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As we explored in “What is Ethereum?”, ethereum aims to function both as a kind of decentralized internet and a decentralized app store, supporting a new type of application (a “dapp”) in the process.
But while no one owns ethereum, the system that supports this functionality isn’t free. Rather, the network needs ‘ether’, a unique piece of code that can be used to pay for the computational resources needed to run an application or program.
Like bitcoin, ether is a digital bearer asset (similar to a security, like a bond, issued in physical form). Just like cash, it doesn’t require a third party to process or approve a transaction.
But instead of operating as a digital currency or payment, ether seeks to provide “fuel” for the decentralized apps on the network.
While this might sound complicated, you can think of a more concrete example of how tokens might power a user experience.
Let’s go back to the example of a decentralized online notebook. To post, delete or modify a note, you need to pay a transaction fee in ether to get the network to process the change.
In this way, ‘ether’ has sometimes been called ‘digital oil’, and taking this analogy further, ethereum transaction fees are calculated based on how much ‘gas’ the action requires.
Each action costs an amount of gas that’s based on the computational power required and how long it takes to run. A transaction costs 500 gas, for example, which is paid in ether.
As an economic system, the rules for ether’s economy are a bit open-ended. While bitcoin has a hard cap of 21 million bitcoins, ether does not have a similar limit.
Of the ether that does exist, 60m was purchased by users in a 2014 crowdfunding campaign.
Another 12m ether went to the Ethereum Foundation, a group of researchers and developers working on the underlying technology. Every 12 seconds, 5 ethers (ETH) are also allotted to the miners that verify transactions on the network.
Eighteen million ether, at most, are mined per year. Five ether are created roughly every 12 seconds, whenever a miner discovers a block, or a bundle of transactions.
So, no one knows the total number of ether yet, and the pace of ether creation will be less clear after 2017 when ethereum plans to move to a new proof-of-stake consensus algorithm.
This will probably lead to a change in the rules of ether creation, and thus the mining subsidy might decrease.
For more information, see “How Ethereum Works” and “How to Use Ethereum”.