Free cash time again in the bitcoin world

It's free cash time again in the bitcoin world. Back in July a new coin called Bitcoin Cash was launched based in a software fork from the underlying bitcoin protocol. At the time of writing Bitcoin Cash is worth $318, but traded as high as $914 on 19 August.

When that fork took place, every owner of bitcoin, currently worth $4,800, received a proportional amount of Bitcoin Cash. The same thing is going to happen with Bitcoin Gold later this month, although the value of the new coin will not be known until it starts trading on 1 November.

A software fork can be thought of as a fork in a road, but what is the difference between a soft and a hard fork? There is only one version of the bitcoin code and there are two ways to make changes to it, known as soft and hard forks.

The first approach comes in the form of a soft fork in which code tweaks add new features, but it is not mandatory for every computer (node) on the network to upgrade to it.

Each node has its own copy of both the bitcoin code and the network's entire transaction history. All nodes can carry on in the old way by choosing not to update to the new version of the code that includes the soft fork and as such will of course therefore not be able to make use of its new features.

Those nodes implementing the soft fork can access the new features and at the same time are able to maintain backward compatibility with the old version of the code.

A second and potentially more problematic approach is the hard fork route, whereby code changes must be adopted by all nodes if they want to continue mining, which is the process of verifying and recording transactions. If there is a bug in the hard-forked software changes, the only way it can be fixed is through a subsequent hard fork. This is what happened in the early days of the blockchain platform Ethereum.

After a hack in July 2016 during the launch of one of the first major projects on the platform called The DAO, a hard fork had to implemented in order to return funds to investors. Those wanting to stick with the original code launched Ethereum Classic, which is a continuation of the original Ethereum blockchain.

According to some, strictly speaking the creation of Bitcoin Cash and Bitcoin Gold are not true hard forks because computers on the bitcoin network are not forced to accept the software upgrade. In fact, computers can ignore the new code and carry on as before, which is largely what has happened in the case of Bitcoin Cash.

Instead, it is those nodes that wish to make use of the new features that have to adopt the hard-forked code but, importantly, due to the lack of majority agreement among nodes, they can only do this by starting a new network as opposed to having those changes implemented on the bitcoin network proper.

This is what happened with Bitcoin Cash, where nodes wanted the new features (faster transaction times by changing the block size) and were opposed to the implementation of the SegWit2x bitcoin improvement proposals (BIP) for addressing the transaction issue. Those nodes that wanted to implement the Bitcoin Cash changes had to replicate the transaction history of bitcoin up until the block where the fork was introduced but on an entirely new network.

Technically, this means both Bitcoin Cash (and Bitcoin Gold when it is launched) aren't hard forks at all. In effect, they are just using the existing bitcoin network as a way of distributing a new coin. The bitcoin network itself remains unaffected.

Great, you understand that, but where does SegWit2x come into it? Bitcoin Cash came into existence because there were those in the bitcoin developer and mining community who didn't want to implement what they saw as a half-backed solution to the transaction problem, although the SegWit2x software change was a soft fork initially so it wasn't a mandatory upgrade.

SegWit stands for segregated witness and is the method built into the bitcoin protocol for digitally signing individual transactions.

By tweaking this code, it effectively allows a block to double the number of transactions it can hold without actually increasing the block size parameter.

SegWit2x will hard fork to implement the 2MB block size sometime around 18 November. From that date, all nodes on the network will have to run the new software.

SegWit2x is currently optional for nodes, but this will change when the hard fork is implemented, hence the move by those behind Bitcoin Gold who oppose the move but also dislike Bitcoin Cash because it fails to deal with the fact that bitcoin mining is dominated by a relatively small number of mining pools based in China, although it is it not where they are located as such that is the issue.

Bitcoin Gold advocates believe SegWit2x will further reinforce the dominance of these large mining pools that use specially designed chips - application specific integrated circuits (ASICs) - to mine bitcoin. They fear mining has become too centralised.

Bitcoin Gold, which uses a different hashing (i.e. encryption) algorithm to bitcoin's SHA256, will block the use of ASICs, making mining more 'democratic' as standard GPU (graphical processing units) chips can be used, and these are available in the consumer market from chipmakers such as Nvidia and AMD.

As a consequence, miners will not have to compete with the more efficient, but much more expensive, ASIC-based mining operations when they put their hashing power to work on Bitcoin Gold because ASIC miners are unable to work with its Equihash encryption algorithm.

The mining process of the bitcoin decentralised ledger system is known as the proof of work, and a consensus is arrived at among nodes on the network as to the validity of the proof of work, with the miner who was first to present the proof of work awarded the incentive payment for verifying transactions, which for bitcoin is 12.5 bitcoins per transaction block.

Bitcoin Gold is being pushed by Jack Lia, the chief executive of Lightning ASIC, a bitcoin mining pool based in Hong Kong.

The new coin will launch on 25 October and be available to trade on exchanges a week later.

Technical stuff aside, if you hold bitcoin on 25 October you will receive an 'airdrop' of the new coin in the same proportion as the amount of bitcoin you hold. Not all exchanges will have a market in the new coin, but the decentralised exchanges such as coinexchange that only offer crypto pairs as opposed to fiat, will be the most likely early places to trade the latest variant of bitcoin.

This article is for information and discussion purposes only and does not form a recommendation to invest or otherwise. The value of an investment may fall. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment adviser.