Crypto Market Commentary 

2 February 2020

Doc's Daily Commentary

 

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Checkmate's Corner

Bitcoin? Which One?

One of the most unfortunate critiques of Bitcoin is its growing pool of look-alikes. To the average person, logging into a Coinbase account or scrolling through a ranking site, it is extremely difficulty to understand why there are so many Bitcoins…Bitcoin Cash, Bitcoin SV, Bitcoin Gold, Bitcoin Diamond…

 

Are they all different coins or just different types of the same coin? Which one should I buy? Why is Bitcoin Cash cheaper than regular Bitcoin?

 

It is insane to expect people will go down the rabbit hole and discover the philosophical and technical differentiation between the different blockchains. This is equal parts a symptom of scam projects forking off from Bitcoin and the limitations of pure Proof-of-Work consensus.

 

In this piece, I want to touch on the mechanisms that form these ‘forked’ coins and some of the implications on the broader market as a result.

 

Mechanisms for Forked coins

There are a number of mechanisms which bring new cryptocurrency projects into existence:

 

New Blockchain: The most intuitive pathway for creating a new blockchain is to write one from scratch. Often ideas and code snips can be borrowed from existing projects but all in all, this results in a new codebase which must grow of it’s own accord. There are very few of these for one simple reason…writing code for a blockchain is really hard. Projects which taken this approach are the likes of Ethereum, EOS, Nano etc.

 

Codebase Fork: Another way to create a new coin is to take the codebase of another project (like Bitcoin) and significantly modify the functionality and launch the new network. This is literally a fork of the code but is NOT a fork of the network. Codebase Forks are characterised as having their own unique launch and do not inherit any of the transaction history from the parent project. Decred and ZCash are examples of codebase forks which reconstructed the Bitcoin code to achieve new design goals.

 

Scam Fork: The name says it all but I make a key distinction here. Whilst scams can be both new chains and codebase forks, scam coins like Bitcoin Gold and Diamond were basically forked off the main Bitcoin chain without any real consensus or reason to do so. These projects were forked by a team of developers and all holders of BTC would also have coins available to be claimed on the scam chain.

 

Bitcoin Private is also an example of a Scam Codebase Fork which took Frankenstein elements of ZClassic (for privacy tech) and Bitcoin. This created a scam codebase fork which had a hidden inflation bug, likely exploited by the developers.

 

A Scam coin that forks from a parent chain is an attempt to fork the network but usually has few proponents to support any sustained growth.

 

Contentious Fork: This is in my opinion the most interesting type of fork. This is what created BCH and BSV and comes from some contentious issue regarding upgrade paths and hardfork vs softfork pathways for the parent coin. Where a codebase fork is a fork of the code only, contentious forks are a fork of both codebase AND live operational networks and people.

 

Lets explore the nature of contentious forks and what it means for governance and wider impacts on the market.

Segwit scaling wars

One of the defining moments in Bitcoins history occurred in 2017. A full discussion of the scaling wars is a topic unto itself but in short, it was a culmination of years of discussion, argument and posturing on how best to scale Bitcoin.

 

The option favored by majority of community members and most of the core developers was SegWit and keeping the block size limit fixed at 1MB. Keeping the block size constrained is important to develop a long term fee market and the ideology is to make block-space more efficient whilst enabling small transactions to be pushed up to higher layers (like lightning network).

 

SegWit enabled more innovative scripting capacity and reduced the data footprint of transactions, rather than increasing the block size arbitrarily.

 

The other side of the community was lead by Roger Ver, Craig Wright and Jihan Wu from Bitmain, the dominant miner and ASIC manufacturer at the time. These folks were pushing for an increase to the block size to 2MB and a rejection of SegWit technology.

 

There are a number of technical issues with this approach, the simplest of which is that larger blocks mean it is harder to sync nodes and transmit that data over the global network. It literally takes longer to send and download a 2MB block than a 1MB block which leads to reduced efficiency and more latency. The end result of this is that it is harder and harder for small users to run nodes, requiring SSD hard drives, large size and significant bandwidth. This centralizes rather than decentralises.

 

BSV takes this concept to the extreme and wants one of two global datacenters with gigmeg block sizes…not my words, that is BSV speak…

 

This created immense contention in the community as exchanges, miners and merchants started taking sides. Many actually aligned with the Big Blockers for all manner of reasons, most of which was Juhan Wu passing large envelopes of money under the table (literally and figuratively).

 

The Contentious fork

Bitcoin Cash was born out of this disagreement. Pure Proof-of-Work is extremely good at keeping track of the truth under ALREADY DEFINED sets of rules. PoW is a very poor mechanism for coordinating and creating/agreeing on new rules.

 

This is a feature and a bug. It is a feature because it upholds Bitcoin’s unchangeable monetary policy narrative. This builds confidence for investors. The flip side is that software needs to upgrade eventually. It makes progress slow, tedious, uncertain and sometimes, impossible.

 

Ultimately, the two factions of Bitcoin did not agree and the chain was split with miners actively participating on both sides.

 

This is where the market dynamics contentious forks get very interesting. BTC, BCH and BSV all maintain the same hashing algorithm SHA-256. That means that the same ASICs which mine Bitcoin can also mine BCash and BSV coins and easily switch between them. As the prices change, so to do the profitability for hashing on either chain.

 

If we consider miners as rational actors, all they care about is profit and income. Where one miner ideologically mines solely on BTC, it creates opportunity for profit on the BCH and BSV chain. There is a single hashrate market and block reward pool for SHA-256 hash-power that is competed for by all miners.

The table below from Binance research shows that miners are active on all three chains.

https://research.binance.com/analysis/bitcoin-mining-allocation

Intertwined values

Considering miners on aggregate will mine whatever is profitable, these contentious forks that retain the SHA-256 hashing algorithm actually shed security from BTC to other chains based on the relative prices.

 

This has come to attention now that BCH is considering taxing the block rewards by 12.5% to form a developer fund. This reduces the global pool of SHA-256 rewards available for miners and will actually be a reduction in hashrate security that is shared by all three coins BTC, BCH and BSV.

 

Now since BCH represents around 2.6% of the global SHA-256 hashrate, reducing it by 12.5% means BCH will reduce to 2.275%. This reduction in BCH rewards mean some BCH miners must reallocate hash to BTC and BSV which increases the difficulty. Higher difficulty means reduced profitability across the board. Some miners will be impacted and may need to shut off machines.

Concluding thoughts

On a material basis, the redirection of BCH hashrate if the dev tax goes ahead will be largely insignificant on BTC given it is so small and if price goes up even slightly, it mitigates the effect. However, this does highlight a fascinating mechanism of value being shed by BTC as a result of contentious hard forks.

 

Chain splits split communities and drive value elsewhere. So long as the split chain has value and price, miners will allocate hash-power so long as it is profitable, taking hash away from BTC.

 

Long-term, this will likely result in the demise of minority SHA-256 chains that lose to Bitcoins ultimate liquidity and reputation. However between now and then, it remains confusing, misleading and far less than ideal to have these contentious and scam forks riding the coattails of BTC.

 

It is an outcome of pure PoW governance, and I don’t think we have seen the last scam fork and potentially not the last contentious fork. At least we as crypto insiders are better prepared than ever to make rational decisions around these events if and when they occur.

 

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