How forks impact the price of cryptocurrency
Each time the code of a blockchain changes or is updated, it creates what is called a fork. A soft fork is backward compatible, meaning that any nodes on the network can still recognize the new blocks, but miners will not get credit until they upgrade to the newest software.
In contrast, a hard fork is not backward compatible, meaning any nodes that don’t upgrade won’t even be able to recognize any of the new blocks. Often this ends up creating two different tokens, especially when there are proponents of each. Many times, people line up to support either the old or the new versions, and rivalries can ensue.
We saw this recently with Bitcoin Cash splitting into Bitcoin Cash ABC and Bitcoin Cash SV. But what happens to the prices of these cryptocurrencies when a hard fork occurs? Much of the answer depends on the circumstances and mechanics of the fork in question, but without a doubt it adds volatility to the price.
Let’s have a look at a few recent examples and find out how forks can affect prices.
Double the tokens
Depending on how the fork is structured, there sometimes is an opportunity to double your tokens. For instance, back in August of 2017 when Bitcoin Cash (BCH) first forked away from Bitcoin (BTC), it was to increase the size of the block from 1MB to 8MB. Anyone who owned a certain number of BTC would end up with a duplicate number of BCH after the fork.
That leads investors to buy up as many BTC tokens as possible leading up to the fork, causing prices to rise. The idea is that the added value of the new tokens will more than offset the price drop of the original token caused by the fork.
One of the reasons forks like this cause volatility is that large investors, often dubbed ‘whales’ buy up massive amounts of tokens, driving the price up. Large enough investors can actually steer the market, especially if they act in concert, and, leading up to a fork, they all will want to increase their holdings.
After the fork, they will have a huge number of the new tokens right off the bat, and are likely to sell off the original assets to buy other cryptocurrencies. What happened in 2017 with BCH was that the price of BTC only dropped about $120, while BCH opened at $555 — a huge potential net gain, essentially overnight.
Any investor considered a ‘whale’ or even the next tier, known as ‘dolphins,’ will be paying very close attention to the market due to their huge investment in it. They will be well aware of any upcoming forks, and be prepared to take advantage of them.
If they are paying attention, even smaller investors will try to increase their positions. This causes a ‘feeding frenzy’ of buyers trying to get their hands on a particular coin. Once the fork happens, you need to decide which one you ‘bet’ on more, or believe in more.
For example, in the case of BTC versus BCH, the former was the clear winner after the fork. It was shortly after the fork that bitcoin saw its meteoric rise in value, reaching all-time high prices. If you look at the Bitcoin chart, you can see it take off right after the split. While BCH did okay, it didn’t prove to be the preferred version.
At the beginning of the year, the Ethereum blockchain had a similar hard fork, to apply a series of updates and changes to the original code. One of the biggest changes was converting from a proof-of-work algorithm to proof-of-stake. Many purists or originalists clung to the original version, called Ethereum Classic (ETC).
After the fork, the ‘new’ Ethereum to USD chart had a steady rise while ETC faltered. As of this writing, there’s no comparison with ETH at around $126.35 and ETC at $5.24 . But why did this go the opposite of the bitcoin fork?
That is a harder question to answer. While all the Bitcoin variants work on a proof-of-work algorithm, changing Ethereum’s architecture opened up new uses and markets for it. The change was much more deep and fundamental than any of the Bitcoin forks.
Just knowing that a fork is coming isn’t enough, you need to understand what market forces will do to each branch after the fork. Doing so can mean pretty impressive gains, especially if your wallet or exchange recognizes both branches.
While we mentioned compatibility with respect to nodes and miners, what about your wallets and exchanges? With any pending fork, it’s important to know if your wallet will recognize the new currency. If a crypto fork happens and your particular wallet doesn’t recognize the new one, you could miss a big opportunity.
Knowing that your exchange can trade the new currency is important as well, because you may want to start selling the new one right away. Having all these compatibility issues sorted before the day of the fork is key in not missing an opportunity.
Volatility can hold the market back
While it’s great to simply double the number of coins you hold, ultimately forks, especially hard forks, may not be the best thing for attracting outside investors and new folks, which, in turn, is going to be key to the cryptocurrency’s long-term success.
People on the outside are turned off by these forks because they may not understand the technical nature of the fork — and therefore they may not be able to classify which one is more likely to succeed.
There’s a technology understanding barrier already with cryptocurrency, and forks just muddy the water further. As these coins mature, there will probably be fewer forks — and that’s a good thing for the long-term, widespread adoption of cryptocurrency.