Fork (blockchain)

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In blockchain, a fork is defined variously as:

Forks are related to the fact that different parties need to use common rules to maintain the history of the blockchain. When parties are not in agreement, alternative chains may emerge. While most forks are short-lived some are permanent. Short-lived forks are due to the difficulty of reaching fast consensus in a distributed system. Whereas permanent forks (in the sense of protocol changes) have been used to add new features to a blockchain, they can also be used to reverse the effects of hacking such as the case with Ethereum and Ethereum Classic, or avert catastrophic bugs on a blockchain as was the case with the bitcoin fork on 6 August 2010.[ citation needed ] The concept of blockchain technology was first introduced in 2008 by an unknown person or group of people using the pseudonym “Satoshi Nakamoto” in a white paper describing the design of a decentralized digital currency called Bitcoin. Blockchain forks have been widely discussed in the context of the bitcoin scalability problem. [4] [5] [6]

Contents

Types of forks

Forks can be classified as accidental or intentional. Accidental fork happens when two or more miners find a block at nearly the same time. The fork is resolved when subsequent block(s) are added and one of the chains becomes longer than the alternative(s). The network abandons the blocks that are not in the longest chain (they are called orphaned blocks).

Intentional forks that modify the rules of a blockchain can be classified as follows:

Hard fork

A hard fork is a change to the blockchain protocol that is not backward compatible and requires all users to upgrade their software in order to continue participating in the network. In a hard fork, the network splits into two separate versions: one that follows the new rules and one that follows the old rules.

For example, Ethereum was hard forked in 2016 to "make whole" the investors in The DAO, which had been hacked by exploiting a vulnerability in its code. In this case, the fork resulted in a split creating Ethereum and Ethereum Classic chains. In 2014 the Nxt community was asked to consider a hard fork that would have led to a rollback of the blockchain records to mitigate the effects of a theft of 50 million NXT from a major cryptocurrency exchange. The hard fork proposal was rejected, and some of the funds were recovered after negotiations and ransom payment. Alternatively, to prevent a permanent split, a majority of nodes using the new software may return to the old rules, as was the case of bitcoin split on 12 March 2013. [7]

A more recent hard-fork example is of Bitcoin in 2017, which resulted in a split creating Bitcoin Cash. [8] The network split was mainly due to a disagreement in how to increase the transactions per second to accommodate for demand. [9]

Soft fork

A soft fork is a backward-compatible change to the blockchain protocol that allows new rules to be introduced without requiring all users to upgrade their software. In a soft fork, a majority of the network’s miners implement the new rules and begin following the updated version of the blockchain. The rest of the network can continue to follow the blockchain, but they will be unable to validate that new blocks follow the updated rules. Because a soft fork is backward-compatible, it does not result in the creation of a new blockchain or the splitting of the network. Instead, it allows the network to gradually transition to the new rules while still maintaining compatibility with the old rules. [10]

Cryptocurrency splits

A permanent chain split is described as a case when there are two or more permanent versions of a blockchain sharing the same history up to a certain time, after which the histories start to differ. [11] Permanent chain splits lead to a situation when two or more competing cryptocurrencies exist on their respective blockchains. [11]

Taxation

The taxation of cryptocurrency splits varies substantially from state to state. A few examples include:

Australian Taxation Office (ATO)

The ATO does not classify cryptocurrency splits as taxation events. [11] The ATO classifies the versions of the blockchain coming from the splits as the "original blockchain" and the "new blockchain"[ clarification needed ]. In relation to the cost base, the cryptocurrency on the original blockchain should be assigned all the original cost base, while the cryptocurrency on the new blockchain should be assigned cost base zero. [11]

HM Revenue & Customs (HMRC)

The UK HMRC does not classify cryptocurrency splits as taxation events. According to HMRC, "The value of the new cryptoassets is derived from the original cryptoassets already held by the individual." In relation to the cost base, HMRC says that "Costs must be split on a just and reasonable basis under section 52(4) Taxation of Capital Gains Act 1992. HMRC does not prescribe any particular apportionment method. HMRC has the power to enquire into an apportionment method that it believes is not just and reasonable." [12]

As of September 2021, it is believed that more than 2.3 million people in the UK own a cryptoasset. As these assets don't physically exist, HMRC has been forced to issue guidance stating that cryptoassets will follow the residence of the beneficial owner. So, if you live in the UK and trade cryptoassets, no matter where these assets are “held”, you will be liable to UK taxes. However, there is a growing belief that this guidance may well be challenged in the courts. This could impact future HMRC tax income from those not domiciled in the UK for tax purposes. " [13]

Internal Revenue Service (IRS)

The US Internal Revenue Service (IRS) classifies cryptocurrency splits as "airdrops" and as taxable events. According to the guidance published by IRS, provided the taxpayer is in possession of the keys, they are obliged to pay tax for the new cryptocurrency using the fair market value of the cryptocurrency as their income. [14] [15]

See also

Notes

  1. ↑ Alternatively, this situation is called a blockchain split [2] or a blockchain divergence. [3] If permanent, it is also referred to as a cryptocurrency split.

Related Research Articles

Double-spending is a fundamental flaw in a digital cash protocol in which the same single digital token can be spent more than once. Due to the nature of information space, in comparison to physical space, a digital token is inherently almost infinitely duplicable or falsifiable, leading to ownership of said token itself being undefinable unless declared so by a chosen authority. As with counterfeit money, such double-spending leads to inflation by creating a new amount of copied currency that did not previously exist. Like all increasingly abundant resources, this devalues the currency relative to other monetary units or goods and diminishes user trust as well as the circulation and retention of the currency.

<span class="mw-page-title-main">Cryptocurrency</span> Digital currency not reliant on a central authority

A cryptocurrency, crypto-currency, or crypto is a digital currency designed to work as a medium of exchange through a computer network that is not reliant on any central authority, such as a government or bank, to uphold or maintain it.

Litecoin is a decentralized peer-to-peer cryptocurrency and open-source software project released under the MIT/X11 license. Inspired by Bitcoin, Litecoin was among the earliest altcoins, starting in October 2011. In technical details, the Litecoin main chain shares a slightly modified Bitcoin codebase. The practical effects of those codebase differences are lower transaction fees, faster transaction confirmations, and faster mining difficulty retargeting. Due to its underlying similarities to Bitcoin, Litecoin has historically been referred to as the "silver to Bitcoin's gold." In 2022, Litecoin added optional privacy features via soft fork through the MWEB upgrade.

Proof-of-stake (PoS) protocols are a class of consensus mechanisms for blockchains that work by selecting validators in proportion to their quantity of holdings in the associated cryptocurrency. This is done to avoid the computational cost of proof-of-work (POW) schemes. The first functioning use of PoS for cryptocurrency was Peercoin in 2012, although the scheme, on the surface, still resembled a POW.

<span class="mw-page-title-main">Ethereum</span> Open-source blockchain computing platform

Ethereum is a decentralized blockchain with smart contract functionality. Ether is the native cryptocurrency of the platform. Among cryptocurrencies, ether is second only to bitcoin in market capitalization. It is open-source software.

A blockchain is a distributed ledger with growing lists of records (blocks) that are securely linked together via cryptographic hashes. Each block contains a cryptographic hash of the previous block, a timestamp, and transaction data. Since each block contains information about the previous block, they effectively form a chain, with each additional block linking to the ones before it. Consequently, blockchain transactions are irreversible in that, once they are recorded, the data in any given block cannot be altered retroactively without altering all subsequent blocks.

A decentralised application is an application that can operate autonomously, typically through the use of smart contracts, that run on a decentralized computing, blockchain or other distributed ledger system. Like traditional applications, DApps provide some function or utility to its users. However, unlike traditional applications, DApps operate without human intervention and are not owned by any one entity, rather DApps distribute tokens that represent ownership. These tokens are distributed according to a programmed algorithm to the users of the system, diluting ownership and control of the DApp. Without any one entity controlling the system, the application is therefore decentralised.

<span class="mw-page-title-main">Ethereum Classic</span> Blockchain computing platform

Ethereum Classic is a blockchain-based distributed computing platform that offers smart contract (scripting) functionality. It is open source and supports a modified version of Nakamoto consensus via transaction-based state transitions executed on a public Ethereum Virtual Machine (EVM).

Bitcoin Unlimited (BU) is a full node implementation for the bitcoin and Bitcoin Cash networks. The Bitcoin Core client, from which Bitcoin Unlimited is forked, has a hard coded one megabyte block limit; Bitcoin Unlimited differs by allowing users to signal which block size limit they prefer, find the limit having a majority consensus and automatically track the largest proof-of-work, regardless of block size. However, if a block greater than one megabyte in size is accepted by Bitcoin Unlimited and rejected by nodes with a block size limit, a fork of the network will occur, resulting in two separate blockchains with Bitcoin Unlimited nodes following the chain with the largest proof-of-work.

<span class="mw-page-title-main">Bitcoin scalability problem</span> Scaling problem in bitcoin processing

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<span class="mw-page-title-main">Bitcoin Cash</span> Cryptocurrency that is a fork of Bitcoin

Bitcoin Cash is a cryptocurrency that is a fork of Bitcoin. Bitcoin Cash is a spin-off or altcoin that was created in 2017.

Segregated Witness, or SegWit, is the name used for an implemented soft fork change in the transaction format of Bitcoin.

<span class="mw-page-title-main">Bitcoin Gold</span> Cryptocurrency

Bitcoin Gold (BTG) is a cryptocurrency. It is a hard fork of Bitcoin, the open source cryptocurrency. It is an open source, decentralized digital currency without a central bank or intermediary that can be sent from user to user on the peer-to-peer Bitcoin Gold network.

<span class="mw-page-title-main">Gavin Wood</span> British computer programmer and entrepreneur

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<span class="mw-page-title-main">Polkadot (cryptocurrency)</span> Cryptocurrency

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An airdrop is an unsolicited distribution of a cryptocurrency token or coin, usually for free, to numerous wallet addresses. Airdrops are often associated with the launch of a new cryptocurrency or a DeFi protocol, primarily as a way of gaining attention and new followers, resulting in a larger user base and a wider disbursement of coins. Airdrops have been a more important part of ICOs since crypto entrepreneurs have started doing private sales instead of public offerings to raise initial capital. One example of this is by the company Omise, which gave away five percent of its OmiseGO cryptocurrency to Ethereum holders in September 2017.

<span class="mw-page-title-main">MetaMask</span> Software cryptocurrency wallet

MetaMask is a software cryptocurrency wallet used to interact with the Ethereum blockchain. It allows users to access their Ethereum wallet through a browser extension or mobile app, which can then be used to interact with decentralized applications. MetaMask is developed by ConsenSys Software Inc., a blockchain software company focusing on Ethereum-based tools and infrastructure.

In blockchain technology, a testnet is an instance of a blockchain powered by the same or a newer version of the underlying software, to be used for testing and experimentation without risk to real funds or the main chain. Testnet coins are separate and distinct from the official (mainnet) coins, don't have value, and can be obtained freely from faucets.

References

  1. ↑ Antonopoulos, Andreas (2017). Mastering Bitcoin: Programming the Open Blockchain (2 ed.). USA: O' Reilly media, inc. p. Glossary. ISBN   978-1491954386.
  2. ↑ Thieme, Nick (4 August 2017). "Bitcoin Has Split Into Two Cryptocurrencies. What, Exactly, Does That Mean?". Slate. Retrieved 8 March 2018.
  3. ↑ Wu, Xun (Brian); Sun, Weimin (2018). Blockchain Quick Start Guide. Birmingham: Packt Publishing Ltd. p. 21. ISBN   978-1-78980-797-4.
  4. ↑ Croman, Kyle; Eyal, Ittay (2016). "On Scaling Decentralized Blockchains" (PDF). Financial Cryptography and Data Security. Lecture Notes in Computer Science. Vol. 9604. pp. 106–125. doi:10.1007/978-3-662-53357-4_8. ISBN   978-3-662-53356-7 . Retrieved 28 March 2019.
  5. ↑ Jordan Pearson (14 October 2016). "'Bitcoin Unlimited' Hopes to Save Bitcoin from Itself". Motherboard. Vice Media LLC. Retrieved 17 January 2017.
  6. ↑ Oscar Williams-Grut and Rob Price (26 March 2017). "A Bitcoin civil war is threatening to tear the digital currency in 2 — here's what you need to know". Business Insider. Retrieved 2 July 2017.
  7. ↑ Lee, Timothy (12 March 2013). "Major glitch in Bitcoin network sparks sell-off; price temporarily falls 23%". Arstechnica. Archived from the original on 20 April 2013. Retrieved 25 February 2018.
  8. ↑ Smith, Oli (21 January 2018). "Bitcoin price RIVAL: Cryptocurrency 'faster than bitcoin' will CHALLENGE market leaders". Express. Retrieved 6 April 2021.
  9. ↑ "Bitcoin split in two, here's what that means". CNN . 2017-08-01. Retrieved 2021-04-07.
  10. ↑ "What is Fork? Fork in 3 Title". CryptocurrencyTick . 2022-12-24. Retrieved 2022-12-24.
  11. 1 2 3 4 "Transacting with cryptocurrency". ato.gov.au. Australian Taxation Office. Archived from the original on 2018-09-10. Retrieved 2019-10-11.
  12. ↑ "Cryptoassets for individuals". www.gov.uk. HM Revenue & Customs. 2018-12-19. Retrieved 2019-10-11.
  13. ↑ "Taxing Cryptoasset Profits". www.wilkinssouthworth.co.uk. Wilkins Southworth. 2021-09-01. Retrieved 2021-09-01.
  14. ↑ "26 CFR 1.61-1: Gross income" (PDF). www.irs.gov. Internal Revenue Service. 2019. Retrieved 2019-10-11.
  15. ↑ Davison, Laura; Versprille, Allyson (9 October 2019). "Cryptocurrency Investors Get New IRS Income-Reporting Rules". Bloomberg. Retrieved 11 October 2019.
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