Blockchain forks—the splitting of a cryptocurrency into two—are an occupational hazard for anyone involved in this emerging asset class.
Now the head of a cryptocurrency trading firm has called for the establishment of an industry code of best practice to deal with the consequences of forks.
Max Boonen, chief executive of B2C2, argues in a blog posted on his company’s website that such an industry code could benefit investors by preventing market practices around cryptocurrencies becoming even more complex.
“A lot of people have no idea what they are doing”
“An ecosystem is building around cryptocurrencies and real contracts are being entered into. As is often the case in our industry, a lot of people have no idea what they are doing and today’s decisions with respect to contracts can have unforeseen or unintended consequences,” Boonen says.
Some cryptocurrency forks are entirely harmless and iron themselves out without external intervention.
A non-contentious fork occurs when two cryptocurrency miners find valid blocks around the same time. Both resulting blockchains are temporarily valid, but after a few more blocks the network discards one of them.
Other types of fork are more problematic, however. Such contentious forks fall into two categories, says Boonen.
If a fork implements a new transaction format to ensure that transactions are never valid across the two chains (such a transaction format is said to have ‘replay protection’), then you have a cohabitating contentious fork, says Boonen.
The August 2017 bitcoin cash (BCH) fork from bitcoin (BTC) is an example of such a cohabiting contentious fork.
An alternative, ‘nasty’ kind of fork occurs, says Boonen, when a new fork is set up with a common transaction format and set of past transactions. The antagonistic November 2018 fork of bitcoin cash (BCH) into two new blockchains, BCH ABC and BCH SV, is an example of such a competing contentious fork.
Such a fork leaves cryptocurrency users at severe risk, says Boonen.
“For the love of all that is sacred, use replay protection!”
“Right after the fork, a given transaction is valid on both chains (and can be ‘replayed’ from one chain to the other). It’s not a clean split and it can take a long while (or forever) before one can transfer old coins without unwittingly moving the new coins, and vice versa,” Boonen says.
In his blog, Boonen makes a plea to blockchain developers to avoid a repeat.
“For the love of all that is sacred, use replay protection!” he says.
Given the complexity surrounding forks, Boonen argues that the cryptocurrency industry needs to come together and improve standards.
“For the foreseeable future, most coins will be held by third parties rather than directly by their beneficial owners. As a consequence, our industry needs to put in place best practices for the management of forks,” the B2C2 head says in his blog.
Boonen suggests that the cryptocurrency industry learn lessons from the securities lending and repo markets in the conventional financial markets. In securities loans and repurchase (‘repo’) trades, shares and bonds are lent temporarily to third parties, often to facilitate short sales or ease temporary financing problems.
The term ‘securities lending’ is misleading, since a loan of shares or bonds is actually a transfer of ownership is involved, accompanies by a promise to return the same or similar securities in due course.
However, market convention is for any dividends or interest received by a borrower of shares or bonds to be passed up the ownership chain to the ultimate beneficial owner.
“If a newly forked coin is not supported, you’re out of luck”
Creating a similar standard for cryptocurrency lending relationships would help improve the funding market, says Boonen, who notes that forks are very disruptive to cryptocurrency liquidity. In the case of the recent BCH ABC/BSV fork, borrowing rates shot up on Bitfinex and other markets, Boonen notes.
However, he concedes, there’s ultimately no way of telling which forks should be recognised in cryptocurrency-related financial contracts.
“It seems appropriate that the ultimate owners should enjoy the full benefit of ownership, but it is not always possible. Trivially, if a newly forked coin is not supported by the third party in actual possession of the asset, you’re out of luck,” he says.
“Why is bitcoin cash a well-known fork, but not bitcoin diamond?” Boonen asks rhetorically, referring to two forks of bitcoin.
“The sad truth is that there is no objective criterion to distinguish material forks from negligible forks.”
As far as cryptocurrency custodians are concerned, customer satisfaction should be the driving force in deciding whether or not to support a particular fork, Boonen says.
“It is important that custodians communicate with their clients ahead of potential forks to help them make informed decisions,” Boonen says.
“For a custodian, the main risk is in not supporting a newly forked coin before reversing course long after the fact, as happened with Coinbase and BCH.”
In early August 2017, Coinbase, the popular digital currency exchange and wallet provider, reversed its position on bitcoin cash and said it would henceforth be supporting the new coin. The exchange’s customers had threatened Coinbase with a lawsuit.