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?
Hard Bitcoin Forks
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.
Related: Bitcoin Gains an Important Endorsement
Soft Bitcoin Forks
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.
Consequences of Bitcoin Forks
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!
This article has been republished with permission from Vintage Value Investing.