[header date=”20 November 2018″]Could forking kill crypto? We discuss why bitcoin cash’s split threatens the coin’s future, the IMF’s vision of a digital future, and bitcoin owners’ glum Thanksgiving.[/header]
Forks ad infinitum
Forks are one of the most peculiar concepts in the cryptocurrency world. For investors coming from a finance background (as opposed to computer scientists), they don’t make much sense. How can you split an asset in two but end up with twice as much?
While the financial media occasionally compares crypto forks to stock splits, the analogy doesn’t hold up. With stock splits, each share represents a proportionately smaller claim to ownership in a company but the total ownership doesn’t change.
Instead of a stock split, crypto forks are more like cloning a company, and running the new version as you see fit. If a person owned one share in the original company, then, after the fork, that person owns two shares—their one share in the original company, and one share in the newly-created company. Forks happen when developers have competing priorities for their cryptocurrencies which require modifying their underlying code.
Cryptocurrency owners experienced this when bitcoin forked into bitcoin (BTC) and bitcoin cash (BCH) last year, and bitcoin cash holders just went through it again during last week’s fork into BCH ABC and BCH SV.
How does the market decide which version is more valuable? Or whether a fork has any value at all?
In the same way that society has clustered around a few social media giants, cryptocurrency investors have legitimized some digital assets far above the rest. Alternatives crop up, but rarely attract users, garner media attention, or grant much value to their adopters.
To some degree, the network effects which drive Facebook’s popularity also allow a few coins to reign supreme. Since an overwhelming majority uses—or at least, acknowledges—the entrenched giants (often, the first movers), it’s hard for competitors to gain a foothold in the market. In the crypto world, it also matters which token developers support which forks, since they’re the technocrats the masses follow.
Unlike building a new social media company from scratch, forking a cryptocurrency requires almost no overhead or investment. In fact, if you wanted to fork bitcoin today, you could do it. So what prevents people from creating thousands of versions of bitcoin? Well, technically, nothing. In fact, the prospect of future forking threatens to undermine its value (paywall).
However, the real obstacle—or defense, depending on how you look at it—is achieving widespread legitimacy for the new coins. As Ethereum founder Vitalik Buterin wrote earlier this year, “Issuing new [crypto]currencies is nearly free, but issuing new currencies that people care about requires an increasing amount of ‘marketing as proof of work.’” That is, in order to attract users and get listed on an exchange, a person must get the word out about their promising new coin—and that costs money.
Most immediately, the split of bitcoin cash demonstrates that forking a cryptocurrency can prove injurious to the market. The splintering of the BCH community makes each resulting coin less robust. As hash power is divided between the chains, it’s like a nation’s army dividing in two. Furthermore, if a coin’s future is dictated by competing factions led by charismatic developers, then decentralization becomes even less attainable. Indeed, if just a few people or mining groups can control the future of a fork, then that might be the real threat to the potential value of the new coins.
We live in an irrational world, where greed can overwhelm logic, and the new BCH branches could wind up becoming vehicles for speculative investment. It would be wholly unsurprising if bitcoin’s offshoot’s offshoots gain recognition and trading volume on exchanges. Ultimately, from a trading perspective, whether the fork is good or bad for BCH’s original holders depends on how listings, trading volumes, and prices are impacted—and for the moment, that’s anyone’s guess. —Matthew De Silva
[supplemental headline=”Market Chatter: bitcoin’s holiday blues”]
A year ago, US crypto investors were looking forward to a triumphant Thanksgiving. Bitcoin was trading at about $8,200 and after a minor October correction, heading north again. There could be no better time for gloating over naysaying uncles and convincing reluctant cousins to invest than over a meal for giving thanks.
Much has happened in the last year, and little of it good for investors who didn’t sell near the top. After cresting $20,000, bitcoin has been in a steady slide that sped up alarmingly in the last few weeks, falling 24% since Nov. 7, and giving up a year’s worth of gains. On Monday bitcoin fell below $5,000 for the first time since October 2017.
There’s no one reason for the sell off, but a few factors have been working against bitcoin and its cousins. Fallout from the bitcoin cash fork (discussed above) seems to be creating uncertainty across all cryptocurrencies, while recent SEC enforcement actions against decentralized exchanges and ICOs may be adding another layer of chill. The crypto markets may also be finally catching up with other asset classes which have stumbled over the last month, as fears that a trade war and the prospects of an economic downturn have investors everywhere asking if the good times are going to end sooner rather than later. As equities start to head south, crypto-investment dabblers may figure it’s time to cut their losses in their riskier hedges.
It was only three weeks weeks ago that Kevin Davitt, a senior instructor at The Options Institute at Cboe, was noting how bitcoin futures appeared stable in light of the stock market volatility. Life comes at you fast in the crypto world, and this Thanksgiving investors may just be grateful that the holiday weekend’s lower trading volume could pause the slide.
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The IMF offers a sober evaluation of cryptocurrencies
This past week at the Singapore Fintech Festival, the managing director of the International Monetary Fund, Christine Lagarde, addressed the “case for new digital currency.” She touched upon the role of cryptocurrencies in the global economy and offered a quick but insightful assessment.
“For their part, cryptocurrencies seek to anchor trust in technology,” Lagarde said. “So long as they are transparent—and if you are tech savvy—you might trust their services. Still, I am not entirely convinced. Proper regulation of these entities will remain a pillar of trust.”
In other words, even though proponents claim cryptocurrencies operate independently of the state, in practice, they are subject to governmental rules and oversight. Also, there exists a great divide between cryptocurrency programmers and the mass of cryptocurrency users, who know little to nothing about how they work under the hood and have little reason to trust them.
A staff discussion note released in conjunction with Lagarde’s speech expanded on the IMF’s perspective. The organization deemed cryptocurrencies the “least attractive option” among competing forms of money (emphasis added), explaining that cryptocurrencies might afford anonymity, but received a low score for settlement speed. Furthermore, the note explained, “cryptocurrencies are different along many dimensions and struggle to fully satisfy the functions of money, in part because of erratic valuations.”
Lagarde’s remarks reflected the drive toward a cashless future (as borne out by the IMF’s own research), but seemed to pause at the suggestion of central bank digital currencies based on blockchain. In fact, as David Gerard, author of “Attack of the 50 Foot Blockchain” pointed out, Lagarde didn’t mention blockchain even once in her speech.
What the IMF pointed toward was a digital future which might enhance financial inclusion, consumer protection, and privacy. Lagarde raised important questions about how to prevent monopolies, how the private sector’s role might evolve, and what degree of anonymity might be acceptable. Cryptocurrencies might help answer those questions, but from IMF’s vantage point, they’re hardly the only solution.
[supplemental headline=”De-jargonizer: 51% attack”]
In the cryptocurrency world, majority rules. That means if one miner or group of miners collectively controls more than 50% of a blockchain’s mining power, they can disrupt the network. They can stall payments by preventing the confirmation of new transactions (not unlike the majority party in the US senate preventing a confirmation hearing for a president’s Supreme Court nominee). Miners who control more than 50% of hashpower can also spend coins and unilaterally reverse that spending after they receive their goods or services—a dubious practice known as “double spending.”
If one party has all that power, it leaves the affected cryptocurrency vulnerable to a “51% attack” and undermines the credibility of the network (thus defeating the ostensible purpose of a blockchain). This is particularly relevant toady because the bitcoin cash split leaves its resultant coins—BCH ABC and BCH SV—more vulnerable to such attacks, since less hash power is needed to gain a majority in each of the new offshoots. In fact, according to bitcoin journalist Kyle Torpey, Bitmain—the company that makes the popular AntMiners—recently possessed more than 50% of hash power for BCH ABC through its mining pools.
You can follow the hash rates of BCH ABC and BCH SV respectively here.
[mailto filter=”Jargon” subject=”De-jargonize this…”]Heard a new crypto term? We can tell you what it means.[/mailto]
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