The Economics Behind Bitcoin Forks

We all know about the original version of Bitcoin, and we’ve all heard of its contentious forks. Here, I’ll explain the economic rationale behind the evolution of Bitcoin. The Bitcoin Core white paper was published on October 31, 2008 describing a “peer-to-peer electronic cash system,” while the Bitcoin Core blockchain started with the minting of the “genesis block” on January 3, 2009.

Explaining The Bitcoin Core Blocksize

At the time, the “blocksize,” or how many transactions fit in a block, started out at 36 MB, and wasn’t of particular concern. Eventually, a blocksize limit was set at 1 MB, as Bitcoin Core developer Jimmy Song explained in a blog post, “every node on the Bitcoin network checks that a block is less than 1,000,000 bytes.” 

The average Bitcoin Core blocksize never really came close to this limit, until concerns surfaced around 2015, when blocks would occasionally come near the limit. Still, it wasn’t a serious problem as the average blocksize was significantly less than 1 MB.

 

Problems With The Bitcoin Core Blocksize Limit

However, as blockchain became more popular, due to everything from the launch of Ethereum to figures like Don Tapscott popularizing the space to ICOs raising millions, the Bitcoin Core network became more and more congested.

 

Think of it like a train—the system can only take on a certain number of passengers, or in this case, transactions, while the rest have to wait in line.

When a Bitcoin Core transaction is made, it goes to a memory pool (or “mempool” for short), before miners validate it. The mempool is like the passengers waiting in line at the train station for a spot to get on. 

As we know, there’s a limit to how many transactions can fit in a new block. With the increased popularity of the network in 2017, more and more unconfirmed transactions remained in the mempool limbo, like passengers filling up a train station, and seemingly no one getting to where they need to go.

This was a massive problem. At its worst, the Bitcoin Core network had 200,000 unconfirmed transactions for over a day. Imagine 200,000 people waiting at Grand Central Station for their train, but they don’t get to board for over 24 hours! At that point, it’s better to find an alternative, like a bus or a plane, or, ahem, another Bitcoin blockchain.

Creating Alternatives to Bitcoin Core

With scalability issues posing a seemingly insurmountable problem, and Bitcoin Core developers not wanting to budge, an alternative was needed. People like Gavin Andresen proposed to increase the Bitcoin Core block size, but this was shot down.

At its worst, the Bitcoin Core median transaction fee was around $37.49 per transaction, on December 21st, 2017, with average fees eclipsing $54 at the time.

Astonishingly, peak confirmation times exceeded 11,453 minutes, or over an entire week. Basically, what was intended to be a “cash system” was useless as a cash system.

In economic terms, only the most saleable commodity can become money. With transaction fees that exceeded the daily wage in many countries and transaction times that were outrageous in any scenario, Bitcoin Core was useless as a means of exchange.

Bitcoin Cash: A More Saleable Bitcoin

Bitcoin Cash was introduced to remedy these issues, and create a version of Bitcoin in which the original properties of digital money still existed. Bitcoin Cash was released on August 1st, 2017, even before the worst congestion of the Bitcoin Core network. While Bitcoin Cash brought several upgrades, the main one is an increase in the blocksize limit to 8 MB, over Bitcoin Core’s 1 MB.

As discussed, there’s a limit to how many transactions you can put in a block, limiting a network. By literally just increasing the blocksize, you increase this limit, enabling faster, cheaper transactions and a better user experience, all requisite for greater adoption.

Economically, Bitcoin Cash would be a more saleable commodity, as it could be used as a means of exchange due to its low transaction fees and fast speeds.

The Austrian school explains saleability as follows: “If we call any goods or wares more or less saleable, according to the greater or less facility with which they can be disposed of at a market at any convenient time at current purchasing prices, or with less or more diminution of the same, we can see by what has been said, that an obvious difference exists in this connection between commodities.”

While that’s a mouthful, it just means that if you can sell a commodity easily, at its current purchasing price, it’s more saleable.

In the same way that, in the long run, markets will select among a few (potentially one or two) superior products, like Coca Cola and Pepsi, a unified monetary system will prefer one, or a very small number, of commodities as media of exchange.

This has already been reflected in the Ethereum space as thousands of tokens have died off, and users are showing their preference for a smaller number of tokens at the very top.

So, how do markets select the winning commodity? This can be found by evaluating the criteria for saleability. One aspect is “the cost of transport incurred in proportion to its value.” In terms of cryptocurrencies, if one coin, says Bitcoin Cash, has a lower cost of transport (transaction fees), then it wins out in terms of saleability. As we’ve discussed, only the most saleable commodity becomes money and therefore becomes the most valuable.

BitcoinFees.cash nicely compares the transaction fees of BTC and BCH, showing that Bitcoin Cash has always had, and continues to have, significantly lower fees than Bitcoin Core, making Bitcoin Cash a more saleable commodity.

Bitcoin Cash: A More Sound Bitcoin

Sound money” is money that is not prone to rapid depreciation or appreciation in purchasing power, over the long run. 

One component of sound money is its “portability,” referring to a commodities value-to-weight ratio. For example, gold is more portable than copper, because if you want to pay for something, say a life-size Iron Man suit, you’d need only a tiny amount of gold rather than a truckload of copper. 

Put differently, transporting that gold would require fewer resources than transporting copper. Due to the higher transaction fees in Bitcoin Core, transporting it requires more resources than Bitcoin Cash, so Bitcoin Cash is more of a sound money.

Bitcoin SV

As of early 2020, if we take a look at the CoinMarketCap rankings, we’ll find that a third flavor of Bitcoin is in the top 5: Bitcoin SV. 

The desire for Bitcoin SV, a hard fork of Bitcoin Cash, fundamentally arose when Craig Wright and Calvin Ayre disagreed with two proposed adjustments to Bitcoin Cash: Smart contracts and canonical transaction ordering.

Essentially, as Bitcoin SV is a relative of Bitcoin Cash, it’s rooted in the same economic rationale and need for an alternative to Bitcoin Core. Regardless of where you stand in the debate of Bitcoin Core versus Bitcoin Cash versus Bitcoin SV, the Bitcoin SV hard fork undoubtedly brought a lot of tension and risked serious damage to the space.

Bitcoin Gold

While Bitcoin Cash and its fork, Bitcoin SV, are more focused on blocksize, Bitcoin Gold focuses on mining.

After people found out that Bitcoin mining can be done highly efficiently with custom ASIC machines, instead of, say, gaming computers, the mining space became highly centralized, in contrast to the decentralization ethos of blockchain.

Bitcoin Gold introduces an alternative mining algorithm that’s less susceptible to ASIC optimization. Instead, they want ordinary users to earn Bitcoin Gold with their own computing, as was done in the early days of Bitcoin.

This is accomplished by using an alternative version of Bitcoin’s proof-of-work algorithm, called Equihash. This is intended to be impossible to speed up with custom hardware like ASICs.

In most other regards, Bitcoin Gold is identical to Bitcoin Core, so it comes with the exact same scalability issues, rooted in its block size limit, resulting in lower saleability. As a result, Bitcoin Gold is a highly fringe cryptocurrency.

Bitcoin Diamond

Yet another fork is Bitcoin Diamond, which is similarly ranked to Bitcoin Gold on CoinMarketCap, though both are far under Bitcoin Cash and Bitcoin SV.

Bitcoin Diamond doesn’t really deserve as much space as the others, as the main difference is that it multiplies the supply of Bitcoin by 10, via literally just moving the decimal point (instead of making it more divisible).

It has far less professionalism and trust than the other forks, but has still managed to gain some appeal as a fringe currency. Some are concerned that Bitcoin Diamond is just another scam, and you can’t blame them, as no one knows who’s behind Bitcoin Diamond. As of writing this article, Bitcoin Diamond is worth less than a dollar.

What’s Bitcoin Core’s Response?

Given all these hard forks, some more successful than others, you’d expect Bitcoin Core developers to take some action as well. After all, Bitcoin Cash has proven that a higher block size reduces transaction times and costs while increasing user experience.

The lightning network could be said to be Bitcoin Core’s reaction to its lingering scalability issues. It intends to facilitate truly instant, scalable transactions via a Layer 2 solution. While the lightning network is already rolled out over almost all of Bitcoin Core’s network, clearly we don’t have instant, scalable transactions just yet.

Lightning network explorers let you see some of the coverage of the network:

As Bitcoin Visuals shows, the lightning network is basically fully rolled out.

Unfortunately, the lightning network has not had the intended effect so far, as comparing the fees between Bitcoin Core and Bitcoin Cash clearly shows.

As of writing this article, Bitcoin Core’s next block fee is $0.50, while that of Bitcoin Cash is $0.0016. While fifty cents may seem small, it really isn’t, regardless of how wealthy you are. If you’re a retailer selling goods, say a fruit for fifty cents, then a fifty-cent fee means you can’t use Bitcoin Core. Even if you’re selling $50 goods, a $0.50 fee is an unnecessary hit to your margins.

This isn’t even to mention the fact that roughly half the world lives on less than $5.50 a day, making a fifty-cent fee a massive concern. Further, one in ten people lives on less than $1.90 a day (extreme poverty). Bitcoin Core simply doesn’t accommodate everyone, even with the lightning network.

$0.0016, on the other hand, is something that’s manageable for anyone, anywhere in the world. Maybe Bitcoin Core will learn something from these forks, and make adequate changes to its own network, but only time will tell.

Conclusion

The scalability problems with Bitcoin Core remain, leaving it with higher transaction fees and confirmation times than forks like Bitcoin Cash and Bitcoin SV, making BTC a less saleable and less sound money, and therefore economically a lesser means of exchange.

Nonetheless, Bitcoin Core occupies the number one spot, though that’s neither a guarantee or even a solid prediction of its future success, as mass adoption simply isn’t possible with a 1 MB block size limit. This limit effectively caps the usefulness of Bitcoin Core and mathematically limits it to the fringes rather than a viable global money contender.

On the other hand, everything is open to change. If all these hard forks have shown anything, it’s that blockchain developers will make massive changes if they deem them necessary, so there’s no saying that Bitcoin Core’s 1 MB block limit will remain forever. That being said, this limit has been around for years now, forcing down the value of Bitcoin Core and making forks like Bitcoin Cash and Bitcoin SV more and more appealing alternatives.

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Frederik Bussler

Frederik Bussler is the Founder of the Security Token Alliance, the industry's largest think tank with over 100 partners. As a public speaker, he has presented for audiences including IBM, Nikkei, Slush Tokyo, and the Chinese government, and is featured in outlets including Forbes, Yahoo, Thrive Global, Hacker Noon, European Commission sites, and more.

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