Dr. Pavel Kravchenko holds a PhD in technical sciences and is the founder of Distributed Lab.
For quite some time now I've been asking smart people the same question – what is bitcoin, actually?
I put the question to Mike Sofaer of Brian Kelly Asset Management when I saw him at the Scaling Bitcoin conference recently. Mike replied: “Bitcoin is collective insurance against the collapse of fiat currency systems.”
His answer left me with a fresh question – why can't we have lots of insurance companies?
Let’s imagine that we have a decentralized system – which means that miners (well at least, the ones among whom there's consensus) aren't working together, and the correlation of their decisions is negligible. The upshot would be that each miner verifies the actions of all the others, and is exclusively interested in following the rules to a T.
This kind of setup is similar to an insurance company with a pool of policies sufficiently diversified that the occurrence probability of a certain percentage of identical claim situations happening simultaneously is actually zero.
And in reality, that's exactly how insurance corporations operate – they have policies against floods, and against forest fires, when it's obvious that the two calamities couldn't both happen at the same time.
So how can the cryptocurrency economy develop similar robustness? Maybe forks are part of the answer.
Stepping back, previous bitcoin forks, along with ones that didn't go ahead, have shown that the first cryptocurrency is sufficiently robust and stable, even during such unpredictable circumstances.
To be clear, the kind of forks I’m talking about in this post meet the following criteria:
- They share a common transaction history
- They use identical cryptography – in other words, the wallet keys in one fork will fit the wallets in the other fork
- They use the same mining algorithm (in this they differ from other forks, where the algorithm was changed to prevent 51-percent attacks)
The primary causes of bitcoin forks are struggles for the control of bitcoin's development. The system itself is decentralized – but obviously, opinions differ on how the project can be further improved are divided.
If, 1) bitcoin were made completely anonymous, 2) miners were decentralized and not grouped together in pools, 3) the number of transactions per second would increase in proportion to demand – there would be little impetus for forks.
In this scenario the system – which would be continuously getting closer and closer to perfection, along with the desired guaranteed proven security and real decentralization of control – would have the highest chances of success.
But clearly, we are far from hitting that trifecta.
Who gains from forks?
There are several groups with vested interests in these forks:
- Bitcoin miners. They are relatively indifferent to what they mine – for them, the only concern is maximum returns, so more forks means more options.
- Speculators looking for a proven technology (bitcoin forks have benefits over other cryptos, since it's the oldest codebase) that offers them high liquidity, volatility and adoption.
- Users who want to use cryptocurrencies for making high-value transactions in the grey economy. Forks indirectly cause liquidity to increase, since there are more instruments to trade and the market capitalization of all cryptocurrencies grows, creating more opportunities to transfer value between chains. Meanwhile, governments find it harder and harder to track all the differing cryptocurrencies, and the level of competition causes fees to fall.
Yet in the final analysis, forks have a whole series of both negative and positive consequences.
On the negative side, they erode investor confidence in an asset (which one is the true bitcoin?) – as well as creating inflation, one of the main arguments against forks.
If we are afraid of inflation, then we implicitly equate bitcoin with services. As one example, if there's only one hair salon in town, then the price of haircuts will be higher than if there were a hundred such salons. Nevertheless, you could have as many copies of the Mona Lisa as you like – and their number will never affect the value of Leonardo's original.
Alongside the negatives, there are also some positive benefits of forks. One example is that forks prompt technological improvements, because they force teams into competition with each other.
Man behind the curtain
The most difficult problem for any bitcoin-type system is proving that the system is truly decentralized from a control viewpoint. Consider bitcoin cash (BCH), where the main mining operations are historically concentrated in the hands of a small group of people (there are also concerns about ownership of BCH and exchanges where it is traded).
It's clear that not everyone sold their bitcoin cash coins (even Satoshi didn't sell his, or hers, or theirs). However, the opportunities for rigging the price are substantially greater here than in the original bitcoin. So far the bitcoin cash community has not rolled out any clear criteria to prevent manipulation, so it remains hard to say if they are even capable of such development.
On the other hand, you have to admit that if full anonymity were in place, a fork with 10,000 independent miners and millions of users would look exactly the same as a fork with three miners and a hundred users (since we have no idea who controls the hashrate, or accounts).
Merely having indicators about the trading volume and market cap is useless while dealing with cases of manipulation, or people having the exchanges "in their pocket."
If the bitcoin experiment survives, it will teach us how to create anonymous decentralised systems with provable decentralized control. That's when such systems can begin to compete against each other on their level of true decentralization, security, quality of service and transaction fees.
Of course, there isn't any reason whatsoever to suppose that the "traditional" financial systems couldn't mutate into this format either. Every state, whether real or virtual, can set up its own currency that's managed by its "central bank" – using a format, for example, such as smart contracts, which analyse economic performance stats and use them to establish monetary policy.
Freedom to fork
It seems to me that new forks are bound to happen, especially for ethereum, when it switches to proof-of-stake (it's just much easier to create a fork than with proof-of-work). Regarding bitcoin, it's very likely that new potential improvements will appear – whose introduction will require a hard fork (such as the hotly anticipated one for MimbleWimble).
We must note that a large number of bitcoin forks with a single mining algorithm will increase the likelihood of a double-spending attack. It could be that the next bitcoin fork will be exactly the place where this kind of attack is probable. But the upside in that could be that real experience of such an attack would provide the stats to guard against similar attacks on other networks in future.
On balance, then, I've begun thinking that forks have positive value, provided that systems don't compete to be king of the hill. If we follow along the line of thinking of decentralization, then there ought to be numerous systems.
Based on this principle, users ought to have free choice as to which system to select at any given moment. A single global currency, carved into the stone of the Founding Fathers as a covenant of the true path seems these days more and more like an Orwellian future – even if served with decentralization sauce.
Forks offer ideological leaders the chance to put their ideas on improving protocols into practice without getting bogged down in endless bickering with others.
What's more, it doesn't mean starting a new cryptocurrency from scratch, and trying to win over users for it – there are already people holding bitcoins.
The long-term view is that this approach will yield results – since it makes it possible to test different technical solutions independently of each other, and then choose the best ones.
Forked path image via Shutterstock
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