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Exploring Ethereum: What are Smart Contracts?

August 5, 2021

In 2020, the total number of digital payments surpassed 700 billion, representing 14% growth over the previous year.

Cryptocurrency is taking the financial world by storm, with Bitcoin and Ethereum remaining the most popular options for investors. But, there’s more to Ethereum than you might think.

In this article, we dive into the world of Ethereum and explain what smart contracts are to help you and your firm prepare for a (possible) wave of decentralised digital assets.

What Is Ethereum?

When talking about cryptocurrency, Bitcoin and Ethereum are the main two that come to mind, with Ethereum’s native Ether (ETH) being the second-largest cryptocurrency after Bitcoin. 

However, Ethereum isn’t just a cryptocurrency, and it’s not actually in direct competition with Bitcoin. Ethereum was born from the functionality limitations of Bitcoin, with its founder, Vitalik Buterin, comparing Bitcoin to a pocket calculator that does “one thing well”.

Computers all over the world host Ethereum’s blockchain, and each computer has a copy of the blockchain. There needs to be widespread agreement before any changes can be implemented to the network, much like Bitcoin’s blockchain. 

However, the Ethereum network is more sophisticated than Bitcoin in that it allows developers to build decentralised applications (“dapps”) through groups of smart contracts, which will be stored on the blockchain. 

ETH tokens power the Ethereum blockchain network, enabling users to make transactions, earn interest on their holdings, use and store non-fungible tokens, trade cryptocurrencies, play games, use social media… The list goes on and on.

Smart Contracts

The Ethereum network hosts smart contracts, which are collections of code that carry out a set of instructions and run on the Ethereum blockchain. They’re called contracts because the code running on Ethereum can control valuable digital assets, like Ether tokens.

The concept of a smart contract isn’t new. It was first proposed in the early 1990s by Nick Szabo, who coined the term. However, smart contracts have grown in popularity in recent years and are now transforming the way businesses work to drive efficiencies.

Smart contracts work like digital “if-then” statements between two or more parties. A network of computers executes the actions, for example, releasing funds to the appropriate parties, when certain conditions are met and verified. 

The Ethereum blockchain is updated when the transaction is completed, which means the transaction can’t be changed, and only parties who have been granted permission can see the results.

The Benefits of Smart Contracts

Smart contracts are secure because they’re self-executing, and all transactions are traceable, transparent and irreversible. Other benefits include:

 

  • Efficiency and accuracy: When a condition is met, the contract is executed straight away. There’s no paperwork involved — smart contracts are digital and automated to save time and eliminate human error.
  • Transparency: Replacing the “middle man” with encrypted transaction records distributed across various users means there’s no doubt about whether information has been altered. Everything is transparent and traceable.
  • Security: Blockchain transaction records are encrypted, making them hard to hack. With distributed ledger technology, each transaction is connected to the previous transaction recorded. Hackers would need to alter the entire chain to alter a single record.

Investing in Ethereum

Investing in Ethereum is easy. Like Bitcoin, you simply buy a token (Ether) through a crypto exchange and hold it with the hope it will increase in value over time.

Why invest in Ethereum?

  1. Ethereum 2.0 could give Ethereum a competitive edge over cryptocurrencies. Ethereum 2.0 promises to reduce the energy consumption of the blockchain — one of the main criticisms of this technology at the moment.
  2. Ethereum is more diverse in terms of functionality compared to cryptocurrencies like Bitcoin. Ethereum is not only host to the Ether token, but it also acts as the foundation for other applications like decentralised finance.

However, cryptocurrency markets are extremely volatile, even more so than the traditional stock market. For example, throughout 2018, Ethereum’s price dropped dramatically by nearly 94%.

Investing in cryptocurrency is highly speculative. Therefore, there’s no guarantee that Ethereum will prove successful in the long term. While it has the potential for huge gains, it’s incredibly risky.

How cryptocurrency is affecting the accounting industry

As of January 2021, there are over 6,000 cryptocurrencies in existence. They’re becoming more prevalent, making it the perfect opportunity for CPAs to leverage this new trend to provide more sophisticated services for their more tech-savvy clients.

CPAs need to stay ahead of the curve. It’s not outrageous to believe that crypto could revolutionise the way we use currency. For example, in the not-so-distant future, employers may even consider paying their staff in cryptocurrency, and it may be possible to shop using crypto. Accountants need to fully understand the tax implications behind crypto and communicate these clearly to clients.

As you probably know, the crypto market is anything but stable. CPAs, therefore, need to be well-versed in this technology to be prepared to guide clients through dips in the market and ensure they’re making wise investment decisions. This could be an invaluable resource for businesses in years to come.

Whether cryptocurrencies like Ether fade into irrelevance or remain a fixture in modern society, accountants need to be prepared.

Prepare for the Future with INAA

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