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Bitcoin Forks Explained

BTC

In early November, while Bitcoin enthusiasts and investors were waiting for a long-anticipated update to the software that supports the famous digital currency, mass email from the group behind the project informed everyone that they were canceling the update.

For months, Segwit2x, as the update was called, was at the center of a heated debate between different stakeholders in the Bitcoin community on how to address Bitcoin’s struggles in increasing the speed at which it handles transactions.

In their announcement, the Segwit2x leaders stated the update had not won sufficient consensus in the community, hence their decision to call it off.

The debate surrounding Segwit2x and the eventual withdrawal of the update proposal demonstrates how updating cryptocurrency software (called "forks" in the crypto-jargon) can be complicated.

Here’s what you need to know about forks and how they affect Bitcoin and other cryptocurrencies.

What is a fork?

In traditional software, where a single organization or company owns the code of an application and servers where it runs, pushing updates is straightforward: You update the code, compile it and deploy it on the server side and, if necessary, send patches to the users. Whoever installs the updates will be able to benefit from the new features.

In cryptocurrencies like Bitcoin, however, things are not that simple. Instead of running on the servers of a single company, the Bitcoin software runs on thousands of computers called miners. These computers are scattered across the world and get compensated in bitcoins for verifying transactions and maintaining the network. Related: The Five Most Important Blockchain Trends In 2018

When a group of developers creates an upgrade to the Bitcoin software, all (or a vast majority of) those computers must install the new software. This is called "consensus."

But miners might not agree to update their software. Why? Because a change to the protocol might affect the rules of mining competition, favoring some types of mining hardware while negatively affecting others. In that case, those who stand to lose will probably refrain from installing the software, unless there’s already a strong consensus behind the update.

If a specific update doesn’t win consensus and a considerable number of miners don’t agree to install the new version of the Bitcoin protocol, the software "forks." This means there will exist two concurrent versions of the software and, depending on how fundamental the differences between the two versions of the Bitcoin software are, the result might be a “soft fork” or a “hard fork.”

What’s the difference between a "soft" and a “hard” fork?

If a new version of the Bitcoin protocol is backward-compatible, then the fork that results from the lack of consensus is a "soft fork." This means that miners running both versions of the software will be able to continue mining bitcoins on the same blockchain.

Blockchain is the distributed ledger where Bitcoin transactions are registered. Every few minutes, a number of new transactions that miners have confirmed are compiled into a block and registered on the blockchain, which is then replicated across all the computers in the Bitcoin network (read here and here for more on the process).

An example of a soft fork is the original SegWit, which came into effect last August. In a nutshell, SegWit changed the way transactions were packed into each block, but it did it in a way that allowed nodes running the old software to continue processing them.

Alternatively, if the new version of the software is not compatible with the previous one, the resulting fork will be a "hard fork."

The developers of a hard fork update usually specify a block number at which it will become activated, at which point a new blockchain and a new cryptocurrency are created. From that point on, the miners running the different version of the software will be registering transactions on their separate blockchains.

An example of a hard fork is the Bitcoin Cash fork, which took effect last August and created the new BCH cryptocurrency. Bitcoin Cash changed the blockchain block size from 1 MB to 8 MB to accommodate for more transactions per block, which means its blocks could no longer be registered on the original Bitcoin blockchain and needed their own separate version of the ledger.

What you need to know about the extra hard fork money

As mentioned in the previous section, a hard fork creates a new cryptocurrency. What this means is that, for instance, when the Bitcoin Cash hard fork occurred, whoever held bitcoins received an equal amount of BCH on the new blockchain.

Hard forks will, as many like to publicize, double your cryptocurrencies and give you free money, which is true. That’s why there’s usually a hype and rush to buy bitcoins before a hard fork occurs, which sends bitcoin prices soaring. Related: The ‘Wolf of Wall Street’ Is A Multi-Million-Dollar Deadbeat

But things are not that simple. When a hard fork splits the Bitcoin blockchain, it reduces its mining power. It will also split the community, which means demand for each individual coin will become lower. If the mining power diminishes too much, transactions will take longer to confirm, which can in-turn dissuade users from using that specific coin.

All these parameters can negatively impact the prices of a coin, and if transactions become too slow, the cryptocurrency might die altogether.

In fact, part of the reason that the Segwit2x hard fork (mentioned at the beginning of this article) was called off was that a lack of consensus threatened to create two very weak currencies that would endanger the very existence of all Bitcoin versions.

Bottom line: While after a hard fork your bitcoins might double in number, there’s a chance their collective value won’t be worth a lot more, and might even be worth less. And as the Bitcoin community grows, and individuals and organizations with differing (and often conflicting) goals enter the fray, many more forks will probably lie ahead.

By Ben Dickson via the Amity Blog

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