How would a hard fork affect Bitcoin’s usefulness as a store of value?

Some powerful voices in the Bitcoin community have been pushing for a hard fork to increase the block size for more than a year, but multiple efforts have so far failed to activate the fork. Both Bitcoin XT and Bitcoin Classic have been unable to gain enough hashrate, but the most recent hard fork attempt, Bitcoin Unlimited, is currently receiving explicit support from two major mining pools, viabtc and Bitcoin.com, and has about 8% of the total network hashrate.

Needham & Company recently released a Bitcoin price report, in which the financial services firm shared their concerns about the impact that a hard fork could have on Bitcoin’s price. The report said:

“If a significant number of users and transaction processors (“miners”) on the network choose another version of the Bitcoin software, [then] the Bitcoin network could fork and potentially result in two different blockchains. This could adversely affect the price, perception, and use of Bitcoin.”

Bitcoin is often likened to digital gold; however, the usefulness of digital currency as a store of value must also be balanced against its ability to resist censorship for online payments. Much of the disagreement in the Bitcoin community can be seen, at least in part, as a debate between Bitcoin as digital gold and Bitcoin as a peer-to-peer payment network .

Both sides of the debate have ideas about how to preserve these use cases in the long term. The desire to allow more payments on the Bitcoin blockchain has been the main driving force behind various hard fork initiatives over the past year. But how do hard forks affect the perception of Bitcoin as digital gold?

A hard fork could result in two blockchains

From a technical perspective, the main problem with a hard fork is that it requires all users to move to a new blockchain with different rules. For this reason, some community members will oppose hard forks in any case, except when there is a bug at the protocol level that necessitates a hard fork.

Bitcoin Core contributor Eric Lombrozo told CoinJournal:

“No one can enforce a hard fork (especially miners, but this applies to everyone else in the ecosystem as well). A contentious hard fork would almost certainly result in a network split with all the implications that entails.”

In fact, the Ethereum blockchain was forced to undergo a controversial hard fork earlier this year, aimed at returning lost ether to users of The DAO. Disagreements within the community over whether this action should be taken resulted in about 15% of mining power remaining on the original Ethereum blockchain, Ethereum (original chain), rather than moving to the new hard forked chain, Ethereum (fork).

The use of Ether is different in that it is often viewed as the power factor, or gas, for distributed applications on the Ethereum network, rather than a digital currency.

Some people believe that Bitcoin's difficulty adjustment algorithm prevents a blockchain with less hashing power from continuing after a hard fork. There are two problems with this argument: First, miners do not control the protocol rules. While miners may decide to create larger blocks, full nodes do not have to move to this newly created blockchain. Once 75% of the network hashing power decides to start mining on a different chain with larger blocks. Speculators on exchanges may be the ones who decide whether miners stay on this new chain. After all, if the economic majority sticks to the original chain, then miners are willing to abandon the new chain and return to the original chain.

The second problem is that the weaker chain could decide to change the difficulty adjustment algorithm (or possibly the proof-of-work algorithm) via a hard fork. Since blockchains are inherently broken, without changes to the consensus rules, this argument would suggest that a hard fork would be needed to fix the broken protocol layer.

There are many unknowns when it comes to hard forks, but what is clear is that the likelihood of two blockchains emerging after a hard fork depends on both network effects and how controversial the consensus rule change is.

Risks of a Hard Fork

According to Needham’s Spencer Bogart, the key concern in the event of a hard fork is the split into two chains. Bogart told CoinJournal:

“If there were two blockchains and one wasn’t significantly more powerful than the other, I think that would be a negative for Bitcoin as digital gold. It’s hard to imagine how it could be negative because there are so many variables at play, but it’s definitely not worth the risk, especially with all the great things we might soon be able to do with Bitcoin as a second layer (particularly SegWit).

Segregated Witness is a soft fork change to the Bitcoin protocol that provides various technical improvements without requiring everyone to move to a new chain. Much like a hard fork increase to the block size limit standard, Segregated Witness increases the effective capacity of the network from 1MB to an estimated 2MB per block or more transactions per block. Segregated Witness also enables a more elegant version of two-layered network protocols for Bitcoin, such as the Lightning Network, which can allow users to transfer settlement rights to surrounding Bitcoins without having to touch the blockchain. The blockchain essentially serves as a method of resolving disputes in this system.

Bogart added that he believes those advocating for a hard fork have the best of intentions. His best guess is that the hard fork will be a short-term negative for Bitcoin and ultimately look like a speed bump on Bitcoin’s straight upward trajectory, “but I don’t want to know.”

Bogart’s cautious view on the debate surrounding the increase in Bitcoin’s block size limit could explain Needham’s general support for Bitcoin Core’s scaling roadmap.

The risks of not forking

Early Bitcoin adopter and angel investor Roger Ver has become the most vocal supporter of a hard fork to increase the block size. When asked what he thought of the impact of a hard fork on Bitcoin’s price, Ver admitted that there might be some impact, but he claimed that there would be an impact even if there was no hard fork.

Ver told CoinJournal:

Companies like Coinbase, which once believed in only Bitcoin, are now integrating altcoins, and as a result, Bitcoin has not been able to scale. I think Bitcoin has not been allowed to scale quickly enough to keep up with consumer demand, which creates a greater risk. People who want to use Bitcoin are now being locked out because of potential dangers that may exist in the future. The fact that it is already easy for people to switch from Bitcoin to other altcoins because of services like Shapeshift.io makes the problem of Bitcoin splitting into two coins even less serious.

In addition to Coinbase, Ver also pointed to Jaxx, a blockchain wallet that integrates multiple cryptocurrencies, as another example of Bitcoin losing its role as the only digital asset worth mentioning. Because the number of transactions that can fit in a block is limited, users are sometimes forced into an effective bidding war for the next block node. According to Ver, if transaction fees are too high, users may leave and look for alternative options, but because of Bitcoin's network effect, this also means that there is a little bit of friction when transferring to another cryptocurrency.

Ver also expressed his disappointment that Bitcoin Core contributors did not support the hard fork to increase the block size. He believes that increasing the block size would attract more users:

“Unfortunately, we are seeing the current [Bitcoin Core team] not only voice loud and strident opinions about things they are completely ignorant of, but also implement those opinions into Bitcoin to the detriment of the entire ecosystem. Sadly, they do not realize that the economic code underlying Bitcoin is just as important to Bitcoin as the software code.”

Ver has recently seen tweets that disagree with his views as proof that his fellow Bitcoin Core contributors and supporters are economically illiterate.

“When the cost of using something goes up, people use it less. This means that higher Bitcoin fees will lead to fewer people using Bitcoin.”

Ver said:

“The reason I was able to realize the importance of Bitcoin before any other businessperson in the world, and almost everyone in technology, is that I understand the money being made because of my lifelong love of studying economics.”

While higher fees make on-chain transactions less attractive to users, general use of Bitcoin continues to increase as capacity limits are approached. Bitcoin prices have continued to rise over the year, network hashrate has strengthened following the halving event, and while on-chain transaction growth in 2015 was half that of 2016, Xapo CEO Wences Casares claimed that their off-chain transactions have “skyrocketed” since January.

The problems caused by higher on-chain fees may affect those who use Bitcoin for censorship-resistant payments more than those who use Bitcoin as a store of value. A hard fork that splits hashrate and influence on the Bitcoin network may have a greater impact on long-term speculators. However, it should be noted that Bitcoin's censorship-resistant payments also rely on having a large amount of hashrate directed toward the network, making it difficult for one party to reject certain types of transactions. Hashrate is incentivized by block rewards, which have value because some people use Bitcoin as a store of value or digital currency.

That being said, Ver noted that transferability is also a key component of any efficient currency. He said,

“Bitcoin digital gold is just a made-up concept. Most people don’t know why gold or Bitcoin has value. If we want to use Bitcoin as a currency, then Bitcoin needs to have all the properties to be a currency.

He then pointed to a slide that listed many properties of a currency, such as difficult to counterfeit, scarce, easy to store, divisible, homogeneous, durable, and easy to trade. In Ver's view, the current block size limit is undermining Bitcoin's tradability and also harming its homogeneity. If a digital asset with higher properties than Bitcoin emerges, people will start using it.

Right now, it seems that the hypothetical digital asset that could replace Bitcoin is not an active threat. While Coinbase and Jaxx are able to make it easier for users to use altcoins, it is worth noting that Bitcoin is still the only digital asset that can be used in any meaningful way. To see if users are switching from Bitcoin to altcoins to pay for higher fees, the best available data is the number of transactions occurring on these various networks each day, and there is no sign of increased activity on other blockchains. For example, while Ethereum saw a significant increase in daily transactions in the first half of this year and the ether price began to grow, a contentious hard fork and recent DDoS attacks have brought transactions to a standstill.

Even if some users stop using Bitcoin due to the block size limit, they do not seem to be switching to other blockchains; however, it is meaningful to continue observing these statistics.

Both sides of the debate seem to be concerned with theoretical dangers rather than those actively playing out before our eyes. One camp fears the potential downsides of hard forks, while the other believes that other cryptocurrencies will eventually gain more adoption than Bitcoin due to its block size limit.