by Emma Newbery | May 15, 2021
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Bitcoin's younger sibling is giving it a run for its money.
Ethereum is a digital currency that claims to be "the world's programmable blockchain." It is more nimble than Bitcoin, and chances are you won't move far into the world of cryptocurrencies before you come across it.
But what does it do? And should you buy it? Read on to find out.
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Ethereum, the world's second-biggest cryptocurrency by market capitalization, is like Bitcoin's agile little sibling. It uses less energy and has faster transactions and more business applications.
Many digital currencies run on Ethereum's platform, which launched in 2015. A new, improved, version called "Eth 2" is being rolled out in stages. It will support more transactions per second, consume less energy, and have enhanced security.
One big difference between Ethereum and Bitcoin is that its blockchain ledger has smart contract capabilities. Smart contracts are self-executing pieces of code that allow an action to be performed when certain conditions are met.
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For example, a smart contract in a digital book might set out what royalties should be paid when the book is sold. Or it might mean an insurer automatically pays out in specific situations, without any need for the client to file a claim. Payments could also be set up to transfer automatically as goods move along stages in a supply chain.
Like every investment -- but especially crypto investments -- there are risks involved with buying Ethereum.
For one, its price is volatile. You might see dramatic gains, but you might also see heavy falls. Also, since cryptocurrencies are a new type of investment, it's difficult to judge which coins will perform well in the long term.
I put a small amount of money into crypto each month. But before I started, I first built up my emergency fund. I also made sure my new crypto investing didn't come at the cost of my retirement contributions.
These moves ensure I'm only investing money I can reasonably afford to lose. That way, if the price of cryptos collapses tomorrow, I can wait for it to rise again. And if it doesn't, I can stomach the losses.
Where you choose to invest should depend on your own priorities and strategy, but here are the reasons Ethereum could be interesting.
Ethereum underpins a lot of the exciting applications of blockchain technology. It's designed to be used to create new coins and run smart contracts. Plus, right now, you need to own Ethereum if you want to do other things -- such as trade on some platforms or buy NFTs. If the crypto world continues to grow, so should Ethereum.
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One concern I have about crypto is the environmental cost. To validate and confirm transactions, a number of cryptocurrencies use a proof-of-work (PoW) model, which uses a lot of energy.
Right now, Bitcoin uses about 130 terawatt hours (TWh) of energy each year, which is about the same amount of energy as countries like Ukraine or Argentina. Ethereum uses about a fifth of that amount, but it's still as much as a small country like Ecuador.
Eth 2 will move from the carbon-costly PoW model to the more energy-efficient proof-of-stake (PoS) model. I won't go into the technical details here, but estimates suggest the new mining model could cut its energy consumption by 99%.
Eth 2 will also be easier to scale and more secure, which is a bonus.
One way to earn interest on your crypto is through staking.
Staking involves tying up your coins for a set amount of time so that they can be used to mine more coins. One challenge is that there are limited staking windows. Once they are full, you have to wait for another window.
I don't have that problem with Ethereum. Right now, many top cryptocurrency exchanges will let you stake until the Eth 2 limits are reached. In doing so, you'll also be part of the Eth 2 development.
The downside? Your Ethereum will be tied up for an undefined amount of time, which could be as long as two years. Since I plan to hold my Ethereum long term, I'm comfortable with this -- especially as I'm earning about 8% interest on my staked coins.
We've already touched on the general risks of cryptocurrencies. There are also some Ethereum-specific risks to be aware of.
First, Ethereum is not the only cryptocurrency to offer smart contracts. Currently, several coins are operating in this market. They include:
And if these coins can do it better, there's a chance they could knock Ethereum off the top spot.
There's also the ever-present danger of hacking. Not only could the exchange or hot wallet where you store your currencies be hacked, but so could the Ethereum network itself.
That's why it's better to be safe than sorry. As with any investment, don't just take my advice -- or the advice of anyone on social media. Do your research and try to understand what the cryptocurrency you're interested in actually does, and what its long-term potential is.
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Emma Newbery owns Bitcoin, Neo, Cardano, and Ethereum. The Motley Fool owns shares of and recommends Bitcoin.
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