What is Ethereum? Bitcoin's smart sibling is 'the only game in town' for banks to build blockchains

"Every institution in the city I have spoken to is looking at Ethereum to build their blockchain apps for the next five to 10 years," declared Ethereum communications officer Ken Kappler. "It is basically the only game in town".

The much-vaunted, not-for-profit platform confirmed last Wednesday (22.07.15) that its full launch would happen "within days".

Ethereum comprises a platform on which developers can build out blockchain applications, plus a token of value – ether – to incentivise a peer-to-peer computation network, like Bitcoin does. Ethereum's blockchain protocol has the flexibility to facilitate smart contracts – something the bitcoin network does, but only in a limited way to honour bitcoin transactions.

Financial services are viewed as low-hanging fruit from the perspective of blockchain enhancement, because they do things like turn contractual agreements into securities which can be coded into smart contracts and easily balanced on blockchains.

Ethereum did not reveal which banks and financials are currently looking at its technology. IBTimes asked Kappler what these new verifying networks within banks would look like.

"If you were to have a private network involving say financial institutions what they would do is likely be more guarded about where they store databases," he said.

"The database would only be kept on centralised servers and access would be restricted, users in the banks would probably log in through some sort of basic internet server.

"In general it would look much like what we have today rather than anything like bitcoin. It wouldn't be open, it wouldn't be available to everyone. It would be very easy to audit and it would allow banks a way to deal with each other without having to pay for intermediaries.

"The point of the bitcoin consensus network and the computing power to run it is because you can't trust anyone else on the network. If it was bank's network they could define who was on the network, they could say they trust them and trust them," Kappler told IBTimes.

Smart Contracts

Smart contracts refer to defined services which are enacted by code on a censorship-proof ledger system. Smart contracts are expected to securely execute a wide range of services in the future including, financial exchanges, voting systems, crowdfunding platforms, self-enforcing contracts, intellectual property.

Questions about the extent to which smart contacts will operate over functions previously overseen by people or operate within legal contexts are the subject of some debate. This was evidenced by a large turnout at the Barclays-run East London escalator last week, where Ethereum was giving its presentation.

Richard Brown, executive architect for banking industry innovation, IBM UK, provided further definition of a smart contract.

He said: "The thing that occurs to me when we look at the only examples we have, which is smart contracts on the bitcoin network, is that you find yourself in a world where a computer program is controlling assets.

"Where as in every other walk of life, every other IT system, they can move assets around but they are always owned by a defined legal entity. If you look at smart contracts and bitcoin, it is entirely unclear who owns some of these assets at certain points in time."

Brown said in the case of issuing securities or automating derivatives on a system like Ethereum, an obvious question would be what standards would be in place.

‎"Oracle might do it one way, Microsoft another - someone might have a sort of derivatives platform that can take loans as collateral. What is the compatibility that says an Oracle one and a Microsoft one will be written to the same standard?

"There is a whole layer of standards and market level agreement that needs to be in place," said Brown.

Ethereum has developed an entirely new blockchain to address limitations inherent in the original architecture of the bitcoin blackchain. Kappler said there was no way to turn the bitcoin blockchain in to the type of platform needed to facilitate smart contracts.

"There is a problem with software like this, and there will be a problem with Ethereum in the future, which is that in order to grow you need to have a doctrine for all users to change up the software, to update the software as time goes by.

"Bitcoin has never had that facility, in part due to the fact that it was created by an anonymous person, and in part by the fact that consensus networking also tends to keep people conservative in their adoption of new technologies."

Not-for-profit

One of the fundamental decisions Ethereum made at the beginning was to be a not-for-profit organisation. The company crowdfunded the creation of the project and decided to have its funds managed by a foundation, rather than by the individuals being paid to build the platform.

"We didn't think, 'what's the best platform we could build for financial institutions', or 'which is the best platform we could build for Google', so we could sell ourselves to Google and make a lot of money."

Ethereum issues its own incentive, ether tokens, to anyone who joins the network and provides computing power. Based on Ethereum's crowdfund each token clocked an initial value of 10 cents. Ether tokens are not finite like bitcoin; the number will inflate at a certain rate each year.

Ether tokens

"The crowdsale and the initial allocation to the Ethereum Foundation came to something like 76 million ether, which is an irrelevant number really because it has no value yet," said Kappler

"Going on each year we expect to issue another 26 million through the mining and validating of blocks. We hope to move to proof of stake at some point, which may see the end of the increase in the inflation of the ether tokens as we move to just paying for transactions rather than also paying for blocks being validated."

Kappler added that Ethereum uses smart contracts to take a lot of the risk out of owning ether by defining a smart contract that holds the tokens, rather than a third party wallet service. This would typically include certain permissioning systems, such as a master-private key which could drain the account instantly, or a private key used for day to day use which can only remove say like $200 per day.

Ethereum by virtue of its not-for-profit status, says it will be able to take the time "holding the hands" of large and highly risk-averse organisations like banks.

Smart contracts enacted by code are predicted to be more transparent and easier to audit. But running business contarcts on decentralised virtual machines could turn out to be a very expensive clearing and settlement services. There are also privacy concerns for large corporates.

"Anything that happens on the blockchain has to be paid for because the network has to provide it, and the costs of this could be prohibitive for providing these services," said Kappler.

"The idea of the ethereum platform is that everything is transparent on the ledger. If that isn't satisfactory to banks then we may have a problem.

"They can obviously take our technology and fork it and use it to build their own systems.

"You have already seen companies like Eris that have forked ethereum, looking to consult and basically sell this technology to banks and build their own stacks," he said.

Beyond the world of finance Kappler hopes in the long term to see Ethereum become a fundamental layer of the internet: somewhere to go to facilitate a contract, and also something built into the backbones of your consumer-facing products.

He said people could basically create their own eBay with this level of functionality. Or it could be used to create a driver-run Uber, where the blockchain provides the system between drivers and users and doesn't take permission for that service.

He also mentioned a group he knows that is working on a door handle which can control the people who can open it via the blockchain. Instead of dealing with an Airbnb company, a user would be renting access to a door handle for 24 or 48 hours. Obviously you wouldn't want to have a central database with a list of people who could get into your door.

Kappler said there is scope for smart contracts on a blockchain, "anywhere where there is currently a database that should be a public good but isn't".