Bitcoin’s civil war threatens to blow up the cryptocurrency itself

Future of Finance
Future of Finance

It is not uncommon for a new technology still finding its footing to undergo periods of tumult—witness the long ago war over videotape formats VHS and Betamax.

Bitcoin, the cryptocurrency growing in popularity, turns out to be no different. For the last several years, technical experts have been arguing over how to adapt the currency’s software to allow it to handle more transactions and meet the increased demand. The debate has recently become so heated that it threatens to throw bitcoin itself into chaos, a phenomenon most clearly seen in the recent plunge in bitcoin’s price.

The conflict threatens to “fork” bitcoin, splitting it in two. Each branch would run a different version of the cryptocurrency’s software. Bitcoin’s principal innovation has been its blockchain, an immutable ledger of all the transactions ever performed with the cryptocurrency. A fork would generate two versions of the ledger, creating practical problems, like coins that could vanish, and philosophical ones, like agreeing on which blockchain represents the one, true, bitcoin.

The tension reached a fever pitch last week when bitcoin’s top exchanges (with some notable exceptions, such as Coinbase) issued a joint statement explaining how they would deal with the split, called a hard fork. This acknowledgement of the very real possibility of a fork sent bitcoin traders scrambling to sell their holdings. Bitcoin fell 24% over two days, from March 16, though it has recovered significantly.

Both camps have doubled down on their positions, and the saber rattling is growing louder. There is talk of of changing the proof-of-work algorithm that bitcoin runs on, which could render the bitcoin mining industry, which earns millions a day in revenue, useless in one fell swoop. Miners—who process transactions and also increase the total supply of bitcoin in circulation—are now threatening legal action against developers who are working on such a proposal. There’s also a widely circulated conspiracy theory that involves John McAfee, the anti-virus entrepreneur who’s embroiled in a murder case in Belize. McAfee is supposedly colluding with a powerful Chinese miner to force a fork.

The arguments

The bickering over the right way to grow bitcoin’s transaction capacity is known as the block size debate. It has been raging for years. Last January it claimed a famous victim: longtime Core developer Mike Hearn, who quit the bitcoin world dramatically (paywall) because of the block size impasse. As if on cue, Hearn’s departure was dismissed as a “whiny ragequit” and the battle continued.

The squabble over block size has divided the bitcoin world into the Bitcoin Core and Bitcoin Unlimited camps. The Core group, trading under the current BTC ticker, wants to solve the transaction problem by implementing a clever workaround called Segregated Witness, or SegWit, that will effectively increase the block size from the current 1 megabyte to 2 megabytes. The 1 MB restriction was an arbitrary limit put in place by bitcoin’s creator, Satoshi Nakamoto; some speculate it was to ensure that the bitcoin blockchain could be easily downloaded by users, and thus encourage adoption. In any case, it was a problem to be dealt with only if bitcoin succeeded.

The Bitcoin Unlimited camp, which would trade under a new ticker symbol BCU, wants to remove any restriction on block size and thus transaction capacity. But that would force a hard fork and two bitcoins would then inhabit the Earth. The Unlimited camp is backed by Roger Ver, an early bitcoin adopter whose relentless evangelizing for the cryptocurrency earned him the moniker “Bitcoin Jesus.” Unlimited is also backed by major miners, and part of its pitch is that miners should decide on block sizes. It proposes to do this by letting miners set their own caps for blocks, reasoning that eventually, miners will come to an agreement about what the optimal block size should be.

Supporters of Core argue that the Unlimited code is riddled with bugs. Indeed, last week a bug was exploited, sending 70% of Unlimited nodes offline thus reducing the amount of processing power devoted to implementing it.

But Core is making a larger, philosophical point, about who controls the bitcoin network. They don’t like the idea of miners setting block sizes because they believe it increases centralization of bitcoin. Without a block size cap, powerful miners can simply mine bigger blocks, and thus be responsible for larger chunks of the bitcoin network, entrenching themselves further.

Coffee money or digital gold?

There’s also a struggle about bitcoin’s function. As Adam White, who runs the GDAX exchange, tells Forbes, the Core camp wants to treat bitcoin as digital gold: a finite resource whose fundamental properties can’t be changed. The Unlimited folks want bitcoin to be digital cash, with limitless transaction capacity so that everyday payments can be recorded on the blockchain. Vinny Lingham, a noted analyst of the bitcoin industry, observes: “Roger [Ver] wants cheap coffee transactions, Core wants to ensure [bitcoin is] sufficiently decentralized and secure.”

Still, bitcoin’s blocks are getting filled up, meaning transactions can’t be processed quickly enough—hence the urgency for a solution. Critics say that Core developers’ proposal for a 2 MB block size, SegWit, simply delays the inevitable—a hard fork—because it doesn’t raise the cap enough. A solution to Satoshi’s block size limit can no longer be avoided.

Who’s winning?

So who’s winning? One exchange has opened what is effectively a prediction market for a hard fork. It lets traders buy tokens representing the adoption of either Core or Unlimited. If Unlimited isn’t adopted, and a fork doesn’t occur, Unlimited tokens become worthless. By this measure Core is winning: tokens representing its adoption are worth four times the Unlimited tokens.

But Unlimited is gaining ground among miners. About 40% of the processing power, or hashrate, on the bitcoin network supports Unlimited, compared to 60% supporting Core, according to analytics site Coin Dance. And the gap is rapidly closing.

The picture isn’t as simple as who’s got more hashing power. In order for Core’s SegWit proposal to be adopted, 95% of hashing power must be devoted to it, according to a threshold set by its developers. Unlimited doesn’t have a fixed threshold. Instead, it relies on a rather circular logic: It can only be adopted if miners decide to admit blocks larger than the current 1 MB, but miners would only have an incentive to so if other miners did the same. “It’s kind of like people getting together to cross a road. Everyone holds hands and then someone decides to cross and everybody crosses with it,” one Redditor explained.

A hard fork isn’t unprecedented for a major cryptocurrency. Ethereum experienced this after a hack, birthing what’s now known as ethereum classic. The fork also arose from ideological disagreements: The solution to the hack was to undo some transactions, which struck some ethereum users as an unprincipled move. A blockchain’s immutability is one of the pillars of the cryptocurrency world. Today the two coexist; there is even a publicly traded ethereum classic fund for the over-the-counter markets, although the value of all ethereum in circulation is about 18 times greater than ethereum classic.

But ethereum is a lot younger than bitcoin; it was only a year old when it split. The value of all ethereum in circulation is about a quarter of bitcoin’s current $17 billion value. A messy hard fork for bitcoin could mean serious disruptions for miners, who operate industrial-scale facilities, the well-funded exchanges, and the myriad startups who have raised $1.5 billion in venture capital collectively since 2012. A lot is riding on the question of how to scale bitcoin, and the conflict is showing no signs of easing up.

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