When a new investor enters into the cryptocurrency market, they are often confused by different quotes for what appears to be the same currency. For instance, Bitcoin and Bitcoin cash have different quoted prices and so do Ethereum and Ethereum classic. This can cause considerable confusion to the novice trader. However, with time and experience, traders realize that the quotes are actually being made for two separate cryptocurrencies. These currencies may have been the same in the past. However, over time, the currencies were split to form two different currencies. This is just like a company using a spin-off to list a part of its business as a separate entity on the exchange.
In cryptocurrency parlance, this act of splitting a single currency into two is called a fork. In this article, we will discuss what cryptocurrency forks are and what do they represent for the trading community.
What are Cryptocurrency Forks?
The term fork is an analogy to a fork that is often present on roads. A fork is a junction wherein a single road diverges into two separate roads. Therefore, in cryptocurrency parlance, a fork represents a point in time whereas a single cryptocurrency actually splits up and becomes two separate currencies.
Up until now, we know the fact that cryptocurrencies are mined and regulated by communities. A lot of the time, these communities may have significant disagreements about the fundamental features of the currency. For instance, some of the developers may feel that they need to move to a proof of importance-based consensus mechanism whereas others may want to stay on the proof of stake mechanism.
Many times, the cryptocurrency may witness a significant hack and this could lead to disagreements about what the future security arrangements should be. Needless to say, the end result is the division of one community into two or more communities. Sometimes, the community is able to reconcile the rules and start operating as one unit. Other times, the differences become irreconcilable and lead to the cryptocurrency breaking up.
It is important to realize that the same cryptocurrency can end up forking multiple times. To make matters worse, it is possible for the separated forks to once again merge into a single currency at a later date. This is the reason we see multiple versions of the same currencies being traded in the crypto markets and these versions keep on changing. For instance, Bitcoin, Bitcoin Cash, and Bitcoin Gold are all offshoots of the same currency. This can make matters extremely complex for investors who are not accustomed to this level of technical jargon.
What Happens as a Result of a Cryptocurrency Fork?
A cryptocurrency fork is considered to be a major event that changes the very fundamentals on which the currency is based. Basically, when a cryptocurrency fork happens, a part of the cryptocurrency community decides to update the software which is being used for mining. On the other hand, some people decide not to upgrade.
These changes lead to wide changes in the user base as well as the acceptance of the cryptocurrency. These factors can be considered to be fundamental to the valuation of any cryptocurrency. This is why forks often lead to wild fluctuations in value. However, the result is often the same, and two separate currencies pop out with different public ledgers which originate from the same blockchain technology.
However, after a cryptocurrency fork, it is possible that one currency might end up becoming more dominant as compared to the other. In such cases, the other currency has lower community adoption value and over time fades into oblivion. In most cases, both currencies co-exist with each other. This is because often there is enough support for both segments of the community when a fork takes place. Hence, the community adoption, as well as the financial value of either currency, is not changed drastically.
The Two Main Types of Cryptocurrency Forks
There are two main types of cryptocurrency forks viz. accidental fork and intentional fork. The details of both these types of forks have been listed below:
- Accidental Forks: As suggested by the name, this type of fork is not intended by the mining community. It just so happens that when mining is going on, it is not always possible to uniquely identify who mined a block. Sometimes, two or more miners may mine a block at the exact same point in time. This leads to an accidental fork. An accidental fork is generally not a cause of concern as it is solved by the cryptocurrency itself. Generally, the different miners continue mining on subsequent blocks. The network once again checks the number of blocks and generally continues with the longer chain while abandoning the shorter chain.
- Intentional Forks: Intentional forks, on the other hand, are the type of event that we have mentioned in the article above. This means that this is a deliberate and premeditated split caused as a result of a disagreement. Here, too there are two types of forks (hard fork and soft fork). The nature of the fork can have a huge impact on the financial valuation of the underlying cryptocurrency. It is for this reason that we will study the concept of the hard fork and soft fork in greater detail in the forthcoming articles.
The bottom line is that cryptocurrency forks are critical events that lead to wild fluctuations in value. They do not occur very often. However, when they do, they cause a lot of volatility in the market value of these currencies which creates opportunities for higher-than-average profits.
