Crypto · Beginner · 4 min

Ethereum and smart contracts

You can explain how Ethereum differs from Bitcoin, what smart contracts do, and which risks come with code that runs on its own.

Money that runs code

Bitcoin was built to move money. Ethereum, launched in 2015, was built to do more: to run programs on a blockchain, so that agreements could execute themselves without a company in the middle.

That idea created most of what people now call crypto beyond bitcoin: tokens, stablecoins, trading apps without operators, and many projects that no longer exist. This lesson explains how Ethereum works and where its particular risks lie.

Smart contracts, gas, stake

Smart contracts. A smart contract is a program stored on the blockchain that runs automatically when certain conditions are met. Ethereum describes smart contracts as its core functionality. They can:

create and manage tokens,
run exchanges where trades are matched by code instead of a company,
hold deposits and grant loans according to fixed rules.

Once deployed, a contract runs exactly as written. Nobody can stop it from making a mistake that is in its code.

Gas. Every operation on Ethereum costs a gas fee, paid in its native coin, ether. Fees compensate those who process transactions and rise when the network is busy.

Proof of stake. In September 2022, Ethereum switched from proof of work to proof of stake in an upgrade called the Merge. Validators now lock up ether to secure the network instead of competing with computing power. According to ethereum.org, this cut Ethereum's energy use by about 99.95%. It did not make the network faster or fees cheaper.

The programmable design has costs. More code means more ways to make mistakes. Bugs in smart contracts have been exploited many times, and because confirmed transactions are hard to reverse, losses usually stand. Code audits reduce risk but do not remove it.

Code is law, bugs too

A fictional lending app on Ethereum holds 40 million in deposits in a smart contract. Its code has passed an audit.

An attacker finds a flaw in how the contract calculates collateral.
Within minutes, the attacker borrows far more than the collateral allows and withdraws the funds.
The contract did exactly what its code said. There is no bank to call and no central party to reverse the transactions.

Some projects try to recover funds by negotiating with attackers. Often, the money is simply gone.

Common mistakes

"Smart contract means safe contract." Code can contain costly errors.
"Audited means safe." Audits find many bugs, not all of them.
Ignoring gas fees. Small transactions can cost more in fees than they are worth.
Treating ether like a share in Ethereum. It is a coin, with no claim on any company.

The takeaway

Ethereum is a blockchain that runs programs called smart contracts. They power tokens and apps, and their bugs can be costly.

Check yourself

Quick quiz

4 questions. Instant feedback, nothing is saved.

1Tap the blockchain built to run general programs.

Tap the chart.

Ethereum lists smart contracts as its core functionality: programs that run on the blockchain.
2What happened to Ethereum's energy use after the Merge in September 2022?

The switch from proof of work to proof of stake removed the energy-hungry mining.
3What is a gas fee on Ethereum?

Every operation costs gas, paid in ether. Fees rise when the network is busy.
4A smart contract has a bug that lets attackers withdraw funds. What usually happens?

Code runs exactly as written. If it is wrong, the loss usually stands.

of 4 correct.