There is more than one way to define a hard fork. One definition is that a hard fork is a permanent change to the rules of a digital currency's blockchain. Once this takes place, the new chain doesn't follow the rules of the old chain. Any blocks mined using the old rules, for example, would be rejected by the new chain. As a result, the change in the digital currency's protocol is called a hard fork.
Hard forks can take place for several reasons, such as implementing technical upgrades. However, executing a hard fork requires the approval of a majority of devices mining the digital currency, and the exact majority needed can vary based on the cryptocurrency in question.
When a hard fork takes place, there are several potential outcomes. For instance, a network can split in two if users decide support both the new blockchain and the old one. Here is a short list of the possibilities:
Digital currency users embrace both blockchains, resulting in the two chains having roughly equal support.
Users adopt both blockchains, but one receives greater approval. In this scenario, one of these blockchains is dominant, drawing the majority of support and community resources. However, the alternative blockchain still has backing.
One blockchain becomes dominant, drawing most of the community support and resulting in the other chain having little adoption.
Hard Fork Examples
There are many examples of hard forks, with some resulting in chain splits and others not. One well-known instance is the hard fork that the Ethereum blockchain underwent in July 2016. Leading up to this event, a projected named the Decentralised Autonomous Organization (DAO) managed to gather an amount of ether worth roughly US$150 million at the time.
The DAO was basically a decentralised investment fund. Investors who provided funding would have a say in where the fund's money went. Companies had the ability to submit proposals for funding, and once a curator approved a proposal, the DAO's investors would be able to vote on the idea. Any proposal that received a minimum percentage of votes (20%) would cause funding to be sent to the wallet of the contractor who floated the idea.
While this idea generated widespread interest and substantial funding, a hacker exploited the code and drained money from the DAO. To address this problem, the Ethereum community eventually executed a hard fork that reversed all contributions made to the DAO so investors could get their money back.
Some members of the cryptocurrency community opposed this hard fork, and decided to keep mining blocks using the protocol that Ethereum had before the fork. They referred to this blockchain as Ethereum Classic.
Another hard fork that generated significant visibility was the one that created bitcoin cash. This digital currency came in to existence in August 2017 when developers modified bitcoin's existing code to create a new protocol. The new protocol had 8MB blocks instead of the more traditional Bitcoin's 1MB blocks, allowing bitcoin cash's network to handle a far greater transaction load.
A similar case involved Litecoin Cash, a digital currency that came in to existence 18 February 2018 by hard forking the Litecoin blockchain. Litecoin Cash's rules are rather close to those of Litecoin, except that the new cryptocurrency uses a hashing algorithm that makes previously outdated hardware useful once again.
Further, Litecoin Cash harnesses a DarkGravity V3 algorithm that will cause the mining difficulty of every block to automatically readjust.
A hard fork represents a permanent change in a digital currency's protocol, and requires the support of a majority. Once an upgrade takes place, the new protocol will not accept any blocks mined using the old rules. As a result, any miners who want to continue to support the old protocol would need to form a separate chain.
Hard forks can be executed for several reasons, such as upgrading a digital currency's protocol or to reverse a transaction when the broader community deems it necessary.
Senior Market Specialist
Russell Shor (MSTA, CFTe, MFTA) is a Senior Market Specialist at FXCM. He joined the firm in October 2017 and has an Honours Degree in Economics from the University of South Africa and holds the coveted Certified Financial Technician and Master of Financial Technical Analysis qualifications from the International Federation…