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What Are Forks In Crypto?

When actively trading cryptocurrencies or as an active member of the crypto space, you must have certainly stumbled across the term “fork” numerous times already. But what are forks of cryptocurrencies?

 

What Does Fork Mean In Cryptocurrency?


Well, as the term fork suggests, the old path is split into two, like a junction. But how does it work in cryptocurrencies?

First and foremost, we must understand how cryptocurrencies work on a basic level. Cryptocurrencies are digital assets which are used as a medium of exchange and store of value that use solid cryptography to secure financial transactions, control the supply, and to make wallets and transactions pseudonymous while ensuring transparency. In other words, the cryptography ensures privacy and the prevention of fraud and manipulation. Furthermore, the creation and access of cryptocurrencies is decentralized as opposed to centralized digital currency and central banking systems.

 

How Cryptocurrencies Are Created?

Most cryptocurrencies are created via a mining process, e.g. Bitcoin, of which total supply is 21 million and its current circulating supply is around 18 million. Essentially, mining is the only possibility to add new cryptocurrency to the circulating supply. To be more specific, miners are basically “minting” currency, like central banks are printing fiat money. However, the mining process can be done by every individual with computing power and does not need a central entity.

As the mining process requires computing power, it needs a lot of electric energy. Therefore it costs money to mine BTC (and other cryptocurrencies). To make it desirable to participate in the mining process, the miners receive a so-called block reward, which is essentially Bitcoin itself, because Bitcoin is mined in block units. 

The Bitcoin block mining reward halves every 210,000 blocks and the reward will decrease from 12.5 to 6.25 coins in 2020. In July of 2019, the price of Bitcoin was around $14.000, which means you’d earn (12.5 x 14.000)=$175,000 as soon as your computing power found a block (which depends on effort and luck).

Besides the Bitcoin earnings, miners can have the voting power when changes are proposed in the Bitcoin protocol. As cryptocurrencies are built on code which is called blockchain technology, changes in the software require the consent of the miners. If the miners fail to find consent, there will be a software upgrade which leaves the old software behind. Consequently, there will be a new and old coin, one running on the new software while the other running on the old protocol. 

 

What Is A Hard Fork And What Is A Soft Fork?

Now, there is a difference between a hard and a soft fork. To be more specific, a hard fork is when a single cryptocurrency splits into two versions. Due to the changes in existing code the two versions of the software are meant to be incompatible.

A soft fork is essentially the same but it creates two compatible versions of the software and token. Ultimately, both fork types create two different versions of the blockchain but the soft fork is backward compatible, which means that users that failed to upgrade their software to the latest version won’t be entirely cut off from the network. While blocks created by the latest software version will be accepted by old version nodes, the old version’s block will be rejected by the new software’s nodes. This forces users to upgrade, which usually ends up in the miners switching to the newer version because the chain with the biggest hashing power eventually absorbs the shorter one. Therefore, if more than 50 percent of miners (majority) upgrade to the newer version, then the older version will become irrelevant and vice versa. But since the nodes from the old software accept new version blocks as well, the new version is likely to win.

 

Why Do Forks Happen?

Forks can happen by accident, for example, if two miners discover a block at the same time, some nodes of the network register different data, resulting in two chains. However, they are quickly identified and resolved, which is why they don’t harm the network’s security.

Normally, the majority of cryptocurrency forks are done on purpose, when developers want to modify the source code to add new features, fix vulnerabilities or change the fundamental rules of network operation. In essence, forks are intended to improve the cryptocurrency.

But whether it is an improvement or not can be very subjective, which is why hard forks often create not only a new protocol and new digital token but sometimes also a new community, as it happened with Bitcoin Cash and Bitcoin Gold, which are both Bitcoin hard forks. 

 

What are the risks and opportunities of hard forks?

Forks often grant holders of the old cryptocurrency “free coins”, as it was the case with Bitcoin Cash. For every Bitcoin (BTC) you held in your private wallet you received one Bitcoin Cash (BCH). At a given date there will be a snapshot of all balances and the forked, new coin will be distributed accordingly.

 

How Do Airdrops Differ From Hard Forks?

In fact, airdrops are often given to exchange wallets when a fork has occurred. Airdrops are coins being sent to an existing wallet for any kind of reason. Therefore, sometimes airdrops are given to you for free in exchange for your email, e.g. as a marketing mechanism.

 

Who Can Initiate A Hard Fork?

Interestingly enough, anyone can do a hard fork by entering the public GitHub and updating the software, but very few will convince enough miners to update their software or to download the wallet of the new coin, quite apart from the fact that exchange listings cost enormous amounts of money. 

 

Popular Hard Fork Examples

  • Bitcoin Cash
  • Bitcoin SV
  • Bitcoin Gold
  • Bitcoin Diamond
  • Ethereum Classic
  • Ethereum’s Byzantium

 

Soft Fork Examples

  • Initially, Bitcoin didn’t have a block size limit until the restriction to 1MB was introduced through a soft fork.
  • The pay-to-script-hash function was enabled for multi-signature addresses in Bitcoin’s network, thus enhancing the code without changing the structure.
  • SegWit, scaling solution.

About the author

Konstantin Kaiser // Professional Analyst and Day Trader
specializing in the Cryptocurrencies market. Konstantin is also a popular financial writer covering the blockchain for websites like fxleaders.com and investing.com.