What is the Bitcoin hard fork?

INTRO

As Bitcoin transaction volume has grown, the current 1 MB block size limit has become a considerable problem which will impede its further growth. To solve this, there are two proposals for an upgrade of the Bitcoin protocol. Each of these is supported by a faction in a deeply divided ecosystem. In a situation with no clear winner, one faction might decide to break consensus and create a hard fork. If the minority faction then decides to fight back, it would plunge the ecosystem into the unknown and probably wreak havoc on Bitcoin. However, the probability of a civil war is low.

BACKGROUND

The existing Bitcoin protocol can’t handle more than 3-4 transactions/second. Transaction verification has become a serious bottleneck. Users sometimes have to wait hours for verification of their transactions. To avoid getting stuck in a queue, they must pay a fee to the miners. The fee is rising and is currently over $0.40/transaction. As the user base grows, this is becoming more and more untenable.

The problem is the current size limit of 1 MB/block. There has been a heated debate within the Bitcoin community for years about raising the maximum allowed block size. The arguments in favour have been that a growing transaction volume makes this change inevitable. The arguments against have been that larger blocks are more difficult to mine. If only miners with specialised high-performance hardware can compete, concentration in the hands of the largest miners could potentially threaten Bitcoin’s decentralised architecture.

BU vs SEGWIT

The strongest resistance to an increase in block size has come from developers at Bitcoin Core, who control the Bitcoin protocol. The main proponents of an increase in block size are the large miners, primarily located in China.

Each camp has introduced its own upgrade candidate. Bitcoin Unlimited (BU) is supported by the miners. It is a hard fork and will replace the current size limit altogether. BU will allow the maximum permitted size to be increased by a consensus mechanism among the mining community. The alternative solution is Segregated Witness (SegWit), which is supported by Bitcoin Core. SegWit is a workaround that will increase security and block capacity while keeping the 1 MB block size limit intact. SegWit is a soft fork and can be introduced without breaking Bitcoin into two incompatible forks.

SegWit is not a long-term solution but the SegWit codebase has been tested more than BU (which recently crashed due to exploits). It would be possible to introduce SegWit now and BU at a later stage. The problem is the deep mutual distrust between the two camps.

Currently, around 35% of the mining community has signalled a willingness to adopt BU while 29% has gone for SegWit. In an ideal world, one side will eventually dominate. When 90-95% of all miners have settled on the same solution, they will activate the upgrade, and the minority will concede.

HARD FORK WAR

But in a less clear-cut situation, there is a risk that the BU side will try to force its agenda and the opposing camp will fight back. For example, if 65% of the miners decide to activate BU while 35% don’t, newly mined BU blocks will be considered invalid by the non-BU nodes and miners. If a hard fork is ever created, there will suddenly be two incompatible blockchains – and two flavours of Bitcoin. A coin that is mined in one fork will only be valid within that fork. However, owners of older Bitcoins will be unaffected. They will actually own Bitcoins in both forks and will suddenly have double the amount of coins. But this is not a windfall gain. The price of Bitcoins will probably nosedive. If a pre-fork Bitcoin was priced at $1200, the two forked versions might be priced at something like $650 and $350.

Two incompatible Bitcoins would confuse the market as the general public can’t be expected to understand these intricacies. People will buy cheap “Bitcoins” not knowing that they have bought into a fork (which might be the losing one). Merchants who accept Bitcoins will be forced to take sides, or accept both versions (at different prices). The damage to the brand value and public perception of Bitcoin will be severe.

If a hard fork is followed by a war, a lot of money is at stake and it will probably be dirty. Each side will do whatever they can to destroy the competing fork. Some players in the BU camp own large amounts of old Bitcoins and will probably dump the competing fork’s Bitcoin onto the market to drive the price down and destroy its credibility. The Bitcoin Core (SegWit) camp has threatened to change the software protocol to shut out the miners. Don’t be surprised if hacking and DDOS attacks are thrown into the brawl as well.

The best scenario would be that a fork is created when it has achieved 75-90% support or higher. Once the fork is implemented, it will be in the remaining miners’ interest to stop mining blocks on the pre-fork blockchain and switch to the new fork. The old fork will quickly die and a new consensus will be reached. This logic applies even if the majority is lower, but at some point (perhaps around 65%), the minority might choose the nuclear option.

CONCLUSION

The probability of a civil war is low. Both sides know that it would damage trust, the Bitcoin price, and Bitcoin’s brand value. The value of the two new Bitcoins would probably collapse during the conflict, and Bitcoin buyers from the wrong fork might lose all their money once the conflict is settled. The swift emergence of a clear winner is also in the interest of all current Bitcoin holders. By dumping their holdings in the losing fork, they will be voting with their wallets.