Right now, there is no measure of “intrinsic value” in the crypto world. And even if there is a measure for a specific protocol, investor sentiment tends to overshadow it by a significant amount. The lack of certainty in this space creates a high level of volatility that naturally plays out in the prices and makes it difficult to determine a fair value for cryptocurrencies. By understanding hard forks better, you can properly make a decision ahead of time in order to protect your investment.
First thing’s first: let’s get the definitions straight. A hard fork is a change to a cryptocurrency’s protocol that creates two different versions of a cryptocurrency. Soft forks, on the other hand, stick to just one cryptocurrency (and one blockchain). Segwit was an example of a soft fork, and Bitcoin Cash is the most well-known example of a hard fork.
Hard forks can signify upgrades to security or new functionality, or they can be designed with the express purpose of reversing past transactions. However, the most well-known function of a hard fork is to split a cryptocurrency into two. A new version and old version result, and it turns into somewhat of a battle between the two for dominance of the aggregate community.
We have seen this play out most notably with Bitcoin Cash, but Bitcoin Gold and Setwit2x were also cases where this occurred.
There are three outcomes that can occur when a hard fork is executed. Either one blockchain becomes dominant and the other one fades into obscurity, both achieve similar adoption and are able to act independently of each other, or both remain successful with one outshining the other. The third case is the most common, as network effects often lead to compounding success within a single domain.
With Bitcoin Cash, we have seen a very active community attempt to push the cryptocurrency to dominance over Bitcoin, but BTC is so entrenched that this is nearly impossible. When a cryptocurrency forks into two separate coins, there end up being two ledgers and two sets of code, all with the same original blockchain.
Even if you’re not worried about the future of the space, hard forks have created some question of how the overall ecosystem can adapt to them. The complications involved in managing a hard fork and distributing the private keys to the newly minted cryptocurrency can be significant. Generally, issues arise from the fact there is no “standard” method of handling an event such as this, and it becomes a question of each exchange’s policy. As we have seen with lawsuits such as OKCoin’s, sometimes the lack of clear guidelines and announcements can create confusion in the space.
An additional reason why investor confidence comes into play are the intense debates that ensue during a hard fork. Nodes are forced to choose between upgrading to the new version of the protocol software or maintaining the old one. This sort of divisive choice can be seen as “democratic”, but it also foments instability in the way that unrest within a country would hurt its currency.
From an investing perspective, the value of your cryptocurrency pre-hard fork should be the same as the aggregate value of your cryptocurrencies post-hard fork. This would be the case in an ideal world, however things seldom work out this perfectly. What it does do is create a betting-type market where you can sell the cryptocurrency you think is most likely to disappear, and still maintain your investment in the other cryptocurrency.
The key point here is that hard forks create additional volatility in an already volatile market. Whenever a hard fork is on the horizon, it helps to have a plan and know whether you are going to “make a bet” on one currency or the other, or sell before the hard fork occurs.
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