Occasionally, users of cryptocurrency will see wild price fluctuations related a phenomena called a fork. Let us explore what causes a fork and the potential ramifications of this event.
To overly simplify, cryptocurrency uses computer generated code to create a form of digital money. Bitcoin was the first to gain popularity; however, hundreds of such coins such as Litecoin and Dogecoin now exist.
The advantage of cryptocurrency is that it is mostly a decentralized peer-to-peer payment network that eliminates much of the overhead related to credit and to banking.
The term cryptocurrency was developed as the coins themselves are encrypted sections of the public ledger commonly known as the “blockchain”. This ledger contains all bitcoin transactions so that each user can verify the validity of each transaction using his or her computer. Each transaction must carry digital signatures and sending addresses to be considered authentic. Anyone can add a new page to the ledger when they have the right solution to the mathematical equation contained with the coin’s programming code.
Just like any other computer program, the code of a specific coin can be upgraded and altered to help the coin flourish. These changes must be made very carefully to keep new coins compatible with older coins. Applications accessing and altering blockchain must all be able to read and write the data correctly and consistently.
What causes a fork?
Forks can occur from two different events. An accidental fork occurs if coin updates are not truly compatible. People using different versions of the software create two different ledgers–one from the older version, and one from the newer version. In this circumstance the coin developer must rapidly eliminate the bugs causing the incompatibilities and decide how to merge the different blockchains.
A hard fork is generated when the cryptocurrency’s developers decide that changes must be made to the programming of the coin that will create incompatibilities between the older and newer version. When the changes are made, all users of that coin must willing to update all applications to continue to use that coin type correctly.
If this is confusing, let us use Microsoft Word for example. Microsoft frequently releases new versions of Word. Each version attempts to be backwards compatible and retain the ability to read and edit older documents. However, often older versions of Word have great difficulty in reading documents created in one of the newer versions. So if you create a document in Word 2007 and your buddy edits and saves it in Word 2013, you may have problems reading it. Despite the assumption that its going to be the same document, you two have created a fork in your document.
Why are forks bad?
Often forks are associated with great anxiety and panic within a cryptocurrency. When two different blockchains exist, only one can ultimately be correct. Thus, coin transactions found on the “wrong” blockchain could ultimately be lost. Therefore, during a fork event people will be warned to make not transactions until that fork can be resolved.
Forks are very painful for companies that depend on that type of coin. As transactions could be lost during the fork, business using that cryptocurrency are handcuffed. Additionally, forks cause a tremendous amount of work through a coin’s community as all the associated software must be updated to the coin’s latest version. Users, exchanges, miners, and many others must update to prevent the loss of coin.
Any potential for lost coins can scare users away from using a particular cryptocurrency. Frequent software updates and additional work can cause exchanges, business, and users ultimately to switch to a more stable coin type. A less popular coin is a less valuable coin. In theory if a fork is not fixed, this would cause a complete incompatibility and two different versions of the coin. In the incredibly competitive cryptocurrency market, the community would be unlikely to tolerate this. The value of a permanently forked cryptocurrency would rapidly become worthless.
Ultimately, a fork is a stressful event to a cryptocurrency community which frequently increases risks associated with that particular coin type. As coin investors weigh these risks, some will choose to sale. Often during a fork event the coin’s value will fall. If the fork puts in the coin’s long term survival at risk, this drop is value is warranted. Conversely, if the fork ultimately improves the coin’s stability and structure through code improvements, a fork can be an excellent buying opportunity.
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