What are Crypto Forks and How Do They Affect Investors?
If you've been around the crypto space long enough, you've probably heard about crypto forks. So, what are they exactly?
Those who have been in the crypto space long enough will likely have heard of the term crypto forks before. One of the most notable ones being the hard fork that created the Bitcoin Cash (BCH) from Bitcoin (BTC). So, what are crypto forks anyway – and how do they affect investors?
A fork event is generally considered to be a rare occurrence in the crypto space, but when it does happen it often triggers a reaction from investors. Raoul Pal, CEO & Co-Founder, Real Vision Group & Global Macro Investor, revealed that he had actually held Bitcoin a lot earlier but sold his position in 2017 when there was a hard fork event:
“Bitcoin was supposed to be a store of value, you couldn’t mess with the formula… and now they are talking about a ‘hard fork’ changing it?”
For many investors who do not know what a hard fork is, many shared similar sentiments to Raoul and probably followed his course of action. However, since then, Raoul has reaccumulated his Bitcoin and has been more bullish than ever.
That said, as a savvy crypto investor, understanding crypto forks will help you anticipate and get a better idea of the bigger picture in the crypto space. In this article, we will discuss what cryptocurrency forks are, how they work, as well as their impact on the value of cryptocurrencies.
What are crypto forks?
Since the birth of Bitcoin, many other new cryptocurrencies have been created, and some of these were not built from scratch but were a result of a fork. For example, Bitcoin Cash, Bitcoin SV, and Bitcoin Gold.
In its broadest sense, a fork is a change in the blockchain’s protocol that the software uses to dictate whether or not a transaction is valid. To put things simply, any divergence in the blockchain can be considered a fork.
How do crypto forks work?
A fork can occur when the participants of the blockchain or developers decide that something fundamental about a cryptocurrency needs to change.
While forks may be initiated by developers or members of a crypto community who might be dissatisfied with the existing functionalities offered by the blockchain, they may also emerge as a way to crowdsource funding for new technology projects or cryptocurrency offerings.
In short, crypto forks occur when there is a split in the consensus of participants in a particular network. And as a result, what was once a single blockchain network splits into two.
To change the existing protocol of a blockchain, developers have to actively alter the code. This process results in permanent change and has severe consequences.
When a fork occurs, participants of the blockchain network decide which version of the network they are to work with. Typically, there are two types of crypto forks, Hard Forks and Soft Forks.
What is a hard fork?
Within blockchain technology, a hard fork (or hardfork) occurs when there is a radical change to the network’s protocol. This may result in previous invalid blocks and transactions being validated, or vice versa. However, for a hard fork to occur, all notes or blockchain participants are required to upgrade to the latest version of the protocol software.
What is a soft fork?
On the other hand, a soft fork is a change to the software protocol where only previously valid transaction blocks are made invalid. This is possible because the old nodes in the blockchain are able to recognise the new blocks as valid. As such, a soft fork is backward-compatible. This kind of fork requires only a majority of the miners upgrading to enforce the new rules, which differs largely from a hard fork that requires all nodes to upgrade and agree on the new version.
Hard versus soft fork
When a soft fork occurs, only one blockchain will remain valid as users adopt the update. Whereas with a hard fork, both the old and new blockchains will co-exist. As such, the adopted software must be updated to work by the new rules.
Although both forks create a split, a hard fork creates two blockchains and a soft fork is meant to result in one.
What happens after a crypto fork?
For the everyday investor, forks may sound too technical and therefore service as a barrier to crypto investment. However, a crypto fork may not always be disruptive. These are some of the expected outcomes of a crypto fork:
Winner takes all! (One dominant blockchain)
Since a fork will result in two blockchain networks, there is a chance that one blockchain may gain more attention and therefore adoption than the other. As such, the resulting blockchain with the larger group of participants and ecosystem becomes the dominant blockchain.
Why not both? (The adoption of both blockchains)
There are cases where the resulting blockchains from a fork operate independently from one another and are able to derive in their own following. In such cases, both blockchains are able to flourish.
The impact of crypto forks
Crypto forks can affect cryptocurrency prices, either negatively or positively.
As observed by Raoul Pal, people may be shaken out of their positions. One such example was Ethereum’s Constantinople upgrade. This crypto fork negatively affected Ethereum’s price.
On the contrary, the Litecoin hard fork is an example of how crypto forks can positively affect cryptocurrency prices. Litecoin’s hard fork resulted in the creation of a new coin, and therefore, the altcoin’s price rose tremendously.
Cryptocurrency forks can result in both negative and positive effects on the price of the crypto asset. Whatever the impact, crypto forks are essentially for blockchain networks to improve their protocol and ability to scale.
Hopefully, this article has been insightful for those of you wondering what crypto forks are! To learn more on all things crypto, explore our library of in-depth articles and guides on the Easy Crypto Hub.