Bitcoin forks and forks of other cryptocurrencies are a huge deal in the Bitcoin market. A major fork can swing prices, make headlines, and divide the community on technology issues. But what are they? And why are they such a big deal?
Bitcoin is built on a technology called blockchain, a relatively new type of software that allows a network of users to come to agreements with each other. With Bitcoin, this means agreeing on which Bitcoin transactions are valid and which ones aren’t.
The unique nature of the blockchain software means that upgrading it isn’t as simple as with other types of software. The users of the network have to somehow come to an agreement about new rule changes and how and when to implement those changes. When these changes happen, they are called forks.
Simply put, blockchain technology is an ingenious solution for a network of computers to come to a consensus about something. When you send Bitcoin to someone else on the Bitcoin network, the network comes together to check that your transaction is valid. If most of the network agrees that it’s valid, your transaction is accepted and recorded onto the blockchain forever. It will be added to the next block of transactions and linked to the previous one using a clever cryptographic technique to make sure it can never be overwritten in the future. These cryptographically linked blocks link one after another to form a chain called a blockchain.
The Bitcoin network checks if your transaction is legitimate by looking at the entire history of the specific Bitcoin you are trying to spend, to make sure you really do own it. If you try to spend a Bitcoin you don’t really have, it will be immediately obvious. The transactions won’t add up, and your transaction will be rejected.
Of course, there are many, many more technical details we don’t need to go into here.
So blockchain networks are basically a set of rules that allow a network of computers to agree which transactions are valid and which ones aren’t. But what happens when you want to update those rules?
This is where things get difficult. Writing the new code and physically updating the software is the easy part. The hard part is getting everyone to agree to the rule changes. Some examples of rules changes might be:
- To increase the scalability of the network (Bitcoin Cash hard fork);
- Technological innovations (Segregated Witness soft fork);
- Add new privacy features (Bitcoin Private hard fork);
- Changes to mining rules (Bitcoin Gold hard fork).
The problem is that changes to blockchain protocols come with tradeoffs. It means that an improvement in one area usually has costs somewhere else. For example, improvements to scalability in the Bitcoin Cash fork has led to less decentralization in the network. Something many Bitcoin users won’t tolerate. Bigger tradeoffs usually led to bigger splits in the community.
In theory, everyone can have a say in this process. Miners have a big say in new Bitcoin forks. Transactions on the Bitcoin network are validated and agreed on by Bitcoin miners. Anyone can become a Bitcoin miner if they want, and the strength of your vote will be determined by how much computing power you contribute to mining.
In reality, though, Bitcoin mining isn’t done by the regular users. It’s a very technical and expensive process that is done mostly by professional Bitcoin mining groups and companies. These pro miners have access to cheap electricity and specialist Bitcoin mining hardware that gives them vastly more ‘voting’ power than regular users. Users also have power in the process of changing the rules. A new blockchain created by a miner initiated fork will only work if users accept it too.
So, what happens if everyone can’t agree?
When the community is split on a rule change decision, a hard fork can occur. So far, Bitcoin Cash has been the most successful hard fork of Bitcoin. In its early days Bitcoin Cash managed to become the third largest cryptocurrency by market capitalization with the starting price of over $500. As of April 16, 2018 the ‘new Bitcoin’ has sunk one step down, ranking 4th in the market cap list, and you can now buy Bitcoin Cash at $750. Let’s use this hard fork as an example.
Over the last few years, Bitcoin has had trouble scaling to the large number of transactions it needs for global use. One quick fix to this problem is to increase the ‘block size’. That is, to increase the number of transactions allowed in each of those linked blocks. This has the immediate effect of increasing the speed of the network, but also makes it more difficult for users to run full validating nodes. The argument against this rule change is that this tradeoff will make the network more centralized, with more power concentrated in the hands of a few.
This dispute was never resolved, but the miners that liked the idea went ahead with it anyway. They agreed to update their version of the Bitcoin protocol to the new rules on August 1st, 2017. Those that didn’t want the changes stayed with the old version of the rules.
The two different sets of rules are incompatible with one another. After August 1st, there were two versions of the blockchain – the Bitcoin blockchain still running the old rules, and the Bitcoin Cash blockchain running the new rules. The two split off in different directions like a fork in a road.
Sometimes, the new rule changes are actually backward compatible with the old rules. If so, not everyone needs to update at once. The condition is that the transactions using the new rules have to appear valid to anyone using the old ones. You can think of this as when the rules get tightened. Soft forks can be used to add new transaction types, and this is how Segregated Witness was added to the Bitcoin protocol.
Forks are a big deal. They are a key factor in determining the fate of every cryptocurrency. Some key consequences of a fork include:
- New functionality;
- Two or more competing blockchains (E.g. Bitcoin and Bitcoin Cash, Ethereum and Ethereum Classic);
- Coin holders end up with two coins, one on each of the forked blockchains;
- Big price fluctuations;
- Divides in the coin’s community.
Forks will continue to be a pivotal part of the blockchain world. They are a key way (along with ICOs) of improving the technology and creating new projects. Upcoming forks can seem a little scary as the prices wobbles, but much of the time it’s a good thing for coin holders. After all, often you’ll end up with a whole new type of Bitcoin for free!