I put the question to Mike Sofaer of Brian Kelly Asset Management when I saw him at the Scaling Bitcoin conference recently. Mike replied: “Bitcoin is collective insurance against the collapse of fiat currency systems.”
His answer left me with a fresh question – why can’t we have lots of insurance companies?
Let’s imagine that we have a decentralized system – which means that miners (well at least, the ones among whom there’s consensus) aren’t working together, and the correlation of their decisions is negligible. The upshot would be that each miner verifies the actions of all the others, and is exclusively interested in following the rules to a T.
This kind of setup is similar to an insurance company with a pool of policies sufficiently diversified that the occurrence probability of a certain percentage of identical claim situations happening simultaneously is actually zero.
And in reality, that’s exactly how insurance corporations operate – they have policies against floods, and against forest fires, when it’s obvious that the two calamities couldn’t both happen at the same time.
So how can the cryptocurrency economy develop similar robustness? Maybe forks are part of the answer.
Stepping back, previous bitcoin forks, along with ones that didn’t go ahead, have shown that the first cryptocurrency is sufficiently robust and stable, even during such unpredictable circumstances.
To be clear, the kind of forks I’m talking about in this post meet the following criteria:
- They share a common transaction history
- They use identical cryptography – in other words, the wallet keys in one fork will fit the wallets in the other fork
- They use the same mining algorithm (in this they differ from other forks, where the algorithm was changed to prevent 51-percent attacks)
The primary causes of bitcoin forks are struggles for the control of bitcoin’s development. The system itself is decentralized – but obviously, opinions differ on how the project can be further improved are divided.
If, 1) bitcoin were made completely anonymous, 2) miners were decentralized and not grouped together in pools, 3) the number of transactions per second would increase in proportion to demand – there would be little impetus for forks.
In this scenario the system – which would be continuously getting closer and closer to perfection, along with the desired guaranteed proven security and real decentralization of control – would have the highest chances of success.
But clearly, we are far from hitting that trifecta.
Who gains from forks?
There are several groups with vested interests in these forks:
- Bitcoin miners. They are relatively indifferent to what they mine – for them, the only concern is maximum returns, so more forks means more options.
- Speculators looking for a proven technology (bitcoin forks have benefits over other cryptos, since it’s the oldest codebase) that offers them high liquidity, volatility and adoption.
- Users who want to use cryptocurrencies for making high-value transactions in the grey economy. Forks indirectly cause liquidity to increase, since there are more instruments to trade and the market capitalization of all cryptocurrencies grows, creating more opportunities to transfer value between chains. Meanwhile, governments find it harder and harder to track all the differing cryptocurrencies, and the level of competition causes fees to fall.
Yet in the final analysis, forks have a whole series of both negative and positive consequences…