How Ethereum Works – in Detail

One key technology underpinning Ethereum is a smart contract.  

A smart contract is a software program that automatically executes when certain conditions are met. Instead of relying on a middleman such as a company, or bank, Ethereum allows rules to be written into the code and then it is carried out by the network. This allows the applications built on Ethereum to operate without traditional middlemen, and they can act as the sole intermediary, executing transactions automatically based on pre-set rules.  

Decentralized applications, often called dApps, are built on top of smart contracts. 

These applications can look like those on your phone, but they operate behind the scenes differently. In a traditional app, one company usually has control over the software and data and sets up rules for how activity takes place on that app. On the Ethereum network, instead of relying on a central company, the blockchain controls the transactions, ownership records, and some of the application rules.  

This difference is important because it changes the relationship between users and developers interacting with the traditional app space. Because of the open software offered by Ethereum, developers can build applications that connect to shared assets across multiple platforms on the blockchain.  

Think of it as if any app on your phone could freely connect to any other app without needing permission. For example, a ridesharing app could automatically pull funds from a payment app, record it in a budgeting app, and then apply rewards from a credit card account—all in a single action.  

This edge has promoted the growth of digital assets. Just as smart contracts allow applications to operate on Ethereum, they can also provide the rules and infrastructure that allow digital assets to be created and transferred on the network. 

Similar to how assets in the physical world can come in different shapes and sizes, digital assets follow that same structure. Stablecoins, NFTs, tokenized memberships, and other blockchain based assets can all coexist and interact with one another on the Ethereum blockchain.  

Layer 2 

Because every transaction has to be processed and verified by the network, a surge in users can congest the queue, leading to longer wait times and higher fees for those trying to get their transaction through quickly. 

To tackle that, developers built additional networks on top of Ethereum, which are often referred to as Layer 2 (L2) networks. L2s have their own applications and communities but use Ethereum as its foundation. This relationship is key because it has allowed the broader Ethereum ecosystem to grow. Today, L2’s are popular amongst general users who may prefer to use them for speed and cost compared to the main Ethereum network, at the cost of some decentralization.