smart contracts.
• Ether (ETH) is the network’s native asset used to pay for computation and to secure consensus through staking (post-2022).
• Bitcoin focuses on a UTXO transaction model secured by proof-of-work mining and primarily records value transfers.

The Ethereum Virtual Machine (EVM): a global programmable state

The EVM is the runtime that every full Ethereum node implements. It defines how contracts execute, how storage is read and written, and how gas costs are applied. When a transaction invokes a smart contract, nodes execute the same instructions in the EVM to deterministically update the shared state. The EVM’s deterministic execution model is what lets independent nodes agree on the result of contract calls and the new state after a block.

Because the EVM is part of the protocol, programs uploaded as contract code become permanent entries in state at an address; they can hold ETH and other tokens, and they react only when triggered by transactions from externally-owned accounts or by other contracts. This model contrasts with Bitcoin, where programmatic capability is intentionally limited and not centralized into a global virtual machine (source: Ethereum.org).

Ether (ETH): why the network needs a native token

ETH is Ethereum’s native cryptocurrency and serves several protocol roles. Users pay ETH to cover the computational and storage costs that their transactions impose on the network. These payments create a market for block space and discourage spam.

Part of the transaction fee (often called the base fee on modern Ethereum fee mechanisms) is burned, reducing supply, while other fee components are paid to validators who propose and attest to blocks. This design both allocates cost to users of computation and links economic incentives to network security (source: Ethereum.org).

Accounts and smart contracts: externally‑owned vs contract accounts

Ethereum defines two kinds of accounts: externally‑owned accounts (EOAs) and contract accounts. EOAs are controlled by private keys and can sign transactions; they hold a nonce, a balance, and other metadata. Contract accounts are controlled entirely by their code: they have an address, code, storage and a balance but no private key and cannot initiate transactions on their own. Contracts execute only when called by an EOA or another contract.

An account’s nonce prevents replay attacks by ensuring transactions from the same account execute in a single order. The typical user experience—wallets, addresses, signing transactions—relies on this account model and on cryptographic key pairs derived from a secure private key (source: Ethereum.org).

Ethereum transaction lifecycle: step-by-step (high level)

A transaction lifecycle on Ethereum (post-merge PoS architecture) proceeds roughly as follows:

1) A user (via a wallet) creates and signs a transaction with their private key. The transaction includes destination, value, data (optional), and fee parameters.

2) The transaction is sent to a local or remote execution client and propagated to other nodes’ mempools.

3) In each slot, a validator is pseudo-randomly chosen to propose an execution payload (a block of transactions). The proposer’s execution client builds the block of transactions respecting gas limits and ordering policies.

4) The proposer’s payload is included in a Beacon/consensus block; other validators re-execute the transactions on their execution clients, check results and attest to the proposed block.

5) Over subsequent epochs, validator attestations form checkpoint votes. When checkpoints attract sufficient support (two‑thirds of stake in the classical finality math described by Ethereum.org), a checkpoint can become finalized; at that point, reversing that finalized state would require large economic penalties and slashing to validators.

This step-by-step description follows the architecture laid out in Ethereum’s consensus documentation and the developer intro pages (source: Ethereum.org).

Proof of stake in Ethereum: concept and consequences

Ethereum replaced proof-of-work with proof-of-stake in 2022. Under PoS, validators put up ETH as collateral and are selected (pseudo-randomly) to propose and attest to blocks. Validators who violate rules or equivocate can be penalized or slashed—losing part of their staked ETH—to preserve economic security.

Running a validator requires depositing 32 ETH into the deposit contract and operating three software components: an execution client (handles EVM execution), a consensus client (handles the beacon chain and consensus rules) and a validator client (sends attestations and proposals). New validators enter via an activation queue when capacity and network conditions permit (source: Ethereum.org).

PoS introduces tradeoffs compared with PoW: it reduces the need for energy-intensive mining, changes the source of economic security from energy expended to staked capital, and requires careful validator key management and software availability for liveness. The Ethereum documentation explains these mechanisms and the penalties (slashing) designed to deter attacks.

Bitcoin basics and key contrasts with Ethereum

Bitcoin records transactions using a UTXO (unspent transaction output) model. Wallets control private keys that authorize spending of UTXOs; transactions consume previous outputs and create new ones. Miners bundle transactions into blocks and produce proof-of-work to add blocks to the chain. The computational work required to create blocks makes rewriting history expensive (source: bitcoin.org).

Key contrasts to remember:

- Purpose: Ethereum is designed to run general-purpose programs (smart contracts) and host decentralized applications; Bitcoin’s design intentionally focuses on secure value transfer and a tamper-evident ledger.

- Data model: Ethereum uses an account model with nonces and contract accounts; Bitcoin uses UTXOs which are consumed and recreated with each transaction.

- Consensus: Ethereum uses proof-of-stake with validators and slashing mechanics (post-merge); Bitcoin uses proof-of-work mining with computational difficulty adjustments.

- Programmability: Ethereum’s EVM supports persistent contracts and richer on-chain state; Bitcoin’s scripting is intentionally limited and not a full virtual machine for arbitrary stateful programs. Sources: Ethereum.org and bitcoin.org.

Gas and transaction costs (brief overview)

Every operation in the EVM has an associated gas cost; a transaction’s gas limit and gas price parameters determine how much computation it may consume and what the user offers to pay. Gas exists to measure and charge for resource usage and to prevent programs from consuming unlimited compute across the network. Detailed gas accounting and optimisations are covered in dedicated guides; this section gives a conceptual view only (source: Ethereum.org).

Common Ethereum applications and realistic examples

Because Ethereum lets contracts hold state and enforce code-defined rules, common use cases include token standards (ERC-20, ERC-721 and others), decentralized exchanges, lending markets, and on-chain governance primitives. Developers deploy contracts that implement application logic; users interact with those contracts through transactions or web3 interfaces.

Hypothetical example (labelled hypothetical): Suppose a community issues a token contract that mints 10,000 units to a treasury address and exposes transfer and approval functions. A user calls transfer to send 100 tokens to another address; the wallet constructs and signs a transaction, includes it in the mempool, and the transaction is executed in a block by a proposer. The contract’s storage updates atomically during execution; if execution runs out of gas or reverts due to a failing require-check, the state change is rolled back and only the gas spent is consumed. This example is hypothetical and demonstrates the semantics of contract execution; it does not imply external real-world promises are enforced by code.

Advantages, limitations and risks of Ethereum vs Bitcoin

Advantages of Ethereum’s model: programmability and composability. The EVM lets independent contracts interoperate: a token standard deployed by one team can be used by a decentralized exchange and by wallets without central coordination. PoS reduces energy needs associated with block production compared with proof-of-work. Ethereum’s account model can make some user flows simpler (e.g., single address per user for multiple interactions).

Limitations and risks: smart contract code can contain bugs that cause loss of funds; because contracts can hold value, errors or vulnerabilities can have direct monetary consequences. Interacting with unfamiliar contracts carries risk—users should review or rely on audited code, and use wallets that show transaction details clearly. PoS shifts some risk to validator availability and key management; a misbehaving or compromised validator can lose stake through slashing. The fork-choice rule (LMD-GHOST) and finality rules differ from Bitcoin’s longest-chain PoW rule, creating different reorg and finality properties (source: Ethereum.org).

Security tradeoffs compared with Bitcoin: Bitcoin’s PoW model ties security to cumulative computational work; reversing history requires redoing that work. Ethereum’s PoS ties security to economic penalties and stake concentration; reversing a finalized block would require slashing a substantial portion of stake. Each approach has different centralization pressures and operational risks—mining pools on Bitcoin vs large staking providers on Ethereum—and those are active subjects of technical and economic debate (sources: ethereum.org, bitcoin.org).

Comparison table: Ethereum vs Bitcoin (concise)

The table below summarizes major differences. Each row states the mechanism and the practical implication.

Safe practices when using Ethereum and Bitcoin

Follow general cryptographic hygiene for both networks: use reputable wallet software or hardware devices, verify receiving addresses, and avoid reusing sensitive signing material across unknown services. For Ethereum-specific risks: be cautious when approving contract allowances (ERC-20 approvals), prefer contracts and dapps with audits or reputable track records, and review transactions your wallet will sign—data fields can call arbitrary contract functions.

Do not try to improvise secret-sharing or split recovery phrases manually; use tested multisig schemes or professionally designed key custody tools when multiple approvals or high-value custody is required. Multisig is a distinct security architecture from backups: multisig changes how approvals are authorized, while backups are about recovery of single-key wallets. For staking participation, operate validator software carefully and understand the responsibilities and slashing risks documented by Ethereum.org (source: Ethereum.org and bitcoin.org).

Frequently asked questions

Q: What is the EVM and why does it matter?

A: The EVM is Ethereum’s shared runtime that executes contract code deterministically. It matters because it enables general-purpose on-chain programs (smart contracts) whose state is stored on the blockchain (source: Ethereum.org).

Q: Why do I pay gas in ETH?

A: Gas measures the work and storage a transaction uses; ETH is the native asset used to pay those fees, aligning economic cost with resource consumption (source: Ethereum.org).

Q: What changed when Ethereum moved to proof-of-stake?

A: Ethereum’s consensus switched from miners using PoW to validators staking ETH. Validators propose and attest to blocks and can be penalized or slashed for misbehavior. The switch affects how new blocks are produced and how economic security is enforced (source: Ethereum.org).

Q: How is Ethereum finality different from Bitcoin confirmations?

A: Ethereum’s PoS finality uses checkpoint votes where, if enough stake supports a checkpoint, it becomes finalized and difficult to revert without slashing; Bitcoin’s confirmations are probabilistic—more confirmations reduce the chance of reorgs but there is no protocol-level finality (sources: Ethereum.org, bitcoin.org).

Q: Are smart contracts legally enforceable?

A: The code enforces on-chain logic for state and value transfers, but whether those rules correspond to legal obligations depends on jurisdiction and off-chain agreements; smart contracts do not magically enforce real-world actions. Exercise standard legal and operational caution.

Conclusion: different tools for different goals

Ethereum and Bitcoin share the basic idea of a distributed ledger backed by cryptographic keys, but they purposefully diverge in architecture and intent. Ethereum offers a programmable global state (EVM), an account model that supports smart contracts, and a proof-of-stake consensus secured by staked ETH. Bitcoin focuses on a simple, robust ledger for value transfer built on a UTXO model and secured by proof-of-work mining. Each design has advantages and tradeoffs: programmability and composability versus minimal, auditable rules and deep study by a large community. Which network suits a use case depends on whether you need on-chain programmability and composable tokens (Ethereum) or a focused, battle-tested ledger for value settlement (Bitcoin).