Ethereum is the second largest cryptocurrency by market capitalization rate, and as such it is often the second-highest search for blockchain-based project lawyers after Bitcoin.
The Ethereum project is often an exciting revelation of blockchain technology applications, especially after getting to grips with the basics of what Bitcoin has to offer.
To sum things up, Bitcoin was created as a decentralized peer-to-peer cryptocurrency. It uses a global distributed ledger called blockchain to ensure transactions are accurately verified and the network is maintained.
Now, Ethereum is similar in that it uses blockchain, but it differs in that it does so much more than just be a way to send someone money. Of course, you can send someone the ether (ETH) equivalent of $1,000 (approximately 0.35 ETH at the time of writing) the same way you can send someone $1,000 of BTC, but you would be overlooking the biggest feature of Ethereum.
Think of Ethereum as a smartphone with an app store, where any developer can launch an app, as long as it meets the standards set by the Ethereum community.
Ethereum essentially created a blockchain that anyone can build on; rather than building their own blockchain, independent developers can simply rely on the Ethereum network. This platform, called Ethereum Virtual Machine (EVM), has been used to launch more than 10,000 decentralized applications (dApps).
To give you a better idea of what Ethereum is in fact used for:
The OpenSea NFT Marketplace, a startup recently valued at $1.5 billionis largely built on Ethereum (although it does support other chains, but more on that later.)
Tie, a stablecoin pegged to $1, is built on Ethereum; it is the largest of its kind, with a market capitalization (USDT) of nearly $70 billion.
Uniswapa protocol designed for decentralized peer-to-peer token exchange and a key facet of the decentralized finance (DeFi) universe, is built on Ethereum.
Axie Infinity, a blockchain-based game in which fierce little cartoon creatures battle it out, is built on Ethereum. Its token, AXS, has a market cap of over $4.3 billion.
So, aside from developer, financial, and consumer applications, Ethereum has one feature that deserves any lawyer’s attention: smart contracts.
Ethereum: Quick Facts
The Ethereum blockchain is a public, permissionless blockchain with many of the same technological components found in Bitcoin: cryptographic hash function, decentralized P2P network, private and public key encryption, and Proof-of-Work consensus algorithm.
Ethereum’s native coin, Ether, has the second highest market capitalization and is one of the fastest growing digital assets to date. Projects launched on Ethereum use their own native token (to be distinguished from the term “coin”, as coins have their own blockchains).
Ethereum allows users to specify how much computing power to devote to a transaction – a measure of processing power called “Gas”. If a transaction can be completed within a specified limit, it will be executed – otherwise, the changes are rolled back. Simple payments are quite low computational processes and require less gas, while more complicated operations like minting an NT (or deploying a smart contract) require more gas.
Gas fees have been quite a controversial topic in the cryptocurrency community. Since thousands of decentralized applications use the Ethereum blockchain, the network can get congested at peak times and gas fees can increase astronomically.
For example, on a quiet day in 2021, gas fees might cost around $5 to send someone ether or around $40 to buy an NFT on OpenSea. However, during peak times, it’s normal to see gas charges of $80 to $200 to send a payment, or even thousands to buy an NFT!
Ethereum has several network upgrades in motion that emphasize the scalability of the project. However, that hasn’t stopped competing networks like Binance Smart Chain to simply copy the idea of Ethereum and make adjustments to prioritize cheaper transactions.
Enter the smart contract
Smart contracts are pre-programmed contracts that allow specific legal functions to be performed once certain criteria are met. For example, a smart contract could specify that a set amount of cryptocurrency tokens will be automatically transferred or sold if a required condition is met.
Smart contracts on Ethereum use Ethereum’s proprietary language called Solidity. The Ethereum Developer’s Handbook defines smart contracts as “a type of Ethereum Account. This means that they have a balance and can send transactions over the network. However, they are not controlled by a user; they are deployed to the network and run as scheduled. Smart contracts can define rules, like a regular contract, and automatically apply them via code. Smart contracts cannot be deleted by default, and interactions with them are irreversible.
(starting the blockchain OpenLaw focuses on simplifying smart contracts for a mainstream audience)
In practice, the decentralized lending industry uses smart contracts to transparently collateralize and issue loans. Platforms like BlockFi and Celsius lend cryptocurrency to people who request it and have collateral for them – one can get a $100,000 loan at 1% interest rate by placing around 9.6 BTC as collateral (around 400 $000). Those cryptocurrency interest accounts also pay users for holding their cryptocurrency on the platform. Businesses make money on the difference in borrowing and lending rates, like a traditional bank.
However, many of these loans are based on smart contracts. Does the person have the guarantee? If so, grant the loan. Is the person paying their interest payments? Has the person returned their principal and paid their interest? Any questions that would otherwise require the approval of a human or multiple humans can be handled by the smart contract, which runs automatically.
Ethereum even allows complete removal of the centralized entity (BlockFi or Celsius, in this case). DeFi ecosystems like SushiSwap allow users to lend and borrow from each other without ever knowing who the other party is, without any human being involved in the transaction.
Another great example of smart contracts is the mechanism behind prediction markets.
Ethereum-based prediction market platforms allow people to create custom smart contracts based on the potential future outcome of an event. For example, we could create a smart contract to allow people to bet on the winner of the 2029 NBA Finals.
People would send Ether (or the token of that prediction market) to a wallet described in the contract. Once the 2029 Finals were completed and the winner determined (subject to confirmation by a specific oracle in the contract), the winning parties would receive their tokens and winnings in the wallet address they specified when concluding the contract.
How to build an Ethereum dApp?
Decentralized applications built on Ethereum must meet the token standard they aim to qualify for.
For example, most tokens on Ethereum are ERC-20, a standard for fungible tokens (each token is exactly the same as the others). 1 Basic Attention Token (BAT) will always equal 1 BAT.
Ethereum also specifies ERC-721 tokens, which are Non-fungible tokens (the NFTs you’ve probably heard so much about). NFTs are unique objects that are unlike others, such as a song, picture, or deed for a house.
Generally, dApps must meet the following criteria:
- The code must be entirely open source;
- The token and the project must operate independently;
- The application must use a cryptocurrency token;
- No single entity can control the majority of cryptocurrency tokens (it cannot be a centralized project);
- Future changes to the application should be determined by user consensus;
- The data stored by the project must be stored in a decentralized blockchain, not in a central database, and must meet cryptographic standards;
- The token must use a standard cryptographic algorithm, such as Proof-of-Work (POW), to generate new cryptocurrency tokens.
Final Thoughts: Why Ethereum Matters to Lawyers
Blockchain, especially in the form that Ethereum-focused developers apply it, is poised to revolutionize a wide variety of industries, and law is at the forefront.
Legal services like Rocket Lawyer and Legal Zoom are already experimenting with blockchain smart contracts. rocket avocado Rocket Wallet product, for example, advertises itself as “legal contract execution and payment on the Ethereum blockchain” and has partnerships with ConsenSys (a Brooklyn-based Ethereum investment company and project incubator) and OpenLaw (a startup working on smart contracts for a mainstream audience.)
However, Ethereum is not the ultimate solution for blockchain and law. Several Ethereum competitors are behind the scenes, each attempting to offer a unique value proposition to entice innovators and developers to build on their platforms. In addition to Ethereum, projects like gimbal, Peasand Solano are all projects with substantial implications for the legal sector.
If you want to learn more about the Ethereum project, we strongly recommend that you read the Ethereum developer documentation and immersing yourself in the ecosystem – even just developing a little literacy on the subject will likely help you for years to come.