Join our Telegram channel (20,000+ subscribers) for daily market analysis & trading tips: t.me/synapsetrading
Have you come across the term “blockchain fork”, “hard fork” or “soft fork”?
Everything moves fast in the world of cryptocurrencies, from price fluctuations to new technology being introduced to the market every day.
While this can be very exciting for an investor, it can also cause confusion and chaos when multiple versions of one cryptocurrency appear out of nowhere.
So, what exactly do these terms mean, and how does it affect your crypto holdings?
In this blog post, I will explain exactly what blockchain forks are, the different types of forks, and why it is important for your trading platform and portfolio.
What is a Fork?
Cryptocurrencies like Bitcoin (BTC) and Ethereum (ETH) run on decentralized, open-source software, which anyone can contribute to — this software is called a blockchain.
Blockchains are named because they are blocks of data made up of transactions that can be traced back to the first-ever transaction on the network.
And because they are open-source, they rely on the work done by their communities to keep them up to date and actively develop the underlying code.
A fork is when a block of data suddenly diverges into two branches.
The new branch will share all of the earlier branch’s history but is headed off in its different chain.
Following this, they go on their way, each going in a separate direction.
There are many possible reasons for blockchain forks.
A fork may either be accidental or intentional.
Both soft forks and hard forks are subcategories of intentional forks.
Accidental Forks vs. Intentional Forks
Thousands of miners are constantly mining a new block at once.
In some cases, two or more miners may mine the same block, resulting in an accidental block.
As soon as an accidental block is mined, the network focuses on the longer chain and abandons the shorter one.
With an intentional fork, the network does not reconverge onto a single chain.
Developers often utilize this type of fork to amend the blockchain’s protocol or fundamental set of rules.
To take just a few examples, developers might use an intentional fork to alter the block size, reduce block time, or experiment with new consensus algorithms.
An intentional fork may be hard or soft.
These two differ in terms of their compatibility with other chains and their applications.
Soft Forks vs. Hard Forks
A hard fork is a permanent divergence from one blockchain that results in a new chain, rendering the previously valid transactions invalid.
This permanent separation requires all nodes to adopt new rules within their blockchain software, and as a result, nodes on different chains may not communicate with each other.
This type of split occurs when developers can’t agree on proposed changes.
If a hard fork occurs, users and miners must make a decision — keep running the old version of the software or upgrade to the newly-forked chain.
In any case, they now own cryptocurrency on both chains.
They still hold currency from the legacy chain and can claim the new protocol’s currency on the new chain.
Once a change has been implemented, any nodes that fail to upgrade to the new consensus rules are kicked off the main chain.
Without upgrading to the system’s latest version, the new consensus rules cannot be processed, which would make the original blocks split by a hard fork incompatible with the new version.
A hard fork may be done when there is an issue with how a cryptocurrency works or if changes are needed to increase scalability and solve other problems within their network, such as what happened with Bitcoin Cash in 2018.
In contrast to hard forks, changes made by soft forks are backward-compatible with the pre-fork blocks.
To make the chains backward-compatible, blocks created under the new consensus rules must also be valid under the pre-fork rules.
Therefore, soft forks do not require the nodes to upgrade — they can still participate in the new network as validators while running the old software version.
A soft fork is done to update and improve a cryptocurrency’s software.
This is done by making all its users change to new rules rather than enforcing them directly (like a hard fork).
Soft forks work because if you don’t update your software, you will still be able to use it as normal and interact with everyone else on the network who has updated their software.
Different Types of Soft Forks
User-activated soft forks (UASF) and miner-activated soft forks (MASF) are the two different types of soft forks.
A UASF is a mechanism that allows nodes to activate on a specified block height.
Once activated, these nodes enforce new rules across all blocks mined moving forward.
When a majority of hash power has signaled support for UASFs, only then will activation occur.
These nodes will reject any blocks generated according to older consensus rules.
Miners who have updated to newer versions of the software are more likely to mine blocks following the latest set of rules; however, if a large amount of hash power remains on outdated versions, this could lead to a replay attack where transactions occurring on one chain would appear on another.
A MASF differs from a UASF in that the change activates at an agreed-upon block number.
Nodes and miners trigger MASFs at regular intervals, which means there is some time before the full activation of new rules.
Miner-initiated soft forks are less disruptive than user-initiated ones because they don’t interfere with how users create transactions.
Blockchain Forks in Practice
Most digital currencies have communities of independent developers responsible for changing and improving the network.
So there are times when a cryptocurrency gets forked to add features or make it more secure.
Developers of a new cryptocurrency can also use forks to create an entirely new currency and ecosystem.
One popular currency that is a product of a hard fork is Bitcoin Cash (BCH), which forked from Bitcoin in mid-2017.
When Bitcoin Cash forked, the block size limit increased from 1 to 8 MB and later to 32 MB.
Created in October 2016, Ethereum Classic (ETC) is another popular example of a hard fork.
This currency was created after a group of developers rejected new rules implemented by hard forking.
Instead, they opted to continue using the old Ethereum chain, later renamed Ethereum Classic.
Because hard forks might cause the blockchain community to split into two separate groups, developers usually try to work on implementing soft forks first.
This way, they can update the network without changing its fundamental functionality and only allowing for new functionality.
In Bitcoin’s Segregated Witness (SegWit) protocol, for instance, it was thought that a hard fork would be required to make significant changes to the fundamental structure of transactions.
However, the developers found an efficient and forward-compatible solution, implementing SegWit with a soft fork.
Nodes that have not updated to SegWit still participate in the Bitcoin network by employing a soft fork.
With a soft fork, developers can also take advantage of upgrades in proof-of-work algorithms, like Ethereum’s move from Bitcoin’s SHA256 algorithm to Ethash.
If a cryptocurrency you are using undergoes a hard fork, this knowledge about forks will allow you to make an educated decision on which branch to follow after the blockchain fork.
How do Forks Affect a Trading Platform?
The term fork is mainly associated with the hard fork of Ethereum that led to the creation of Ethereum Classic.
A hard fork occurs when a cryptocurrency’s existing code is altered, typically because of an addition, deletion, or change in the code’s function.
In this case, Ethereum split into two versions with different rules for making changes.
However, not all forks are created equal.
The Bitcoin Cash hard fork took place in 2017 after a disagreement within the community about upgrades that needed to be made on Bitcoin’s software was not addressed by developers.
This caused those involved with BCH to make some changes so that there would be fewer restrictions on what you could do with Bitcoin.
This can significantly affect how you can buy, sell or trade a cryptocurrency.
Some crypto trading platforms provide access only to cryptocurrencies that are considered viable options for trading.
This could mean that if there is an upcoming hard fork, your platform may not support it or be disabled entirely during that time.
However, there are trading platforms that support all hard forks.
Some even allow you to buy during a fork by providing access to funds and cryptocurrency before trading begins on other exchanges.
This can give you some early insight into how certain changes will impact your crypto portfolio.
And it also means that your platform will be ready for trading as soon as one of these hard forks occurs—rather than waiting until another exchange offers support.
As cryptocurrencies continue to become more mainstream, and with the emergence of new cryptocurrencies, the need to understand blockchain forks becomes increasingly important.
While blockchain forks don’t happen often, they do have a major impact while such an event occurs.
I hope this guide will help you understand what happens during a fork and how it affects you as a trader or cryptocurrency owner.
The next time one occurs, you’ll be able to recognize what is going on, and make an informed decision regarding your crypto assets.
Now that you know all about the different types of blockchain forks, how would you go about deciding whether to follow the new or old blockchain when a fork does happen?
Would you prefer to sell off your tokens and buy them back after the fork, or just hold them through the forking process?
Let me know in the comments below.
If you're looking for the best trading opportunities every day across various markets, and don't want to spend hours doing the research yourself, check out our private Telegram channel!
[Sponsored] Generate 5-8% additional monthly passive income by allowing your trading account to automatically copy trades from professional traders! (No time or experience required!)
If you're looking for a reputable brokerage that covers all products (SG stocks, US stocks, global stocks, bonds, ETFs, REITs, forex, futures, crypto) and has one of the lowest commissions, this is what I currently use.
Spencer is an avid globetrotter who achieved financial freedom in his 20s, while trading & teaching across 70+ countries. As a former professional trader in private equity and proprietary funds, he has over 15 years of market experience, and has been featured on more than 20 occasions in the media.