Bitcoin Explained – Chapter 6: The Fork - The splitting of the Blockchain
In the sixth part of the Bitcoin Explained series, software updates called «forks» are examined more closely. A basic distinction is drawn between «soft forks» and «hard forks».
In the last chapters of the Bitcoin Explained series, it became clear how important the influence of the Bitcoin community is for the survival of the Bitcoin protocol. In various Internet forums, at numerous events and even in entire companies, interested parties constantly discuss the current and future development of the Bitcoin protocol. In addition to the «official Bitcoin core developers», large mining pools and Bitcoin clubs always have a clear position on the direction in which the Bitcoin protocol should develop. From time to time, there are extreme differences of opinion as to how to deal with certain problems or further developments of the Bitcoin protocol. In particularly strong differences of opinion, the community decides to subject the Bitcoin blockchain to a so-called «fork». While all forks are subject to a similar pattern, the result of each fork is always unique and different.
The splitting of the blockchain
Basically, a Bitcoin fork is nothing else than an update of the Bitcoin protocol jointly decided by the community. Since the Bitcoin blockchain is a concurrent, decentralized group of computers, it is important that each of these «Bitcoin computers» (also called «full nodes») use the same core software of the Bitcoin protocol. Understandably, a computer that runs the Bitcoin core software to become part of the Bitcoin network cannot be used as a full node of another blockchain (e.g. Ethereum) - and vice versa.
Soft and Hard Fork - The differences
In general one distinguishes between a «Soft Fork» and a «Hard Fork». A soft fork is a kind of software upgrade that leads to past and valid blocks being recognized as invalid blocks after the update. Since old full nodes regard the new blocks as valid, this is referred to as backward compatibility in the Bitcoin protocol. Backward compatibility is easier to understand using a software example: While older Word versions are able to retrieve files of newer versions, the features of newer Word files cannot be retrieved by old Word versions. The same applies to a Soft Fork.
To initiate a Soft-Fork it is sufficient if only a 51% majority of the Full Nodes decide to upgrade the software. If this majority is reached, then the older network will be taken out of service and the newer blockchain will automatically be recognized as the "true" blockchain. An example of a soft fork is the "Pay to script hash (P2SH)", which was introduced in the Bitcoin blockchain in 2012. The P2SH Soft-Fork enabled the use of multi-signature addresses in the Bitcoin network. Since the introduction of this software update, it has been possible to use multiple private keys for one public key.
Figure 1: Soft-Fork
Forks that are not compatible with the older version of the software are called hard forks. They therefore represent a very radical change in the Bitcoin protocol, which leads to previous invalid blocks being recognized as valid (or vice versa). Therefore, the rule of thumb is that a hard fork is a permanent divergence from the previous version of the blockchain - this means that full nodes running on the old version are no longer accepted and integrated by the new version. This results in a fork in the blockchain: A blockchain that accepts the new software update and continues to run on the new blockchain, and a blockchain that rejects the new software update and thus continues to run on the old blockchain version. In most cases the new software update will be accepted by the biggest part of the community after some time after the hard fork, because the old blockchain is no longer kept up to date and becomes irrelevant.
Hard forks are used to fix important security risks, to add new functionality or to undo highly questionable transactions (such as the Ethereum blockchain in the case of the DAO hack. In the case of hard forks, a new crypto currency is usually generated based either on the new updated version of the blockchain or on the old version of the blockchain.
Figure 2: Hard-Fork
Previous hard forks in the Bitcoin protocol
Bitcoin Cash: Bitcoin's first hard fork was carried out on 1 August 2017, which resulted in the creation of a new crypto currency called «Bitcoin Cash». The reason for the hard-fork in the case of Bitcoin Cash was the desired increase in possible transactions per block. In theory, Bitcoin Cash can therefore handle more transactions than a conventional Bitcoin block.
Bitcoin Gold: The next Bitcoin Hard-Fork took place on 24 October 2017. This resulted in the new crypto currency «Bitcoin Gold». The trigger for the hard fork was the desired re-establishment of the mining functionality of conventional GPUs instead of the popular ASIC chips, which were specially designed for mining processes.
Bitcoin SV/-ABC: A Bitcoin Cash Hard Fork took place on 15 November 2018, creating the Bitcoin SV and Bitcoin ABC crypto currencies. Between the communities of SV and the ABC currency there were big disagreements in the further development of the current blockchain with regard to the blocksize. SV is an abbreviation for «Satoshi's Vision», while ABC stands for «Adjustable Blocksize Cap».
The differences summarized
Soft forks and hard forks are essentially the same, because if the existing code of a crypto currency is changed, an old version is retained while a new version is created. In the case of a soft fork, however, only one blockchain remains valid when the remaining users take over the update. Both forks create a split, but a hard fork creates two blockchains, while a soft fork should ultimately lead to a single blockchain.
The supporters of various crypto currencies have meanwhile grown into huge communities, which is why it comes to differences of opinion within the communities. On the one hand, forks are therefore often seen as a healthy sign of the further development of a crypto currency, although it can lead to a disadvantageous division of the core community.
Next in Bitcoin Explained
The seventh part of Bitcoin Explained deals with the various advantages and disadvantages of crypto currencies (especially Bitcoin). Bitcoin is the pioneer of a new technology and is still the most popular crypto currency. Nevertheless, the Bitcoin protocol contains a number of outdated structures that may leave Bitcoin in the dark compared to newer crypto currencies.
This information is neither an investment advice nor an investment or investment strategy recommendation, but advertisement. The complete information on the securities, in particular the structure and risks associated with an investment, are described in the base prospectus, together with any supplements, as well as the final terms. The base prospectus and final terms constitute the sole binding sales documents for the securities. It is recommended that potential investors read these documents before making any investment decision in order to fully understand the potential risks and rewards of deciding to invest in the securities. The documents and the key information document are published on the website of the issuer on prospectus.vontobel.com and are available from the issuer free of charge. The approval of the prospectus should not be understood as an endorsement of the securities. The securities are products that are not simple and may be difficult to understand. This information contains an indication of past performance. Past performance is not a reliable indicator of future results.
This document and the information contained in it may only be distributed or published in countries where such distribution or publication is permitted by applicable law. As stated in the relevant base prospectus, the distribution of the securities mentioned in this information is subject to restrictions in certain jurisdictions. This advertisement may not be reproduced or redistributed without Vontobel’s permission.