To understand how Ethereum functions, you need to understand these three concepts: Ether, Ethereum Gas, ERC20. Collectively they help power, incentivise and allow others to build their own tokens on top of Ethereum’s blockchain.

Ether

Ether can be thought of as digital oil for Ethereum. To power your car, you need to buy petrol. To power your transactions on Ethereum, you need to buy Ether.

On Ethereum, that Ether is an amount of computer power required in order to make your transaction work.

To go back to the car analogy, it’s how much petrol is required to make the engine work and power the car to the destination you’re looking to get to.

With Bitcoin, there can only ever be 21 million bitcoins. In Ethereum’s case, there is no limit to how much Ether can exist. In other words, there’s no limit to how much petrol can be produced.

In order to calculate how much Ether is needed to make a transaction work, the people behind Ethereum created Gas.

Gas

Gas is the cost the network charges in order to process your transaction.

In the car analogy, it’s how much a petrol station will charge you to fill your car with petrol - normally a part of the cost per gallon or litre.

If you want to send Ether, interact with a smart contract or anything else that needs to be recorded on the blockchain, you have to pay for it.

That payment is calculated in Gas, and is paid in Ether.

In Bitcoin Mining, we learned that miners charge transaction fees to process people’s transactions. It’s similar here. An incentive is created to encourage an Ethereum miner to process your transaction quickly.

That Gas price rises and falls, depending on how busy the Ethereum network is, i.e. how many transactions are needing to be verified.

ERC20

As Ethereum’s popularity grew, and lots of people started creating their own Smart Contracts, a problem arose: how do you get these different contracts to interact with each other?

As everyone came up with their own rules about their smart contracts, you needed to be a genius to work out how to make two different contracts, with two different sets of rules work together.

The answer was ERC20. This is a standard, or set of rules that make it easier for contracts to interact.

This has lead to developers being able to create their own currencies, built on top of the Ethereum network. These are called ERC20 Tokens.

Read more about Ethereum's currencies within currencies.

The future

Ethereum’s clever use of Ether, Gas and ERC20 has lead to an explosion in popularity among developers building things on Ethereum’s network.

As a result, a number of bugs and features have arisen. We’ll explore these in more advanced posts.