Why hard forks are so important to digital currencies

Hard forks, such as the one happening with the Bitcoin Cash protocol this week, can be characterised as little more than a software update. Their importance to the future of cryptocurrency, however, is not just technical – it’s philosophical too. 

At 1600h UTC (5pm BST in the UK) yesterday, Bitcoin Cash (BCH) undertook a ‘fork’, which is basically a cryptocurrency turn of phrase meaning it updated its software. Its team have made several changes and additions to the code that underpins it, chief among them being an increase in the maximum block size from 8MB to 32MB – harking back to the initial schism that bought about the birth of the cryptocurrency in the first place – and allowing faster transactions (over 200 per second, we’re told). There will also be the addition or activation of several other features, that will allow the limited creation of smart contracts as well as other new functionality possibilities.

A hard fork is, to all intents and purposes, the creation of a new cryptocurrency – a code change large enough to require all nodes that form part of the network to update their software or be excluded from mining the new currency. That is what is happening here, though the vast majority of people with Bitcoin Cash in their wallets will not notice anything – unless something goes really, really wrong.

Unlike the original creation of BCH, which saw those with Bitcoin assets receive the same amount of Bitcoin Cash coins, no new crypto will be being magically appearing this time; the old Bitcoin Cash blockchain will wither, and things will return quickly to the usual background level of hype – unless, again, something goes really, really wrong.

This is not even Bitcoin Cash’s first hard fork rodeo. Apart from the initial acrimonious split from Bitcoin, it pulled this trick back in November of last year, in order to mitigate for problems predicting the difficulty of mining its blocks.

So hard forks – especially when there’s no internecine war, no new crypto – and the whole affair feels much more like a soft fork, where an upgrade takes place but old blocks remain valid – can seem like pretty dry affairs. There was certainly no surge in the price of Bitcoin Cash, as many predicted there could be, in the run up to yesterday’s switchover. In fact, there’s barely been a ripple of reaction, outside of those with genuine skin in the game and interested observers.

Here’s the thing, though. Hard forks are always interesting, because they cut to one of the central tenets of cryptocurrency philosophy – consensus.

That word too, of course, carries a technical definition when it comes to Bitcoin and crypto in general. It refers to the need for participants in a decentralised network to be able to reach agreement on the status of its ledger. This is a task that would be taken on by a centralised authority (say, a bank) in a traditional situation, but in the case of cryptocurrency is handled by an algorithm.

Bitcoin and Bitcoin Cash use the Proof of Work system for this, which requires any node wishing to mine a new block, and thus alter the ledger, to prove that it has performed the necessary maths (producing a valid Hash, or identifier, for a particular block) to add it to the blockchain and receive its reward – a new coin. In order to make this harder ‘work’, the creators of cryptocurrencies add difficulty to the process, which can be adjusted to control the time it takes to mine a block, avoiding it becoming easier as computers get more powerful. Bitcoin Cash’s early problems were due to it being difficult to predict the amount of time mining a block would take, and thus hard to set this difficulty.

Pleasing The Selectorate

Beyond the technical, though, cryptocurrencies depend upon a degree of political consensus among the groups responsible for running nodes and mining coins. In political science, this group might be referred to as the ‘selectorate’, a phrase coined in a book called The Logic of Political Survival, by Bruce Bueno de Mesquita, Alastair Smith of NYU, Randolph M. Siverson, and James D. Morrow and applied to cryptocurrency in the excellent article Why Is Bitcoin and Cryptocurrency Valuable by entrepreneur-blogger Taylor Pearson.

The selectorate refers to the group of people that can have an impact on leadership and control in a society – i.e. choose the leader, or influence policy. This is then subdivided three ‘sub-selectorates’, if you will: the nominal selectorate, the real selectorate, and the winning coalition.

The nominals include every person who has some vote on the choice of leadership – i.e. the whole electorate, in the case of a democracy. The reals, or the ‘influentials’, are those who actually choose the leader – i.e. everyone who has a vote and uses it. The winning coalition, or ‘essentials’, are the group whose support translates into victory for the leader.

The selectorate theory posits that the primary goal of a leader is to retain power; so to do this, they must by definition retain their winning coalition. And that’s where the real meat of the matter comes in: the selectorate theory states that the larger the number of people comprising this winning coalition is, the more likely that a leader will be to use ‘public goods’ – things that can benefit a lot of people, like health care, or defence – than ‘private goods’, or things that can benefit only a few, like promotions, cash, and the like. Conversely, an autocrat is more likely to turn to Private Goods to hold his position, because he has relatively few people to keep happy in order to retain power.

This, very roughly, leads to a further conclusion: the more people there are in a selectorate, the more likely a leader is going to do things that benefit more people – not because leaders of any given democracy are intrinsically better people, but because they have more people to please in order to retain control. Thus, the better outcomes for society as a whole will generally come from systems with bigger selectorates.

Doing It Yourselves

Taylor Pearson’s application of this to cryptocurrency feels particularly apt, especially given Bitcoin’s genesis as an act of rebellion against the status quo of international finance in 2008. He posits that cryptocurrency “will allow individuals to define for themselves what sound money is, disintermediating the bankers and enlarging the selectorate and winning coalition of money.”

He goes on to say that “the hope is that, in the same way having a large selectorate in a democracy forces presidents to behave better in order to retain power, having a large selectorate in the realm of money would force better behaviour on bankers if they want to retain power.”

The miners, big investors and leaders of any given cryptocurrency will, of course, still form a winning coalition that can exert more influence you or I – unless you are one of them. It’s not perfect, but it could be better… Paraphrasing a famous quote from Churchill, Pearson suggests that “cryptocurrency may be the worst form of money except for all the others that have been tried”.

Strikingly, though, he sees the idea of the Fork as being central to avoiding consolidation in terms of cryptocurrency wealth and power – in very similar terms to those who trumpet Bitcoin Cash as the ‘true Bitcoin‘, oft-derided as they are.

Essentially, he sees the idea of a hard fork as something akin to a nuclear option when a cryptocurrency is not working to the benefit of a notable portion of its selectorate. The idea that anyone with the know-how and the drive can simply go off and create their own, potentially better system – either to attempt replace what went before, or for a specific niche task – should serve as a powerful rein on the actions of leaders. If enough people adopt any given currency, it becomes a selectorate of its own, hopefully one that learns the lessons of its previous incarnations.

“Historically,” Pearson points out, “it was possible to use different currencies for different purposes. While you may have been required to use a certain national currency to pay taxes, you might use a locally issued bank note for the purpose of trading in your village and you might use specie (gold and silver) to store value in a way that could not be debased if the King got into too much debt. In other words, there was a competitive market for currency for most of it’s history.”

Though we’ve perhaps never know it in our lifetimes, such a system may be coming back, and “Because of their open-source, forkable nature, cryptocurrencies bring back the possibility of different currencies being used for different use cases and force currencies to compete for users. The monetary selectorate can make its opinion known by buying, selling, hoarding or dumping various coins as they see fit.”

See, not as boring as you thought, right? As always, though, which theory you back is pretty much up to you. I like this one, but I probably think the best mantra is always ‘follow the money’ when it comes to assessing forks – who benefits, and why? Nobody forks a currency for fun – okay maybe Dogecoin is an exception that proves that rule – so their reasoning is always fascinating.