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How Ethereum Makes Money

This is part three of a four part post highlighting golden nuggets from "Own The Internet - A Bull Case For Ethereum" on authored by Packy McCormick via Paraphrase, commentary, embellishments and musings by Boston C!)

"I’ve been aware of Ethereum for a long time. I first bought (then sold) ETH in 2017, but it was speculative and I didn’t get it. The big question mark I had with Ethereum was how it made money. How does more activity on top of Ethereum translate into a higher price for ETH?

"In the near future, the answer will be that more transactions mean higher yields for ETH holders and a decreasing supply of ETH. But that’s not how it works, yet."

"Let’s start with how it works today, look at the challenges of the current model, the proposed solutions, and what it will look like in the future."

"Today, when you want to transact on Ethereum, you need to use ETH. There are currently around 116 million ETH, and the price is loosely governed by supply and demand. More transactions on Ethereum means more demand for ETH which means higher price, all else equal."

"When you transact, say if you send another person ETH, a few things happen:
  • You send 1 ETH and the other person receives 1 ETH
  • You pay gas fees, say .01 ETH
  • Your account balance on the chain goes down by 1.01 ETH, theirs goes up by 1 ETH"

"To keep Ethereum running, it uses a Proof of Work consensus mechanism to trustlessly agree on the state of the blockchain. Bitcoin also uses Proof of Work, that’s where Ethereum got it from, although Bitcoin mining is able to be run on cheaper hardware and has 20x more miners than Ethereum, and is therefore more decentralized.

PoW achieves the same thing as your bank account balance going up and someone else’s going down when they send you money, except in the place of a centralized bank, there is a distributed network of miners who agree that these transactions occurred and that all balances are updated.

To do it, miners around the world race to solve increasingly difficult cryptographic problems in order to create a new block on the blockchain containing the new transactions. These problems are typically hard to solve -- read: require a lot of energy -- but easy to verify. When a block is entered into the blockchain, the transactions in it officially become part of the record. Miners who successfully create a block are rewarded with 2 freshly-minted ETH (down from 5 in the beginning) and all the transaction fees within the block.

Those transaction fees, called gas, are what people pay to submit transactions to be included in the block. When a user sends someone ETH on Ethereum, or mints an NFT, or does any number of things that need to be validated on-chain, they have to pay a gas fee. That gas fee goes towards incentivizing miners to spend the money required, in the form of hardware and electricity, to solve the puzzle and create the block.

So currently, the price of Ethereum is based on a combination of supply and demand, and the price it costs miners to secure the blockchain. To participate, you need ETH, and you need to pay the gas. Miners receive ETH in the form of newly-minted supply and your fees. Miners pay for hardware and electricity and taxes, and keep ~5% of their earnings. Today, most of the value accrues to GPU makers, electric utilities, and the government, with the miner’s portion competed down to close to 0."

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