How Would a Hard Fork Affect Bitcoin’s Usefulness as a Store of Value?

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Bitcoin Forking

A loud segment of the Bitcoin community has been pushing for a hard-forking increase to the block size limit for over a year now, but multiple efforts have failed to activate a fork up to this point. Both Bitcoin XT and Bitcoin Classic were unable to gain a significant share of the network hashrate, but the most recent attempt at a hard fork, Bitcoin Unlimited, currently enjoys explicit support from two bitcoin mining pools, ViaBTC and Bitcoin.com, which amounts to roughly 8 percent of the network hashrate.

In a recent bitcoin price report from Needham & Company, the financial services company shared their concerns related to the effect a possible bitcoin hard fork could have on the price. The report stated:

“If there were a significant number of users and transaction processors (‘miners’) on the network that elected to choose an alternative version of the Bitcoin software, [then] the Bitcoin network could fork and potentially result in two different blockchains. This could have a significant adverse effect on the price, perception, and usage of Bitcoin.”

The case has often been made that bitcoin is like a digital gold; however, the digital currency’s usefulness as a store of value must also be balanced with the ability to make censorship-resistant payments on the network. Much of the divide in the Bitcoin community can be seen as, at least partially, a debate between the digital gold and peer-to-peer payment use cases.

Parties on both sides of the debate have their own ideas on how these use cases can be preserved over the long term. The desire to allow more payments to take place on the Bitcoin blockchain is the main driver behind the various hard fork initiatives that have popped up over the past year or so. But how would a hard fork impact the perception of bitcoin as a digital gold?

A Hard Fork May Result in Two Chains

The main issue with a hard fork from a technical point of view is that it requires all users to basically move over to a new blockchain with different rules. For this reason, some members of the community would oppose a hard fork in all scenarios, with the exception of a situation where a bug is found at the protocol level (or some other uncontentious change).

“Nobody is in a position to enforce a hard fork (miners in particular, but that goes for everyone else in the ecosystem as well),” Bitcoin Core contributor Eric Lombrozo told CoinJournal. “A contentious hard fork will almost certainly result in a split network, along with all its consequences.”

Indeed, the Ethereum blockchain hard forked earlier this year in an effort to return ethers (the currency of the Ethereum blockchain) back to users who decided to put money into a vulnerable smart contract for a decentralized venture capital funding effort known as The DAO. The disagreement within the community over whether this course of action should have been taken led to roughly 15 percent of the mining hashrate and price speculation remaining on the original Ethereum blockchain (now known as Ethereum Classic) and not moving over to the new, hard-forked chain.

One distinction to be made with ether is that it is often viewed as the fuel for decentralized applications on the Ethereum network rather than some sort of digital gold.

Some argue that the difficulty adjustment algorithm in Bitcoin would prevent a chain with much less hashpower from continuing after a hard fork. There are two issues with this claim. For one, miners do not control the protocol rules. While miners may decide to create bigger blocks, full nodes do not have to move over to this newly created blockchain. Once 75 percent of the network hashrate has decided to start mining on a different chain with a larger block size, speculators on exchanges would likely be the ones who decide whether or not miners stay on that new chain. After all, if the economic majority sticks with the original chain, then the miners are incentivized to abandon the new chain and return back to the original chain.

Another issue with the arguments surrounding Bitcoin’s difficulty adjustment algorithm is that the weaker chain could decide to change the difficulty adjustment algorithm (and perhaps the proof-of-work algorithm as well) via a hard fork. Since the blockchain would essentially be crippled without this change to the consensus rules, the argument could be made that this is a necessary hard fork that fixes something broken at the protocol level.

There are a lot of unknowns when it comes to hard forks, but what is clear is that the possible existence of two notable blockchains after the hard fork depends on a combination of network effects and the level of contentiousness of the change to the consensus rules.

The Risks of Hard Forking

According to Needham & Company’s Spencer Bogart, a split into two chains is the key problem to fear in a hard fork scenario. “If two chains survive and one is not vastly more powerful than the other, I’d expect it to be negative for Bitcoin’s perception as a digital gold,” Bogart told CoinJournal. “It’s hard to imagine how it wouldn’t be negative but there are too many variables at play to know with certainty—It doesn’t feel worth it to risk it, especially with [the] looming possibility that we may soon be able to do many of the great things that we want to do with Bitcoin on second layer networks (especially [with] Segregated Witness).”

Segregated Witness is a soft-forking change to the Bitcoin protocol that provides a variety of technical improvements without requiring everyone to move over to a new chain. Much like a hard fork increase to the block size limit metric, Segregated Witness will increase the effective capacity of the network from 1MB to an estimated 2MB or more of transactions per block. Segregated Witness also enables more elegant versions of layer-two protocols for Bitcoin, such as the Lightning Network, that could allow users to move the settlement rights to bitcoins around without having to touch the blockchain. The blockchain is essentially used as a court to settle disputes under this system.

Bogart added that he believes those who are advocating for a hard fork have the best of intentions. His best guess would be that a hard fork would be a short term negative for Bitcoin that would eventually look like a small speed bump in Bitcoin’s upward trajectory, but he added, “I don’t want to find out.”

Bogart’s cautious perspective on the debate surrounding a hard-forking increase of the Bitcoin block size limit could explain Needham & Company’s general support for the Bitcoin Core scaling roadmap.

The Risks of Not Hard Forking

Early bitcoin adopter and angel investor Roger Ver has become the loudest voice among those who wish to see a hard-forked increase in the block size limit. When asked for his perspective on a hard fork’s impact on the price and perception of bitcoin, Ver admitted that there could be some effect, but he claimed there are consequences of not hard forking as well.

“Companies like Coinbase, who used to be staunchly Bitcoin only, are now integrating altcoins as a direct result of Bitcoin not being allowed to scale in a timely manner,” Ver told CoinJournal. “I see Bitcoin not being allowed to scale fast enough to keep up with consumer demand as a much much bigger risk. People who want to use Bitcoin right now are being turned away because of a future potential danger . . . The fact that it is already so easy for people to switch away from Bitcoin thanks to services like Shapeshift.io make the potential forking of Bitcoin into two coins a much less serious issue.”

In addition to Coinbase, Ver also pointed to Jaxx, which is a blockchain wallet that integrates multiple cryptocurrencies, as another example of bitcoin losing its role as the only digital asset worth mentioning. Due to the limit on the number of transactions that can fit in a block, users are sometimes forced into an effective bidding war for a spot in the next block. To Ver’s point, users may be turned off and look for alternative options if transaction fees are too high, but the network effects around Bitcoin also mean there is a good bit of friction when moving to another cryptocurrency.

Ver shared his frustration with Bitcoin Core contributors’ lack of support for a hard-forking increase to the block size limit, which he feels would attract more users due to an increase in the supply of block space (and thus an effective lowering of transaction fees):

“Unfortunately, we are seeing the current [group of Bitcoin Core contributors] not only voicing loud and vociferous opinions on things they are completely ignorant about, but implementing those opinions in Bitcoin to the detriment of the entire ecosystem,” said Ver. “Sadly, they don’t realize that the economic code underlying bitcoin is just as important to its success as the software code.”

Ver sees disagreements with a recent tweet of his as proof of economic illiteracy from Bitcoin Core contributors and supporters. “When the cost of using something goes up, people use less of it. This means high bitcoin tx fees are causing fewer people to use bitcoin,” read the tweet in question.

“The reason I was able to recognize the importance of Bitcoin before every single other businessman in the world, and before nearly all of the tech people as well, was because I understood what makes money money, due to my lifelong passion for studying economics,” added Ver.

While it’s true that higher fees will make on-chain transactions less attractive for users, general use of bitcoin has continued to increase as the capacity limit is approached. The bitcoin price has continued to rise over the course of the year, the network hashrate has strengthened after the halving event, and while on-chain transactions saw a bit more growth in 2015 than 2016, Xapo CEO Wences Casares has claimed their off-chain transactions have “skyrocketed” since January as well.

Higher on-blockchain transaction fees are potentially an issue that affects those who are using Bitcoin for censorship-resistant payments more than those who use mainly use it as a store of value. A hard fork that splits the hashing power and network effects gained by Bitcoin over the years into two parts may have a bigger impact on long-term speculators. However, it should be noted that Bitcoin’s censorship-resistant payments also rely on a large amount of hashing power to be pointed at the network to make it difficult for one party to reject certain types of transactions. That hashing power is incentivized by block rewards, which have value because some people view bitcoin as a store of value or digital gold.

Having said that, Ver made the point that transportability is also a key component of any effective money. “Bitcoin being ‘digital gold’ is just a made up concept,” he said. “Most people have no idea why gold or Bitcoin has value. Bitcoin needs to have all the properties that make money, if we want people to use it that way.”

Ver then pointed to a slide he claims he’s been using in presentations about Bitcoin since 2013 that listed various attributes of a good money: hard to counterfeit, scarce, easy to store, divisible, homogeneous, durable, and easy to transport. In Ver’s view, the current block size limit is destroying bitcoin’s ease of transport and is also damaging to its homogeneousness. “If a digital asset comes along that has these properties to a higher degree than Bitcoin, people will start using it instead,” he added.

For now, it appears the hypothetical digital asset that could replace bitcoin is not an active threat. While Coinbase and Jaxx are allowing easier access to alternative cryptocurrencies, it’s worth noting that bitcoin is still the only digital asset being used in any meaningful way. The best available data to see if users are switching from Bitcoin to alternative blockchains for payments due to higher fees is the number of transactions happening on these various networks per day, and there is no indication that other blockchains are seeing an increase in activity. For example, while Ethereum saw a large increase in transactions per day in the first half of the year while the ether price started to take off, this growth in transactions has stalled in the aftermath of The DAO, the controversial hard fork, and recent DOS attacks.

If there are users being left out of Bitcoin due to the block size limit, they don’t appear to be moving to other blockchains en masse; however, it would make sense to keep watching these sorts of stats.

For what it’s worth, Ver pointed out that more than 90 percent of the stake in a bitcoin shareholder vote of sorts supports a hard-forking increase to the block size limit. Of course, the issue with this metric is it accounts for less than 1 percent of all potential stakeholder votes.

Both sides of the debate appear to be concerned with a theoretical danger rather than one that is actively playing out in front of our eyes. One camp is afraid of the potential downside of a hard fork, while the other side believes an alternative cryptocurrency will eventually see more adoption due to Bitcoin’s hard-coded block size limit.