Cryptocurrency Forks or Investment Splits - dummies

Cryptocurrency Forks or Investment Splits

By Kiana Danial

What you get from a cryptocurrency fork won’t fill your tummy, but it may fill your crypto wallet with some money! Many popular new cryptocurrencies were born as a result of a split (fork) in another cryptocurrency like Bitcoin. The following discussion explains the basics of these cryptocurrency splits and how you may be able to profit from them.

What is a cryptocurrency fork, and why do forks happen?

Sometimes when a group of developers disagrees with the direction a specific cryptocurrency is going, the members decide to go their own way and initiate a fork. Imagine an actual physical fork. It has one long handle, and then it divides into a bunch of branches. That’s exactly what happens in a cryptocurrency fork.

Some cryptocurrencies are implemented within open source software. Each of these cryptocurrencies has its own protocol that everyone in the network should follow. Examples of such rule topics include the following:

  • Block size
  • Rewards that miners, harvesters, or other network participants get
  • How fees are calculated

But because cryptocurrencies are essentially software projects, their development will never be fully finished. There’s always room for improvement. Crypto developers regularly push out updates to fix issues or to increase performance. Some of these improvements are small, but others fundamentally change the way the original cryptocurrency (which the developers fell in love with) works. Just as in any type of relationship, you either grow together or grow apart. When the disagreements among a group of developers or network participants intensify, they can choose to break up, create their own version of the protocol, and cause a potential heartbreak that requires years of therapy to get over. Okay, the last part doesn’t really happen.

Hard forks and soft forks

Two types of forks can happen in a cryptocurrency: a hard fork and a soft fork.

Most cryptocurrencies consist of two big pieces: the protocol (set of rules) and the blockchain (which stores all the transactions that have ever happened). If a segment of the crypto community decides to create its own new rules, it starts by copying the original protocol code and then goes about making changes to it (assuming the cryptocurrency is completely open source). After the developers have implemented their desired changes, they define a point at which their fork will become active. More specifically, they choose a block number to start the forking. For example, as you can see in the figure, the community can say that the new protocol will go live when block 999 is published to the cryptocurrency blockchain.

cryptocurrency hard fork
An example of a hard fork.

When the currency reaches that block number, the community splits in two. Some people decide to support the original set of rules, while others support the new fork. Each group then starts adding new blocks to the fork it supports. At this point, both blockchains are incompatible with each other, and a hard fork has occurred. In a hard fork, the nodes essentially go through a contentious divorce and don’t ever interact with each other again. They don’t even acknowledge the nodes or transactions on the old blockchain.

On the other hand, a soft fork is the type of breakup where you remain friends with your ex. If the developers decide to fork the cryptocurrency and make the changes compatible with the old one, then the situation is called a soft fork. You can see the subtle difference in the example shown here.

cryptocurrency soft fork
An example of a soft fork.

Say the soft fork is set to happen at block 700. The majority of the community may support the stronger chain of blocks following both the new and old rules. If the two sides reach a consensus after a while, the new rules are upgraded across the network. Any non-upgraded nodes (that is, stubborn geeks) who are still mining are essentially wasting their time. The community comes back together softly, and everyone lives happily ever after — until the next major argument, of course.

Free money on cryptocurrency forks

Because a new fork is based on the original blockchain, all transactions that previously happened on the blockchain also happen on the fork. The developers of the new chain take a “snapshot” of the ledger at a specific block number the fork happened (like 999 in the figure) and therefore create a duplicate copy of the chain. That means if you had a certain amount of cryptocurrencies before the fork, you also get the same amount of the new coin.

To get free coins from a fork, you need to have the cryptocurrency on a platform that supports the fork before the block number at which the fork occurs. You can call this free money. But how valuable the coins are all depends how well the new fork performs and how popular it gets within the community.