Rehashed #33 - Forking: Feature or Bug?
The 'ins and outs' of a blockchain fork
The concept of forking first appeared in the open source software community, used to describe the moment when a software project fractures based on ideological or technical differences. Similarly, in the crypto space, forks arise when there is internal disagreement on the direction of a blockchain network. There are two types of forks: soft forks and hard forks. A soft fork is a backward compatible method of upgrading a blockchain. Soft forks often implement new functionalities for a blockchain. For example, proof-of-work protocols such as Monero and Siacoin have employed scheduled soft forks as a strategy to evade the grip of targeted mining hardware.
Whereas a soft fork is a backward compatible method of upgrading a blockchain, a hard fork is a divergence from the previous version of a blockchain. A hard fork occurs when the code and ledger of an operating blockchain are altered, creating a live cryptonetwork and ‘child’ chain separate from the parent chain. The state of the original network is replicated, entitling holders of the main chain asset to also receive the forked asset. Post-split, the forked networks have two separate values, each derived from their technical roadmap and supporting communities.
The highest profile contentious fork to date was the creation of Bitcoin Cash in August 2017 after an irreconcilable disagreement between different factions in the Bitcoin community concerning technical changes that would make the network better at handling large transaction volumes. Now Bitcoin Cash is facing an upcoming fork of its own.
A $BCH case study
Bitcoin Cash has recently been the talk of the town in light of its impending contentious hard fork taking place this week. As part of its roadmap, Bitcoin Cash hard forks every six months in an expected software upgrade. Scheduled for November 15, the next hard fork has stirred up significant controversy. The Bitcoin ABC implementation, supported by Roger Ver and Jihan Wu of Bitmain, have proposed a series of upgrades but have been met with heated opposition from Bitcoin SV (Satoshi’s vision), a small group led by Craig Wright, the controversial and self-proclaimed “creator” of Bitcoin, also known in most circles as ‘Faketoshi.’ The technical argument is centred around an increase in block size, with SV proponents arguing for an increase from 32MB to 128MB. Come Thursday, there is likely to a chain split; users holding Bitcoin Cash prior to the hard fork could end up with tokens on both sides of the split.
Poloniex is advertising pre-fork markets for Bitcoin Cash, offering “futures” for both $BCHSV and $BCHABC. Both exchanges indicate that market support for Bitcoin SV is significantly lower than Bitcoin ABC. Traders are much more confident in Bitcoin ABC’s ability to retain its value, with $BCHABC trading at (USD) $405, almost 4x the price of $BCHSV at (USD) $112. Surprisingly, miner support is skewed toward Bitcoin SV. Based on current hash rates, approximately 60% of current Bitcoin Cash miners are estimated to be backing the SV network compared to only 20% for ABC. Miners are instrumental in deciding which rules the network follows in and as history tells us, are likely to alternate between Bitcoin ABC and Bitcoin SV, depending on which coin has the highest value.
To fork or not to fork?
Hard forks are often thought of as bugs, resulting in the value dilution of a network as they split the user base between parent and child. However, in every hard fork that we have seen, the main chain remains dominant in value retention and, with the exception of Zclassic/Zcash and PIVX/Dash, the main chain has shown far greater appreciation in value relative to its forked chains. A recent analysis showed that a hard fork does not appear to correlate with a decline in daily active users or transaction volume on the parent chain. From the forks that we have observed to date (bitcoin is by far the most forked network, with at least 40 chain forks at various block heights), the vast majority of the resulting forked or ‘child’ networks appear to have little usage or value. We only have to look at the most high profile forks, of Ethereum Classic and Bitcoin Cash, to see that they have garnered very little traction relative to the original networks.
Although little value seems to be created from forked chains, the market has generally priced them in as a positive development. Cryptoassets with upcoming forks have behaved like stocks issuing dividends, rather than a value neutral event. Past price movement has typically shown a pre-fork run-up in the price of the main chain and upon the forking event, subsequent fall in price, just as stocks typically drop after going ex-dividend.
Alongside confusing price movement, hard forks create all sorts of technical and operational headaches. They require users to upgrade their software to avoid processing invalid blocks/transactions - nodes running previous versions will no longer be accepted by the newest version. Additionally, standardized operational procedures are yet to be ironed out around how exchanges and wallet providers handle and support such events. For example, the team at BitMEX will only be supporting the Bitcoin ABC implementation, advising that they will settle Bitcoin Cash contracts after the hard fork based on the value of Bitcoin ABC. Yet Poloniex will support markets for both Bitcoin ABC and Bitcoin SV after the hard fork.
From a governance standpoint, forks can be highly effective. Internal disagreements are often highly unproductive; like a tree pruning its branches, forking allows disagreeing factions to pursue their own direction. The market is then free to decide on who to support, leaving developers, miners and users to designate resources as they please. For example, in the case of Bitcoin Cash, perhaps Bitcoin ABC will be better placed without Craig Wright.
Although we only have a small historical sample, forked chains have remained inferior; struggling to attract demand, with little effect on their parent. One could postulate that the original chain would be stronger and have a larger Lindy effect without the distraction and (albeit small) value redirection associated with child chains. However, this effect is likely to be outweighed by the alleviation of community toxicity.
In the News
The SEC has announced that they plan to release "plain English" guidance to help projects determine whether their token sales constitutes a potential sale of securities and how it should trade post-ICO. This will likely help to inform regulatory approach towards ICOs in global jurisdictions.
The SEC has charged EtherDelta founder Zachary Coburn with operating an unregistered securities exchange. The SEC’s settlement with EtherDelta is likely the first of many enforcement actions to come against crypto token exchanges. Many are viewing the (USD) $388,000 penalty as a light slap on the wrist compared to the millions of revenues Coburn likely made off fees.
The total amount of Bitcoin seized or confiscated by the U.S. has reached nearly 453,000, about 2.6 % of the total circulating supply. Of that amount, 85.6% came from just two cases — Silk Road and SELEC, most of which has been sold at auction.
Bitmex has launched its own venture capital arm, joining the ranks of many other crypto exchanges.
15 November - Potential $BCH fork
29 December - Deadline for VanEck SolidX ETF (can be extended to final deadline of Feb 27, 2019)
As always, thanks for joining - see you next week for Rehashed.
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About the author:
Capital markets to crypto convert. From Christchurch → Boston → New York, Freddie became intrigued by the potential of the digital asset economy after plucking a book on Bitcoin off a New York library bookshelf in 2016. Her parents are thrilled that she is chasing magic money on the internet.
Disclaimer: The above references an opinion and is for informational purposes only. The opinions expressed by the author do not represent the opinion of BitPrime.