Miner Economics Part 2 — The Forks

(Note — I wrote this piece at the end of October, before 2x was “suspended” — there is an update to this piece below)

All software upgrades in decentralized protocols (called “forks” since they must “fork” off the main blockchain onto a new chain) must be supported by all factions within their respective ecosystems — the core developers, the users/consumers, as well as the miners. If a small minority of miners, investor activists (i.e Roger Ver), and/or developers don’t agree with the proposed upgrade, they can instigate a separate fork that boasts an entirely new cryptocurrency.

When a fork or specific upgrade must be initiated in a decentralized protocol, miners generally “signal” intent to join the proposed upgrade. Signaling intent may be done in two ways — firstly, through a simple line of text written in a block (i.e. “yes, I support SegWit”) which is not a guarantee that miner support will actually be carried out at the time of the upgrade, and secondly (and more robustly), a technical signaling of intent in which the miner software must be changed in order for the signal to be seen.

As discussed in Miner Economics Part 1, miners hold significant influence within decentralized networks. Although miners are monetarily incentivized, they can essentially create and mine new blockchains at a loss, provided there are opaque longer-term incentives on the table not visible to the observer. The cryptocurrencies that are spawned due to miner activation have arguably less real-world applicability than those hard fork upgrades initiated by the core development team (i.e. such as Ethereum’s Casper upgrade to Proof of Stake consensus). This is incredibly ironic in the case of Bitcoin Cash (BCH) for example, which was created to run 8MB blocks for increased transaction speed in the hopes of spurring global adoption by consumers and merchants, and mainly to prevent the User Activated Soft Fork — BIP148 — from happening (which would’ve drastically reduced miner fees and thus profits).

Bitcoin Cash is unique in that it has little to no actual users and is primarily run by the major mining operators that jump to and from the main Bitcoin network chain depending on BCH’s “profitability ratio” consisting of current price as well as current difficulty (i.e. hash rate). For a very excellent insight into this ratio please see Jimmy Song’s piece here https://bitcointechtalk.com/mining-btc-bch-past-present-and-future-e9432315aa47 as well as a blog post from Chainalysis here https://blog.chainalysis.com/cryptocurrencies-cannot-die/.

Currently, Bitcoin Cash difficulty has leveled and has seen an even profit rate since October 8th (see https://bitinfocharts.com/comparison/mining_profitability-bch.html).

So who actually transacts on the BCH blockchain? It would appear to be the major BTC miners, the crypto exchanges that list BCH, as well as crypto traders/speculators. Thus, rather than providing a tangible, real-world use case, Bitcoin Cash was solely created to withstand a BTC miner profitability reduction which would’ve occurred with the introduction of the UASF/BIP 148. Additionally, thanks to its Emergency Difficulty Adjustment (EDA), BCH can provide enough monetary incentive to miners to ensure its longevity. *

The Ethereum Classic (ETC) fork occurred after the DAO attack, in which the entire Ethereum protocol had to be upgraded in order to return the stolen DAO funds. A portion of Ethereum activists wished for the original code to remain — i.e. “code is law” — and thus wanted to keep the original chain as opposed to moving to the new upgraded Ethereum chain. They managed to successfully attract enough miner support to remain on the original chain, which they aptly named “Ethereum Classic.” Hence Ethereum Classic is simply a cryptocurrency that does not provide any tangible use case besides upholding the original Ethereum blockchain.

Bitcoin Gold Fork — instituted recently this past week, Bitcoin Gold introduces ASIC-resistant mining, in an effort to reduce the risk of miner collusion. Actual miner support seems to be unclear at this point.

Bitcoin 2x or SegWit2x (development led by Bloq CEO Jeff Garzik) is to be released mid-November. It plans to boost Bitcoin blocksize to 8MB similar to Bitcoin Cash, yet also include Segregated Witness or SegWit — which removes the data from the block header allowing for increase transaction data storage per block. BCH does not carry SegWit. There has been fierce resistance to the SegWit 2x integration namely that it reinforces miner control and thus increased centralization — see https://bitcoinmagazine.com/articles/2x-or-no2x-why-some-want-hard-fork-bitcoin-november-and-why-others-dont/.

*Recently, Bitcoin Cash released a statement that it would be instituting a major upgrade to its hash algorithm (https://www.bitcoinabc.org/november) on November 13th. This hash algorithm essentially smooths out the difficulty adjustment of BCH, in an effort to reduce hash rate volatility and to prevent miners from aggressively switching chains. It also ensures a more consistent block creation time, as currently an hours-long waiting period in between blocks is the current norm. This should also enable increased BCH price stability.

Finally, the impact of the impending Bitcoin2x fork on Bitcoin Cash will be interesting to witness, as 2x will hold the same features of BCH in addition to Segregated Witness.

*Update (11/9/17) — the Segwit 2x fork was recently “suspended” in a letter issued by the 2x development team. Most alt-coins proceeded to shoot upwards in value in response to the news.

If you were betting on 2x being a force to be reckoned with (like I was) you took a bit of a beating. However, even though the crypto community at large was exuberant, I wouldn’t be so quick to dismiss 2x just yet. It perhaps could be reenacted soon, even before the end of the year.

Attempting to take some steps back in order to accurately analyze the situation and what occurred:

Bitcoin maximalists (i.e. No2x) stating that it’s a “win” for community cohesiveness etc. In reality, the letter was issued by the 2x devs/backers — thus the power to influence the crypto market simply resided with the decision to issue the announcement.

One can argue that they were persuaded by the pressure of the No2x crowd, but I seriously beg to differ. The original Bitcoin network is more vulnerable than ever, and I am increasingly bullish on Bitcoin Cash (BCH).