Ethereum

In short

I once watched a neighbor spend an entire Saturday trying to understand something his nephew called a world computer, and by supper he was more confused than when he started. If you are holding any Ethereum, or thinking about it, you can skip that kind of Saturday. Ethereum is a public network that runs shared programs, and its coin, called ether, pays for the work. You use ether to cover fees every time you send money or use an app on the network. The fee changes with how busy the network is, so look at the live number before you act. A wallet's recovery phrase is the secret list of words that unlocks it, and nobody can reset it for you. Selling or spending ether is a tax event, so keep a record of what you paid and when.

The whole of it

What it is

A friend of mine runs a small hardware store, and he keeps his books in a ledger that sits on one shelf in one office. If that ledger burned, the records would be gone. Ethereum works the opposite way. It is a ledger kept by thousands of computers at once, each holding the same copy, and no single company owns it.

You have probably heard that Bitcoin is digital money. Ethereum began with a bigger idea. Its inventors wanted a ledger that could also run small programs, which they call smart contracts. A smart contract is a bit of code that lives on the network and does just what it was written to do, such as holding funds until two people both agree to release them. Nobody has to trust a middleman, because the code carries out the terms in the open.

The coin of the network is ether. People often call the whole thing Ethereum and the coin ETH, and either way folks know what you mean. Ether does two jobs. It is a unit of value you can send to anyone, and it is the fuel that pays for work on the network.

Ethereum is not a company, and it has no customer service line. That cuts both ways. Nobody can freeze your wallet, and nobody can fix your mistake either.

How it works

I once watched a county clerk stamp and file deeds all afternoon, one after another, each checked before it went in the book. Ethereum does something much like that, only with computers instead of clerks. When you send ether or use an app, your request goes into a waiting pool. Special computers called validators pick up those requests, check that they are honest, and bundle them into a block. Each new block links to the one before it, which is where the word blockchain comes from.

Validators are not paid by anyone's good will. To become one, a person locks up a large amount of ether as a promise to behave. This is called staking. If a validator cheats, part of that locked ether can be taken away. If the validator does the job well, the network pays a reward. This method is called proof of stake, and the Ethereum community moved the network to it in 2022. You can confirm that history on the Ethereum Foundation's website, ethereum.org.

Every request costs a fee, sometimes called gas. Think of it as postage. A simple transfer needs little work, so it costs less. A complicated app request needs more work, so it costs more. When many people want space in the next block, they bid against each other and fees climb. When the network is quiet, fees fall. Part of every fee is permanently destroyed, or burned, which removes that ether from supply.

Your wallet holds the keys. A key is a long secret code that proves the funds are yours. Lose it and the funds are gone. Share it and someone else can take them. Plain facts.

The numbers, and where to find yours

You have probably noticed that crypto prices move around a great deal. So I will not hand you a price, because it would be stale before you finished reading. What I can do is point you to the places where the real figures live.

For fees, you can check a live gas tracker, and your wallet will also show an estimate before you confirm any send. Look at that estimate every time. For your own holdings, your wallet or exchange shows your balance and the history of what you bought, sold, or sent.

For taxes, the Internal Revenue Service treats digital assets as property. Its page on digital assets explains how a sale or a trade is reported, and Form 8949 and Schedule D are where those transactions are listed. The front of Form 1040 also asks a question about digital assets, and the form's instructions explain how to answer it for the year you are filing. How a gain is taxed depends on how long you held the asset and on your income, and the rate tables are in the IRS instructions for that year. The holding period that separates short term from long term is the current figure, which the official source publishes each year, and the top long term rate is the current figure, which the official source publishes each year. Check those against the IRS page for the year you are filing.

A worked example

A woman I will call Dana is a nurse who bought some ether a while back. She paid 1,500 dollars for 1 ether, and she paid a 15 dollar fee on the purchase. Her cost basis, which is what she paid including fees, is 1,500 plus 15, or 1,515 dollars.

Months later, Dana wants to use that 1 ether to cover a repair bill, so she sells it for 2,100 dollars. The network and exchange take a 10 dollar fee on the sale. Her proceeds after that fee are 2,100 minus 10, or 2,090 dollars.

Her gain is the proceeds minus the basis. That is 2,090 minus 1,515, which equals 575 dollars. Whether that 575 dollars counts as short term or long term depends on how long she held the ether. The holding period that draws the line is the current figure, which the official source publishes each year. A gain on ether held for less than that period is short term, and the IRS tax tables apply the same rates to it that they apply to wages. A gain on ether held for longer than that period is long term, and it has its own rate table.

Say Dana is in a 22 percent bracket and her gain is short term. Her tax would be 575 times 0.22, which is 126.50 dollars. If the gain were long term at a 15 percent rate, the tax would be 575 times 0.15, which is 86.25 dollars. The difference is 126.50 minus 86.25, or 40.25 dollars. Those two rates are examples only, and her real rate would come from the IRS tables for her year and income.

Here is what Dana's story shows. She kept a record of her price and her fees, so she could show every number. That record is what saves a person from guessing at tax time.

Where it goes wrong

A neighbor of mine once typed a wallet address by hand and got one character wrong. The money went to an address nobody owned, and no phone call on earth could bring it back. Sends on Ethereum cannot be undone, so copy addresses carefully and send a small test amount first.

You have probably gotten a message that looked friendly and asked you to connect your wallet or share your phrase. Treat that as a trap. No real support person will ever ask for your recovery phrase. Scams are common in this corner of the world because the money moves fast and cannot be pulled back.

Smart contracts can also have bugs. Code is only as good as the person who wrote it, and a flaw can drain funds from an app. Using a new app means trusting its code, so go slowly with money you cannot spare.

Fees can surprise you, too. A small send on a busy day may cost more than you expected. Watch the estimate and wait if the number looks high.

Taxes catch many folks off guard. Trading one coin for another, spending ether, and selling it can each count as a taxable event. Keep records from the first day.

Price swings are real, and nobody can promise what ether will be worth next month. This guide explains how the thing works and what it costs. It does not tell you to buy, sell, or hold.

Questions to answer before you leave this page

Do you know where your recovery phrase is written down, and could a stranger find it? If you sent ether today, do you know what the fee would be right now, and have you checked the estimate in your wallet? Have you kept a record of what you paid, including fees, for every purchase you made? Do you know which of your holdings would be taxed as short term and which as long term if you sold them tomorrow? Have you read the IRS page on digital assets for the year you will be filing? And if an app asked to connect to your wallet, would you know how to tell a careful request from a trap?