How Ethereum Works: State, Transactions, Gas, and Smart Contracts Explained

Ethereum is more than a network for sending ETH

Ethereum is a programmable Layer 1 blockchain, meaning it is a global computer where state, transactions, consensus, gas fees, smart contracts, and wallet design all work together. This guide explains how Ethereum operates under the hood.

The explanation covers how Ethereum tracks its ledger, how transactions flow through the network, how computation is priced through gas, how smart contracts and token standards make Ethereum programmable, and how other blockchain networks compare.

Key points

• Ethereum uses an account-based state model, unlike Bitcoin's UTXO model.


• Transactions are packaged in envelopes that carry data, fees, destinations, and signatures.


• Proof of stake coordinates block production and finality through slots, epochs, and attestations.


• Gas fees prevent unlimited resource use and are shaped by EIP-1559.


• Smart contracts, token standards, and account abstraction extend Ethereum's capabilities.


• Ethereum can be compared with alternative Layer 1 blockchains on performance, security, and decentralization trade-offs.

State tracking on Ethereum

A state model is the framework a blockchain uses to represent and update its global ledger. Bitcoin and Ethereum use different models because they optimize for different goals.

Bitcoin uses a UTXO model. It tracks individual transaction outputs. There is no native concept of persistent accounts or balances. This design is simple and reliable for transferring value, but it is not built around running applications.

Ethereum uses an account-based state model. It tracks account balances and account data continuously. This design makes it possible to have smart contracts that store data, run logic, and interact with other accounts directly on-chain.

Every participant on Ethereum is an account, but not all accounts behave the same. Externally Owned Accounts, or EOAs, are controlled by private keys and can initiate transactions. Contract Accounts are controlled by deployed smart contract code. They cannot start transactions by themselves, but when triggered by an EOA, they can execute logic, update data, and interact with other accounts or contracts.

Every Ethereum account is defined by four fields: nonce, balance, code hash, and storage root. The nonce records transactions sent from the account and prevents replay. The balance records how much ETH the account owns. The code hash identifies smart contract code for Contract Accounts and is empty for EOAs. The storage root points to persistent contract data and is also empty for EOAs.

Together, these account records form Ethereum's global state. Transactions are the mechanism that changes that state.

How transactions move through the network

A transaction is the mechanism that updates Ethereum's global state. It can send ETH, call a contract, deploy a contract, or trigger logic that causes other internal calls.

Ethereum transactions are packaged in a transaction envelope. The envelope carries the data, fee settings, destination, value, calldata, and signature the network needs to process the sender's intent. EIP-1559 introduced Type-2 transactions, now the common Ethereum format.

A transaction envelope includes identity and replay-protection fields such as chain ID and nonce; economic fields such as gas limit, max fee per gas, and max priority fee per gas; action fields such as destination, value, and calldata; and authorization through the sender's signature.

Once signed, a transaction can enter the public mempool or travel through a private relay. Validators and block builders evaluate pending transactions, include valid ones in blocks, and execute them against the current state. The result is recorded as a state transition: balances, nonces, contract storage, and gas accounting update together.

Proof of stake and finality

Ethereum uses proof of stake to coordinate block production and finality. A block can be included, justified, and finalized. These are not the same thing.

An included block has been proposed and added to the chain. A justified block has received enough validator support within Ethereum's checkpoint system. A finalized block has reached strong consensus and cannot be reverted without a major consensus failure.

Ethereum organizes time into slots and epochs. A slot is the smallest proof-of-stake time unit where one validator may propose a block. An epoch is a group of 32 slots used for validator rotations and checkpoint voting. Validators provide attestations to support blocks and checkpoints, helping the network agree on the canonical chain.

Finality matters because applications, exchanges, bridges, and users need to know when a transaction is not just visible, but economically settled.

Gas fees and EIP-1559

Gas is the unit Ethereum uses to measure computational work and bound execution. It prevents transactions and smart contracts from consuming unlimited network resources.

Each transaction has a gas limit: the maximum amount of work the sender is willing to pay for. If execution runs out of gas, the transaction can fail, but the gas used up to that point is still charged because validators still had to perform the work.

EIP-1559 changed Ethereum's fee market by introducing a base fee and a priority fee. The base fee is determined by the protocol and adjusts with block demand. The priority fee is user-selected and goes to the validator as an incentive.

Smart contracts and token standards

Smart contracts are programs deployed on Ethereum. Source code written in languages like Solidity or Vyper is compiled down to EVM bytecode, which the network executes. Contracts contain variables, functions, events, and error handling.

Token standards make applications interoperable by defining consistent rules for how tokens behave. Key standards include ERC-20 for fungible tokens, ERC-721 for non-fungible tokens, and ERC-1155 for multi-token support. WETH is a wrapped version of ETH that follows the ERC-20 standard.

Account abstraction and wallets

Account abstraction, introduced through ERC-4337, improves wallet flows on Ethereum. It uses User Operations, bundlers, an Entry Point contract, aggregators, and paymasters. This allows for smarter wallets, sponsored fees, social recovery options, and flexible verification methods.

How Ethereum compares with other Layer 1s

Ethereum can be compared with alternative Layer 1 blockchains through several dimensions: validator design, consensus mechanisms, throughput, parallel execution, modularity, and interoperability. Different networks make different trade-offs between performance, security, and decentralization.

Why this matters

Understanding how Ethereum works helps users, developers, and investors make better decisions. Knowing how state, transactions, gas, and finality interact provides context for evaluating on-chain activity, transaction costs, and the reliability of applications built on the network.

Source

• The Block