The Unlikely Truth About Bitcoin Hard Forks

2017 has been quite the year for Bitcoin. Not only has it reached all-time highs, but by the end of it, Bitcoin will have hard forked several times. From an outsider perspective, people may view this uncertainty as negative. The truth is that hard forking is not only healthy for Bitcoin but a necessary step for its future development.

What is a Hard Fork?

A hard fork is a permanent divergence within a blockchain that happens when one group of nodes (computers connected to the blockchain network) signal for the original protocol while another group of nodes signal for a different protocol, isolating themselves from each other. The transaction history in each blockchain is identical up until the point of the fork.

Why Hard Forks?

Hard forks are a natural process in an evolution of a network when participants in it become isolated from each other. They don’t happen just in Bitcoin, they happen everywhere else, too.

Image result for hard fork bitcoinThe best example of a hard fork of a complex network similar to Bitcoin is The Reformation. When Martin Luther posted his 95 Theses on a Church in Eisbein, Germany, it signaled the beginning of the schism between the Catholic Church and soon to be created Protestant sects. One group of people (to think of the last phrase in Bitcoin Terms, conceptualize a ‘cluster of nodes’) began to believe (or, in Bitcoin Terms, ‘signal’) the words of new Protestant leaders, they no longer participated in the universe of the Catholic Church (or in Bitcoin Terms, the blockchain of the Catholic Church).

If you think of Christianity as a Blockchain, all denominations have agreed upon interpretations up to a certain point. Small disagreements in interpretations and practices add up and evidently lead to more serious conflicts. When the conflict causes a split, the separated chains begin to record a different history on their ledger. It is not a surprise that certain different denominations have different leaders and literature to which they ascribe to.

In other words, any network of nodes that interacts with each other has the potential to split when different factions of the network have differences in objectives and values.

Now, let’s go over three of Bitcoin’s most well-known hard forks.

Bitcoin Cash

The Bitcoin Cash hard fork was over a community disagreement for how to scale Bitcoin’s Blockchain. Bitcoin can only process 3-4 transactions per second which is abysmal compared to Ethereum (20 per second), Paypal (193 per second), and Visa (1,667 per second).

Image result for bitcoin cashIf Bitcoin wants to become the medium of exchange it intends to be, then actions must be taken in order to make transaction speeds faster.

To increase the network capacity, the community proposed two scaling solutions:

  1. Seg-Wit (mentioned later in this article), which would allow transactions to take place on a ‘side chain’ run by another entity, alleviating the load on the original chain.
  2. A block size increase, which would record all the transactions on the chain.

The politics of Bitcoin are for another post, but a common critique of Bitcoin Cash is that it centralizes hashing power for those who can afford to mine large blocks. This centralization is antithetical to Bitcoin’s ethos of being decentralized.

Because of this, the vast majority of the Bitcoin community opted for Seg-Wit with 97% of nodes in the network signaling for it. Bitcoin Cash still exists, but is considered by the community to be currently an altcoin. 

Bitcoin Gold

Image result for bitcoin goldIn the case of Bitcoin Gold, the fork will change the Proof-of-Work algorithm from SHA-256 to an Equihash. This fork isn’t as contentious as Bitcoin Cash and is driven by the ideological belief that mining should become more decentralized.

A main critique of SHA-256 is that it requires expensive ASIC miners which are dominated by centralized mining pools mostly located in China. Equihash is mostly mined by GPU cards which is much more accessible to the average miner and is employed by Ethereum and zCash (Classic).

It is important to note, however, that the man behind Bitcoin Gold, Jack Liao, is also the CEO of multi-GPU mining unit manufacturer LightningASIC, giving him a financial incentive to back the hard fork. The fork is intended to take place on October 25th.

Segwit2x

Segwit2x finds its origins in the New York Agreement signed earlier this year. Basically, the different entities in Bitcoin agreed to implement segregated witness by August 1st, 2017 and later increase the block size by November. When the Bitcoin Cash hard forked in August, many Bitcoin core developers felt like the NYA was void, and have refused to increase the block size. Others in the industry, such as Jeff Garzik, support increasing the on-chain Bitcoin block size from 1MB to 2MB, and along with Segwit will increase total block size to 4-8MB.

Image result for segwit2xThe main contention with Segwit2x is that it does not offer replay protection. This means that, if you send your B2X coins to one address, you may find your BTC coin may disappear as well. Since no side will offer replay protection, then what we will witness is a giant game of chicken and when November, whichever protocol has more hashing power will absorb the other one.

The price of Bitcoin will probably be volatile until the Segwit hard fork is completed. Leading up to the Bitcoin Cash hard fork, the price of Bitcoin fluctuated between $1,900 and $2,900, but once the event horizon (the August 1st hard fork) was realized, it only took 13 days until the price of Bitcoin reached $3,000 for the first time.

Although it is next to impossible to predict anything short term in the price of Bitcoin, it can be expected something similar to happen preceding and during the Segwit2x hard fork. Only when the hard fork is resolved and there is a clear winner, then certainty will enter the market again.

Conclusion

Put simply, hard forks are a natural cleansing of the system as well as nice dividends for hodlers. With three notable hard forks happening in 2017, it should be expected that they will not go away in the future. Because of this new reality, cryptocurrency exchanges should be more prepared to deal with hard forks.