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What You Need to Know to Understand the Complicated Splitting of Bitcoin Bitcoin and Ethereum have both seen high-profile forks in the past year, spawning separate coins with different rules. The splits come down to diverging ideologies and the laws of network consensus.

By Rob Marvin

This story originally appeared on PCMag

via PC Mag

On Aug. 1, a new cryptocurrency called Bitcoin Cash appeared online. For the first time in Bitcoin's eight-year history, the original blockchain network underwent what's called a "hard fork." A small faction of Bitcoin (BTC) miners split off onto their own blockchain network, spawning Bitcoin Cash (BCH).

Why the split? The technical answer lies in the long-standing Bitcoin community debate over block capacity, the nuances of which we'll get into shortly. More broadly, the Bitcoin fork speaks to a fundamental ideological rift over what's more important: preserving the decentralized nature and independent control of the Bitcoin network, or accelerating transaction speeds to make the cryptocurrency more viable for mainstream ecommerce and payments.

Bitcoin's split is the second high-profile cryptocurrency fork in the past year, after a smart contract vulnerability and subsequent hack led to a split on the Ethereum blockchain in 2016. The result: Ether (ETH) and Ethereum Classic (ETC). Bitcoin and Ethereum's forks came about for entirely different reasons, yet the parallels between the splits can explain a lot about the complicated nature of reaching a consensus on major decisions within a blockchain network. When an impasse is reached, a fork may follow.

Collectively, all four Bitcoin and Ethereum coins still sit near or at the top of the constantly fluctuating cryptocurrency market capitalization index. But you shouldn't necessarily take a coin's market cap at face value, according to Peter Van Valkenburgh, director of research for Coin Center, a nonprofit organization focused on the policy issues facing cryptocurrencies.

"The headlines are focusing on 'Wow, Bitcoin just gave birth to a $10 billion baby,'" said Valkenburgh. "But the reality is, until there's liquidity on these markets -- enough people trading their Bitcoin Cash coins on exchanges and making transactions on the Bitcoin blockchain -- the market capitalization is really based on artificial scarcity. That's bad economics."

The concepts and technologies at play can be confusing even for software experts to wrap their heads around. PCMag spoke to Valkenburgh to sort through how a blockchain fork works, how the Bitcoin and Ethereum splits parallel one another and what the future may hold for the newly minted Bitcoin Cash.

Blockchain networks: a quick explainer

If you don't understand what a blockchain network is and how it works, then the rest of this article will be even more confusing. To help, Valkenburgh gave a succinct explanation of the mechanics underlying the Bitcoin blockchain.

"The reality is, there are no Bitcoins, they don't exist. They're a construct of software and people's imaginations. The only thing that describes the existence of Bitcoins is the blockchain, a ledger of all transactions," said Valkenburgh.

A blockchain is made up of two primary components. First is the peer-to-peer (P2P) network of computers around the world, often called nodes, collectively validating and bundling batches of encrypted transactions together into code blocks. Each block is then added to the end of the chronological chain, stored not in one central location but, rather, synchronized on each node across the network.

Since the blockchain is decentralized, no one single party (such as a bank, financial institution or government) can control what happens on the network. At the same time, the blockchain gives you consensus agreement and timestamped, tamper-proof data. This eliminates the need for online third parties to facilitate that transaction.

"The Bitcoin blockchain records every event throughout Bitcoin's history -- new coins and evidence of transfers -- back to 2009 when the network started," said Valkenburgh. "Every computer on the network also has to be running compatible software so that the nodes can see and validate transactions. So, if your software is not compatible or if you fail to meet or invalidate any of the consensus rules baked into the Bitcoin code base, then the network would ignore your transaction. That's all it is to have a Bitcoin: the ability to broadcast a valid transaction and transfer that balance."

These "Trustless Consensus" rules include concepts such as Proof of Work, public and private key encryption and most importantly in this instance, a cap of one megabyte (MB) on Bitcoin block size. This particular rule has been a point of contention between Bitcoin core developers and the miners who are coding new blocks since the dawn of the network -- and it's the ongoing debate that ultimately led to the Bitcoin Cash fork.

Breaking down the Bitcoin fork

Like every other cryptocurrency or public blockchain, Bitcoin is open-source software. Changes and modifications to how that software works need to be approved by consensus and every CPU gets a vote. As Valkenburgh explained, if a group of nodes modify their software without consensus, those nodes then invalidate a rule held by the rest of the network and create their own fork of the blockchain.

"If you break any of the consensus rules, then the network will ignore you. If you and a bunch of people choose to break it in a certain way, you'll all then be compatible on a parallel network," said Valkenburgh. "What happened with Bitcoin Cash is, a small minority of miners and enthusiasts frustrated with their perception of the scaling debate made those modifications and forked Bitcoin."

Bitcoin Cash increases the block size to 8 MB. The reason miners want to increase block size in the first place is pretty simple: As Bitcoin has grown in popularity, the network has come under heavier strain to process and validate the transaction load. As a result, transactions have started backlogging. Completion times have ballooned from an average time of 10 minutes to a high of more than 40 hours during a slowdown this past June.

Bitcoin Network Transaction Speeds, 2016-2017

Increasing the block size has been the subject of heated debate in the Bitcoin community for more than two years. Bitcoin Cash simply forked it into reality and increased the block size to 8 MB. Though, in point of fact, Bitcoin Cash actually stole another fork's thunder.

At the Consensus 2017 blockchain conference in New York this past May, a prominent group of international Bitcoin companies announced the New York Agreement, which resolved to introduce a hard fork within six months called Segwit2X. This fork also planned to change the block size but compromised on the contentious issue by only raising the capacity to 2 MB. Some factions of the community felt that block size shouldn't be modified at all, while others (such as the nodes now running Bitcoin Cash) believed simply doubling the size wasn't enough.

Segwit2X currently still has the support of the vast majority of the Bitcoin network which, in essence, makes it a software update as long as the consensus of nodes upgrades to it. Jeff Garzik, CEO of enterprise blockchain company Bloq and a former Bitcoin core developer, is leading Segwit2X development. In spite of the release of Bitcoin Cash, Garzik said that Segwit2X is pushing forward with its own fork to upgrade Bitcoin.

What we can learn from Ethereum

The impetus for the Ethereum fork was a much more dramatic hack and Ether heist rather than good 'ol fashioned network stress. Nevertheless, the value and relative stability of both the ETH and ETC cryptocurrencies in the time since the fork shows the possibility for a successful path forward.

Some background on Ethereum and its fork: The Ethereum blockchain network is different from Bitcoin in that, beyond the cryptocurrency it powers (Ether), it's also a blockchain application platform for building smart contracts and decentralized apps. Ethereum also has more support from major tech companies and enterprise organizations, including the more than 150 members of the Enterprise Ethereum Alliance.

Ethereum is also governed a bit differently. While the Ethereum blockchain is a decentralized network with consensus voting, the platform was designed and is still overseen by the core developers who make up the Ethereum Foundation, including Ethereum co-creator Vitalik Buterin. When a vulnerability in a smart contract called the Decentralized Autonomous Organization (DAO) resulted in a heist of $50 million worth of Ether, Buterin and the developers fought fire with fire: they hacked the hackers and reclaimed the cryptocurrency.

The debate came when deciding how to proceed from there. Buterin and the core developers were faced with a decision: If they intervened and created a new version of the network, it would fix the vulnerability and reimburse the DAO investors. At the same time, Ethereum's official documentation stated that decentralized apps should exist "without any possibility of ... censorship, fraud or third-party interference." Essentially, violating a core principle of the blockchain in order to save it.

"When the fork happened, there was a major ideological discrepancy for Ethereum," explained Valkenburgh. "One side believed all the miners should get together and reverse this transaction, fix the flaws in the smart contract code corrupted by the hacking attempt and give everyone who put their money into the DAO their money back. Immutability is less important than keeping an equitable system that functions. The other side said [the DAO] is an uncensorable smart contract that should continue running and not be reversed. So, by rolling back the DAO hack, you're breaking a [core tenet], and we're going to maintain the faith."

The community ultimately decided to go ahead with the fork, with the new Foundation-led network maintaining the Ethereum name (ETH) and the latter group choosing not to move to the new blockchain and instead becoming Ethereum Classic. Despite questions of whether Ether would survive the split or if Ethereum Classic could be a viable currency, the networks navigated the fork and both remain active and viable cryptocurrencies today (although ETH has skyrocketed in value as compared to ETC). Valkenburgh said this comes down to the strength of Ethereum's community and could serve as an example for Bitcoin's fork.

"I was on the side of Ether but, to my surprise, the vibrant developer community working on Ethereum Classic has helped the price rise slowly from $2 when it emerged to around $14 today. Ethereum at the time was about $10 and recently has averaged around $225," said Valkenburgh. "Maybe we'll see that with Bitcoin Cash. There are definitely strong ideological differences in both examples. But the difference in this case is, Ethereum's fork had less to do with technology and design than what to do about equity and this one 'bad apple' transaction. With Bitcoin, you have this impasse with varying technical solutions."

What's the future of Bitcoin?

The saga of Bitcoin, Bitcoin Cash and the Segwit2X fork is ongoing. Thus far, support for Bitcoin Cash has been divisive among the Bitcoin exchanges, but the tide seems to be turning. Bitfinex and Kraken, two of the top five exchanges (platforms for buying, selling, trading and exchanging cryptocurrencies) announced support in advance of the split. The big holdout had been Coinbase, the most popular online exchange, which had stated it would not support BCH -- until announcing it will add support by 2018. For those worried about how the fork would affect Bitcoin's market value, after a brief dip following the split, Bitcoin rebounded to set a new record. After breaking the $3,000-per-Bitcoin threshold, the original cryptocurrency has hovered around $3,300 to $3,400 this week.

Beyond the short-term controversy over what exchanges support Bitcoin Cash, the larger debate that will shape Bitcoin's future comes down to centralization vs. decentralization. The power of a blockchain network lies in its ability to facilitate trusted online transactions without a third party in the middle. Bitcoin was originally conceived as a P2P electronic cash system for global transactions. The debate over block size and transaction speeds all comes back to Bitcoin's viability as an alternative to banks and credit card companies for mainstream online transactions.

The goal in this case would be to accelerate transaction speeds and reduce latency to the point where a consumer could walk up to a checkout counter and buy groceries with Bitcoin, without waiting an hour or more for the transaction to be validated. To do this, however, Valkenburgh explained that the network itself might be forced into centralizing a decentralized system.

"When data goes through the internet, it has latency. Sending a Bitcoin transaction from the U.S. to China takes longer than sending packets from me to you in New York. And the latency gets worse the more data being sent," said Valkenburgh. "Bitcoin blocks need to propagate through the network to validate and start building the next block on the chain. And if the blocks are big, they propagate slowly and unevenly."

Miners always want to hear about a new block first. If blocks get larger and larger, leading to substantially more latency, then Valkenburgh said there's a strong incentive for miners to geographically co-locate within the same region. That's a slippery slope, one that colors in the other side of the debate over block size. What's more important: maintaining the decentralized autonomy of the Bitcoin network or furthering Bitcoin's charge to revolutionize global payments?

"What would be likely is, all the miners decide to geographically co-locate in western China where there's cheap hydroelectric power or in Iceland or possibility the Pacific Northwest. The fundamental role miners play could then be more easily controlled, either by a cartel of miners who get together privately to block or censor transactions or, more likely, from a government," said Valkenburgh. "It's sacrificing censorship resistance for the ability to use your smartphone to buy a Coca-Cola with a Bitcoin."

Valkenburgh is a staunch supporter of maintaining decentralization but said the debate over block size is mostly because we haven't figured out a better solution. The inability to execute cross-border payments and trustless, online transactions were considered a fundamental flaw of electronic cash systems -- until Bitcoin creator Satoshi Nakamoto found a way to build one that didn't. With the pace at which cryptocurrencies and decentralized blockchain technology is evolving, the Bitcoin and Ethereum forks may ultimately be remembered as nothing but footnotes for what came next.

Rob Marvin

Associate Features Editor

Rob Marvin is the Associate Features Editor at PCMag.

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