Sometimes, two roads diverge on a crypto chain.
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If you’re a crypto enthusiast or investor, you’ve probably seen—among the many thousands of coins in digital circulation—some with similar names to other, “household name” cryptocurrencies. For example, there’s Bitcoin and Bitcoin Cash, or Ethereum Classic and Ethereum 2.0. What are these?
Most likely, they’re different spin-offs stemming from an original coin. They’re a result of changes, called “forks,” made to a blockchain’s protocol. If you’re considering an investment in crypto—forked or not forked—here’s what you should know about these blockchain offshoots.
What is a cryptocurrency fork?
A cryptocurrency fork is a blockchain software update that can either implement minor changes to the existing protocol or cause it to split into two separate and incompatible protocols.
If the protocol change is significant enough, it can lead to the creation of a new blockchain, plus a new coin.
Who initiates a fork and why?
Many blockchain networks are open source, allowing developers to propose and initiate changes when a majority of them find it necessary.
For instance, developers may decide improvements to the existing chain are needed, or that new functionalities should be added, or that security features must be bolstered. Developers may also try to resolve disagreements in the blockchain community—particularly when developers, miners, or users are unhappy with the direction a blockchain is headed.
Two types of forks: Soft forks and hard forks
Changes to a blockchain’s underlying protocol vary in significance. Sometimes it’s a minor upgrade, like a bug fix. Other times, it can be a major, system-wide overhaul.
If the changes cause the protocol to operate in a fundamentally different way from the original, then the new protocol may split from the old one, resulting in two separate protocols and, in turn, two separate blockchains and coins. This is the difference between a “soft fork” and a “hard fork.”
- Soft fork. Changes to the protocol are minor and don’t break compatibility with the old protocol. This means that nodes (computers) that don’t update to the new protocol will still be able to work with it.
- Hard fork. A permanent split is created between the new and the old blockchain. This results in two separate blockchains, both operating concurrently. If you happen to hold coins in the old blockchain, you’ll likely have an equal number of coins in the new blockchain after the hard fork.
Examples of a Bitcoin soft and hard fork
In 2017, Bitcoin underwent a soft fork to implement the SegWit (Segregated Witness) upgrade. The long and short of it is that Segwit improved several functionalities within the Bitcoin network:
- It fixed a bug in the protocol that made it less vulnerable to malicious attacks.
- It increased block capacity, making transactions faster and cheaper.
- It laid the groundwork for possible future scalability.
In contrast, a hard fork also took place the same year that resulted in a new cryptocurrency called Bitcoin Cash. Not every developer was happy with the SegWit solution. They argued that SegWit’s block capacity increase was still too small. So they implemented their own solution, but their update wasn’t compatible with the original system. Hence, Bitcoin Cash was born, and those holding coins in the original Bitcoin received an equivalent amount of Bitcoin Cash coins.
As with all software, you can assume that upgrades will take place as blockchain networks evolve. Whether the development community chooses a hard or soft fork—and whether that choice turns out to be a good idea—is something that is only known after the fact, for better or worse. But there are a few general benefits and risks of forks.
Potential benefits of a blockchain fork
- Collective innovation. When there’s a disagreement about the direction of a blockchain, a fork can allow teams of developers to explore new ideas and solutions that may eventually benefit the entire crypto community.
- Competition and liquidity. A new blockchain and coin increases competition within the field. It may generate new investment and, eventually, liquidity in the crypto market.
- Improvement and value. Successful technical improvements and upgrades (soft forks) help evolve a blockchain’s functionality, possibly leading to the increased adoption of its technology and the value of its coin.
Potential risks and pitfalls of a blockchain fork
- Confusion among coin holders. When a fork occurs, not every crypto enthusiast or investor is going to know or understand what just took place. Crypto is an emerging and complex industry.
- Network strain. A crypto fork, especially a hard fork, can burden a network by splitting its resources. It can make things more operationally complex for miners and nodes, require more storage and bandwidth demands, and cause challenges for crypto exchanges that now need to figure out which coin version to support.
- Security vulnerabilities. A strained network can weaken security due to diluted hash power. Furthermore, if miners (who secure the network) and nodes (which validate transactions) are split and in disagreement, the network’s security diminishes, making it more prone to attacks.
The bottom line
Cryptocurrency forks are pivotal turning points in a blockchain network’s evolution. These changes can be minor adjustments or major overhauls. Although forks can offer some important benefits, they also come with significant challenges and risks. As the crypto landscape continues to take shape, understanding forks and their implications is crucial for anyone involved in this dynamic field, whether they’re a passive enthusiast (aka “HODLer”) or an active trader.
