What is a cryptocurrency fork?
Most major cryptocurrencies require a ‘fork’ at some point. You might have heard the terms ‘hard fork’ and ‘soft fork’ mentioned too. But what is a cryptocurrency fork? And why are they sometimes necessary?
First, you need to understand a little about how cryptocurrencies work. Cryptocurrencies such as Bitcoin, Ethereum and others are based on a technology called the blockchain. Each transaction – when one person pays another using coins – is bundled together into a block. Each block is then verified by computers on the network known as ‘miners’, then added to the ongoing chain of transactions. A cryptographic code, called a ‘hash’, ensures that the blocks are not tampered with and keeps the chain intact.
How blockchains work
The blockchain forms a ledger of transactions which is shared with everyone on the network. This means that no one source controls the currency and if any part of the network tries to tamper with previous blocks, the rest of the network will see it.
This works well for keeping the cryptocurrency secure and decentralised, but it means that any time the community wants to make changes to the system, such as changing the rules for mining, it will have to change the underlying code, breaking the chain. This break in the chain is what’s called a ‘fork’.
The need for forks
A fork effectively creates two versions of the blockchain; one that continues as before and another that reflects the change to the underlying system. In a soft fork, the new network will continue to recognise the transactions on the old one. The old chain, which does not have the update, will not reflect transactions from the new one. That means the new network effectively replaces the old one entirely, making it obsolete.
A soft fork is used when the entire network accepts the change that is being made, for example, an update that simply makes the network run more smoothly.
When the members of the network cannot reach a consensus about how to proceed, then a hard fork is sometimes called for. This creates two entirely separate networks, neither of which will recognise transactions on the other.
This is what happened in the case of Bitcoin Gold. Those backing Bitcoin Gold were concerned that power within Bitcoin was becoming too concentrated, primarily because mining was becoming increasingly expensive. They wanted to change how mining worked so that individuals, or small groups, could once again mine profitably.
They proposed changes to the mining algorithm, but not everyone agreed. Ultimately, it was decided that there would be a hard fork. Bitcoin Gold would split from Bitcoin and the two blockchains would proceed entirely separately.
A similar hard fork occurred within Ethereum following an incident where somebody exploited a loophole in the system to remove $50M of investors’ money from a distributed application running on the network. Part of the community wanted to fork and repay investors and part did not. The part that did not became Ethereum Classic after the fork.