If you’ve been around in the cryptocurrency space for a while, or even if you are just starting getting into it, then you may have probably heard the term “fork” and wondered what it means.
In this article we will be taking a look at what cryptocurrency forks are, the different types of forks that exist and how they are likely to affect your crypto investing.
What is a cryptocurrency fork?
Firstly – it’s important to note that technically ‘forks’ are applied to blockchains, rather than just cryptocurrencies. However, as the main use of blockchains that most people encounter are through cryptocurrencies, we will be using it interchangeably in this article.
A cryptocurrency fork is basically an update to the rules (or ‘protocol’) that govern how a blockchain operates. A change in the rules will mean that the previous way of determining if a transaction is valid or not is changed.
This may result in a minor change that allows the cryptocurrency to continue with a slightly modified way of operating, or it may be a complete divergence where a blockchain is split into two separate blockchains that are then developed independently of each other.
Why do blockchain forks happen?
There are a variety of reasons that crypto forks may happen:
- Developer disagreements
- Bug fixes
- Unhappy community
Blockchain forks may be due to developers disagreements
In the constantly-evolving cryptocurrency space, innovation and breakthroughs are being made everyday. Breakthroughs are made by teams of developers who are usually working remotely and often believe deeply in the merit of their project. They’re not just trying to make money – they’re usually working towards a much bigger purpose than that.
Due to their deep beliefs in what they are doing, it’s not uncommon for disagreements to arise within teams of developers. One group may believe strongly in a path forward, but another group of developers working on the same project may have a different vision in mind.
A fork occurs when the members of a blockchain development team disagree on the way forward for a cryptocurrency project. Instead of finding the middle ground, some members of the team branch out and pursue their own vision for the project.
Blockchain forks may be due to bug fixes
A software bug is a vulnerability or a flaw in a piece of computer code or software, and can either be a functionality bug or a security bug in the software.
A bug can either be minor and the piece of software can still run properly with it, or, the bug can be fatal and needs to be addressed urgently. Not all bugs are urgent, but a good developer team still fixes all bugs immediately.
Minor bugs are usually things that don’t affect a blockchains security or put investors funds at risk, and are usually fairly straightforward to fix once they have been identified.
A ‘fatal bug’ is a bug can either be a functionality bug or a security bug that severly impacts how the blockchain operates.
An example of a fatal bug would be if transactions on a blockchain application were not able to be processed, or a vulnerability in the login process that could allow a hacker to find out a user’s login credentials for their account – putting their funds at risk. This happened in 2017 with Ethereum, when a fork was undertaken to counteract the effects of a hack.
The other type of bug is a functionality bug – something that occurs due to the way software operates that hinders its performance. They may not be noticeable when the code is initially launched, but as the amount of people using the software increases the bug will start becoming noticeable.
A classic example of this is Bitcoin. When Bitcoin was introduced to the world in 2009, its creator could never have imagined the issues that Bitcoin would have as a large amount of people globally started using it. The main issue being the amount of transactions that Bitcoin can process every second – just 4.6. This makes it unsuitable for a global payments system where millions of people may be trying to make payments at a similar time. However, developer teams are now collaborating to fix these shortcomings.
Blockchain forks may be because the community is unhappy
Another reason a fork may happen is that the community is unhappy with a certain aspect of the cryptocurrency or blockchain.
The community consists of everyone in a cryptocurrency or blockchain project. This could be a a member of the development team, it could be the people responsible for maintaining the blockchain or it could be a person who uses the application.
You may not know it, but if you use an application, or invest in a cryptocurrency, then you can already say that you are part of that specific cryptocurrency’s community.
A community may collectively agree that something in a blockchain project needs to change. They may unhappy with how many transactions can be processed in a second (a common issue that communities want to address), or it may be a security or a functionality bug that the community thinks should be fixed. If this is the case, then an update to the blockchain protocol and a fork is likely.
Whether or not all the members of a community mutually agree that changes need to be made, or some members disagree with others, results in two types of forks. These two types of forks are called soft forks and hard forks.
What is a soft fork?
A soft fork usually occurs when members of the community all agree that changes need to be made to a blockchain or a cryptocurrency and agree on what those changes are.
These are normally small changes or additions to the rules of the blockchain. The main purpose behind a soft fork is to improve the original blockchain.
By changing or adding rules in the blockchain, the behavior and performance is essentially altered. Whether or not this performance change would be good is decided on by the community, and is tested on the blockchain.
Testing of new rules is possible since both versions of the rules can run side by side.
How soft forks work
As you may recall, a blockchain is a decentralised network that consists of multiple computers all over the world maintaining it. These computers are called nodes.
When an update is made to the rules in a blockchain, not all the nodes want to follow these new rules.
In the beginning, it is often the case that only a few nodes follow the new rules because they believe that these new rules will improve the blockchain. This results in two sets of rules existing in the blockchain simultaneously.
The nodes in each set of rules share the same history of the blockchain, and nodes following the new set of rules are able to communicate with nodes that are following the old set of rules and vice versa.
After a set amount of time from the introduction of the new rules has passed, the set of rules with the majority of nodes following them will become the single set of rules that all the nodes on the network must then start to follow.
Most of the time the community agrees on the way forward in a soft fork. However, there are also times when the developers can’t mutually agree that one set of rules is better. If this happens, then a hard fork may occur.
A good example of a soft fork is the Segregated Witness (SegWit) fork. SegWit was an update that changed the format of blocks and transactions in the Bitcoin blockchain.
What is a hard fork?
When some members of the community are dissatisfied with a blockchain and the community members can’t all mutually agree that changes are required, a hard fork is usually the result.
In a hard fork, the new blockchain shares the same past as the original blockchain, and will take a snapshot of the original blockchain at the moment the fork happens. This is so the new blockchain can continue where it broke off its links from the original blockchain. The new blockchain may use some of the blueprint of the original blockchain, but it has all of the changes implemented in it and is completely independent from the original blockchain.
Most forks are a spinoff of Bitcoin. Since Bitcoin was the first fully decentralised blockchain, it served as a blueprint for most of the blockchains and cryptocurrencies that currently exist.
Hard fork example: bitcoin cash
How do forks affect the price of a cryptocurrency?
When forks occur, it’s likely that it will have an effect on the price of a cryptocurrency. The reason why the fork was made and whether it is a soft fork or a hard fork are two factors that may determine the effect a fork has.
Soft vs Hard Forks and their effect on crypto prices
It isn’t really possible to say which fork (hard or soft) has which effect on the price of a cryptocurrency. It really depends on the type of fork that is introduced. Not necessarily hard or soft, but whether or not it will affect how nodes are rewarded in the blockchain for their work, or if it will slow down the blockchain in terms of transaction processing speed.
A fork always has some turbulence!
Whether a hard or soft fork, there will always be uncertainty when a fork happens. This uncertainty might lead to intense fear, or extreme optimism. One thing is guaranteed: there will always be market volatility when a cryptocurrency fork happens. This will last at least until the community reaches a consensus on the way forward.
Profiting off of snapshots in a hard fork
When a hard fork occurs, it means that a new version of the original blockchain will run simultaneously with the original blockchain. However, the new blockchain will be completely independent.
As you may recall, the new blockchain shares the same past as the original blockchain, and takes a snapshot of the original blockchain as the fork happens.
When the fork happens, a community member of the original blockchain is given the same amount of the new cryptocurrency (from the new blockchain) as they had in the original cryptocurrency. This is because of the snapshot that the new blockchain takes at the time of the fork basically means the blockchain is duplicated at that point.
Since the new blockchain shares the same history as the original blockchain, any users on the original blockchain have their transaction history repeated. Therefore, the person gets credited with the same amount of cryptocurrency on the new blockchain as they had on the original blockchain.
Essentially earning free money for riding out the fork!
Note: this does not happen with every fork. Make sure to do your research to find out if a fork that you have your eye on will work this way.
Things to consider when a cryptocurrency forks
This is NOT investment advice, but rather some things to keep in mind. The choice of what action to take is yours alone and we always recommend you do your own research.
If you are fearful of the impact that a fork will have on a cryptocurrency you are currently holding, you may decide best thing to do may be to sell your cryptocurrency until the air clears and everything stabilises again.
If you feel that a fork, whether hard or soft, will improve the cryptocurrency and its community, and you are willing to take a bit of a risk, then it one course of action could be to hold the amount of cryptocurrency or even try to buy more of that cryptocurrency.