by Giovanni Colla Rizzi
These are turbulent times for cryptoassets: the week before Christmas, bitcoin dipped close to the $3,000 mark and Ethereum was trading around $83 meaning that both currencies lost roughly 50 since the end of summer.
This general fall in prices started on 15th November and is the effect of uncertainty in the crypto markets caused by a hard fork which happened to Bitcoin Cash, the fourth largest cryptocurrency by market capitalisation
What are forks?
Cryptocurrencies can be looked as sets of instructions according to which groups of users exchange value tokens. These instructions are inscribed in the software which makes each cryptocurrency run and must be downloaded on your hardware in order for you to be able to mine the currency or transact with it directly, without the inter-mediation of exchanges.
In most cryptocurrencies the software implementing the set of rules is open sourcemeaning it is visible to all and publicly modifiable. The reasons for this are that it guarantees transparency in the rules of the game and that it makes the cryptocurrency apt to being modified in order to better fit its environment, in a process roughly similar to that of natural selection. When users identifie a potential breach of security in the rules of the game or a misalignment of incentives of stakeholders, technical modifications can be independently implemented by a subset of users and then adopted by other players.
Open source means these two aims are a structural property of the currency environment, and do not need a centralized party to be attained.
The problem with open source software is that if a disagreement on the rules emerges and cannot be reabsorbed, the community splits (hard fork). Suppose a subset of miners wants to loosen the preexisting limit of the size of newly mined blocks from 32MegaBytes to 128MB in order to process more transactions per block (yes, transactions are just data, at least in the crypto universe). Suppose a different subset miners disagrees and wants to conserve the old rules. All new blocks mined under that rule will be considered as invalid by the second subset and with them all the transactions which they include.
Therefore, the miner pool of the currency will split in half and the blockchain will bifurcate. Each preexisting coin will be cloned into the new rule system and every new coin mined in the two branches will be totally invalid in the other branch.
The effect this has on security of the currency is negative, since the total amount of computing power used to secure transactions is halved. Furthermore, the fragmentation of the monetary environment has negative consequences for the use of the currency as a transaction tool, since currency is a network good and it is more useful the greater its community of adopters. These are the costs which come with the huge benefits of open source software in terms of transparency and flexibility.
What happened on 15th November
The Bitcoin community has long quarreled over the issue of scaling Bitcoin, namely the fact that Bitcoin has a maximum throughput of 7 transactions per second compared to the 2,000 transactions per second of VISA. This debate already led to the split between Bitcoin and Bitcoin Cash on the 1stAugust 2017.
What happened on November 15th is the latest Act in the diatribe. Bitcoin Cash (BCH) itself split in two trunks, that is Bitcoin Cash ABC and Bitcoin Cash Satoshi Vision, both of which competed to inherit official Bitcoin Cash (BCH) denomination and its place in exchanges. The main matter of contention was block size limit, which BSV wanted to increase from 32MB to 128MB. The fork and the subsequent standoff between the miners supporting each branch are the main cause of the aforementioned plunge in crypto prices.
To understand fully the dynamics in play one must consider the interests which lie behind the two currencies and behind BCH per se. In 2017, BCH forked away from Bitcoin because it proposed an increase in Block Size from 1.2MB to 8MB which then became 32MB. BCH was sustained by various large mining pools (sorts of miners’ unions), especially two pools managed by Chinese company Bitmain, which holds 75% of the market for ASICS (the only competitive hardware to mine Bitcoin and Bitcoin Cash). At the time it was rumoured that the move was more motivated form interest than genuine allegiance to Bitcoin as a transaction currency, given that large blocks favour incumbent miners over potential new miners or existing small miners, raising barriers to entry and mining scaling costs. It is extremely important to keep in mind that Bitmain currently manages also the two largest mining pools in Bitcoin, and holds 45% of the total computational power employed in the latter. The importance of this will become clear in a second.
Another supporter of BCH was David Wright, an Australian software developer who often claimed to be Satoshi Nakamoto himself and is the main actor behind the November 15thBCH split. Wright fell out with Bitmain’s higher echelons earlier this summer due to disagreements on how the BCH developers’ community was run and on the aforementioned scaling issue, proposing a radical increase in the block size limit to 128MB. The move is particularly daring: technical difficulties emerge as block size increases (as confirmed by the failures in the BSV network which occurred after the fork).
On the 15th of November Wright implemented his change of protocol, increasing size to 128MB as planned and cause the hard fork by moving his mining facilities away from BCH ABC to support his side of the chain. In a series of tweets he explicitly manifested his willingness to destroy Bitcoin ABC by mining empty blocks on its side of the chain (a move which would effectively paralise its network). In doing so he would with all likelihood be using excess computing power which he had kept concealed before then or rented for the occasion.
Following the fork, prices of both ABC and SV fell compared to the BCH quotation.
At the same time, the increase in computing power which Wright put in Bitcoin SV and Bitcoin ABC (in the latter, mining empty blocks) kept mining difficulty high. Therefore, miners were actively losing on both sides of the chain, resulting in losses for Wright but also for Bitmain. The logic behind what Wright was doing was to inflict losses on Bitmain counting on the fact that they had such a large stake in Bitcoin that they would pull away from Bitcoin Cash rather than mining at a loss.
However, Bitmain retaliated, shifting part of its mining rigs from Bitcoin to Bitcoin ABC, in order to increase its mining difficulty and counter Wright’s attempt to monopolise and destroy its chain. This can be seen in the spike in the yellow line on the 15thNovember in the figure below which plots Hash Rate (network computing power) on a time series.
For the following 2 weeks, Wright and Bitmain tried to out-power each other, the former holding his ground and not flinching in front of substantial losses, the latter periodically shifting computing power away from Bitcoin in the attempt to wear down Wrights resistance. The frequent spikes in the Hash Rate following the fork, which are more pronounced for the yellow line (BCH ABC), highlight this trend. The effect was that for two weeks the number of miners mining on Bitcoin was substantially lower than before. Furthermore, the widespread uncertainty on BCH’s price led many investors to liquidate their positions in Bitcoin altogether. This led to a fall in Bitcoin prices, which made Bitcoin mining less profitable (miners’ rewards are denominated in Bitcoin), further reducing the number of miners in Bitcoin. This is reflected in the great slump in the amount of energy used by the Bitcoin network, which has experienced the greatest drop in years (see below).
In the following weeks the situation stabilised, with the consolidation of Bitcoin SV as a new currency in the crypto universe. Its market capitalisation and price are currently rivaling that of BCH ABC. Overall, BCH and BSV are estimated to have experienced mining losses of more than $10 million and $7 million respectively in the confrontation.
The November 15th fork marked a watershed in crypto. For the first time, phenomena happening in currencies other than Bitcoin influenced the latter’s price. Furthermore, it is the first time a fork receives such extensive coverage and is followed by a computing power rally with the objective of mutual destruction. Notwithstanding the fact that this specific fork had a negative impact on the crypto economy as a whole, it would be wrong to draw the conclusion that forks are per se bad for cryptocurrencies. They endow Bitcoin and its sister currencies with a remarkable property of self-engineering and adaptability to adverse circumstances which makes them complex system not unlike rudimentary living creatures. That this comes with the cost of multifariousness is in the law of things.