What Is Ethereum, and Should You Invest In It?

by Samuel Taube, Managing Editor, Investment U
what is ethereum 0

Our economy could not exist without rules.

A simple debit card transaction would be impossible without the existence of complex contracts, financial institutions and accounting techniques.

But these essential protocols are only as trustworthy as the humans who maintain them. And as we all know, humans aren’t perfect.

Accountants at Enron and WorldCom created billions of dollars in imaginary shareholder value. More recently, Wells Fargo’s account executives opened millions of bogus accounts without the consent of their clients.

Today, a new and fast-growing cryptocurrency project is looking to eliminate the destructive effects of “bad apples” like these. It’s called Ethereum, and it makes its predecessor, bitcoin, look downright primitive by comparison.

What Is Ethereum?

When you saw the word “cryptocurrency” in the last paragraph, your mind probably went straight to bitcoin - the stateless, bankless currency we’ve written about before.

On a surface level, Ether (the digital currency of the Ethereum project) bears some similarities to bitcoin. Both are digital payment tokens that exist in a decentralized, public and tamperproof ledger called a blockchain. As a result, both are outside the control of any government or financial institution.

Rather than being issued by a central bank, these tokens have value that is backed by the blockchain itself, which contains records of every transaction. Since these records are stored redundantly on thousands of computers around the world, it’s impossible to manipulate them through accounting shenanigans...

what is ethereum 1

However, there are significant differences between bitcoin and Ethereum. Bitcoin is basically the cyberspace equivalent of gold bullion. It’s just a store of value. It has no steady inflation rate and no mechanism for automatic or contractual payments.

Ethereum, on the other hand, is much more sophisticated. It’s not just a digital currency; it’s also a programming language that allows users to set up self-executing payments called “smart contracts.”

This is the truly revolutionary thing about Ethereum. Smart contracts eliminate the need for lawyers, accountants or financial intermediaries. They’re voluntary agreements that are coded into the blockchain, making them public and tamperproof.

For example, the process of leasing an apartment could be automated - sans lawyers or banks - with a smart contract. The tenant and the landlord could write code together that automatically transfers the monthly rent (in Ether) from the tenant to the landlord. If the tenant had an insufficient balance of Ether, then the code could automatically forfeit the security deposit to the landlord.

It’s easy to imagine that investment contracts - like options and futures - could be automated through Ethereum smart contracts as well. This could substantially bring down transaction costs by eliminating the need for expensive lawyers and underwriters in this process...

what is ethereum 2

In short, Ethereum technology could pave the way for cheaper, more private and more democratized financial systems. And major financial institutions, from JPMorgan Chase to the Luxembourg Stock Exchange, have started to develop Ethereum-based applications.

Should You Buy Ether?

Ethereum technology is definitely worth keeping an eye on. But it’s not quite time to pour your money into it yet.

When Chief Investment Strategist Alexander Green wrote about bitcoin back in 2015, he expressed a similar position...

I still don’t recommend it, just as I wouldn’t have recommended that you take a ride in the Wright Brothers’ first plane.

But even Wall Street bankers and Federal Reserve officials concede that this new technology will ultimately make the financial system more private, more secure and more efficient.

Cryptocurrencies with smart-contract functionality could be as big of a technological advance as the invention of the airplane. But in that metaphor, Ethereum is indeed one of those flimsy propeller planes from Kitty Hawk.

As a proof of concept, it’s truly earth-shattering. But it will need a little more development time before it’s safe to use.

Cybersecurity remains a problem with Ethereum technology. Since smart contracts are written to the blockchain for everyone to see, they’re appealing targets for hackers and fraudsters.

Investors in an Ethereum-based corporation called The DAO (decentralized autonomous organization) learned this the hard way last year.

The DAO was set up as a sort of leaderless venture capital fund. Rather than having bylaws and a board of directors, its inner workings were governed entirely by prewritten smart contracts.

Unfortunately, those smart contracts contained some security loopholes. These vulnerabilities allowed hackers to drain some $50 million in Ether from its coffers.

Ethereum technology isn’t entirely foolproof - or hackerproof - just yet. So it might be a little too early to bet your savings on this revolutionary new cryptocurrency.

But this fast-growing cryptocurrency platform is getting more sophisticated every day. It may not be long before many of our bank accounts, mortgages and investments are “in the Ether.”

Thoughts on this article? Leave a comment below.

P.S. Cryptocurrencies are disrupting every part of our financial system - and every investor should be paying attention to them.

That’s why our colleagues at Early Investing have created a balanced cryptocurrency portfolio to help you invest in this technological revolution. Click here to learn more.