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School / Crypto-asset Fundamentals

Lesson 3 of 6 · 7 min

Ethereum, Smart Contracts and Tokens

Lesson goalAfter this lesson you know what a smart contract is, how a token differs from a coin and why you usually need the network’s coin as well to send tokens.

Bitcoin was designed primarily as digital money. Ethereum, launched in 2015 based on an idea by Vitalik Buterin, goes a step further: the network doesn’t just remember account balances but can also run programs. The network’s native coin is ether (ETH). Since September 2022 Ethereum has run on proof of stake, so blocks are proposed by validators, not miners.

The smart contract

A smart contract is a program published on a blockchain. It runs exactly as written, with no official approving each step. The name is misleading, because it is not a contract in the legal sense and it is not “smart”. It executes the given code, including its bugs.

Decentralised exchanges, loans and many other services are built on this. History also shows the risk. In 2016 an attacker exploited a weakness in the code of a project called The DAO and drained a significant part of its funds. The community split over whether history should be changed, and that split gave rise to Ethereum and Ethereum Classic.

A coin and a token are not the same

  • A coin is the native asset of its own network, like BTC on Bitcoin or ETH on Ethereum. It is usually what fees are paid in.
  • A token is a record kept by a smart contract on an existing network. On Ethereum the usual standards are ERC-20 for fungible tokens and ERC-721 for unique ones (NFTs).
  • The same ticker can exist on several networks. A stablecoin issued on two networks is technically two different tokens, so the network matters as much as the address when you send.

Ethereum is not the only network with smart contracts. There are other standalone networks and so-called layer 2 networks, which process transactions more cheaply and rely on Ethereum for final security. Each has its own trade-offs between cost, speed and decentralisation, so none is automatically better.

Remember

  • Ethereum runs programs, not just transfers of value.
  • A smart contract does exactly what is written, including the bugs.
  • A coin is the network’s native asset, and a token is a record kept by a contract on that network.
  • Sending tokens usually requires the network’s coin as well, to pay the fee.
  • A token’s existence and a well-known name prove neither value nor any connection to a company.

Test your knowledge

To pass, you need to answer at least two thirds of the questions correctly. You can try as many times as you like.

1. You have 500 tokens on Ethereum in your wallet but 0 ETH, and sending fails. What is the most likely cause?
2. A smart contract sent funds to the wrong party because of a bug in the code, although the author clearly meant otherwise. What is closest to reality?
3. On a decentralised exchange you see a token with the name and logo of a well-known bank. What is the most sensible conclusion?