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Published On: Wed, Nov 8th, 2017

The Bitcoin HardFork could be a black Swan Event

Bitcoin is said to approach a hard fork in about 2 weeks from now. This is defined as a changed in the code in order to increase the block size limit to 2mb. There are many that are saying that not much will happen.

However, there is indeed the prospect that this could be a really dangerous time for Bitcoin and it could be a black swan event. Black swan events were theorized by Nicholas Taleb as those that seem really unlikely but when they do happen they can have devastating effects.

He was the author who claimed that the global financial crisis was a black swan event and we all know the impact that it had on the world.

Why could the hardfork lead to a black swan event? This is because of which chain is likely to survive.

Bitcoin
Image/CASASCIUS

Overview of the Chain Split

For those who do not know, when there is a split in the chain, if two sets of nodes run different software on the two chains then you will have two competing coins. In this case, there could be two competing chains being Bitcoin 1x and Bitcoin 2X.

This has been a really contentious point for the whole Bitcion community as you have two competing groups who are adamant in their ways. On the 1X side, you have Bitcoin core or the main developers. On the other side you have Bitcoin miners as well as a number of Bitcoin related businesses.

Which chain is likely to survive is hotly debated. Miners are signaling that they will support the 2X chain. Currently 90% of miners support SegWit2X. With this level of miner support on the 2X chain, it will mean that a great deal of hash power is being moved away from the 1X chain.

The result will be that the amount of blocks that can be properly mined will drop dramatically. There are some estimates that the 1X chain will have 100 minute blocks. This will mean that transactions will become incredibly slow.

There are some estimates that this slow block propagation time would result in a single transaction taking about half a day. This could seriously harm user adoption and lead to less demand for Bitcoin.

This slow transaction speed would go on for about 4 months well into March next year. Whether the current Bitcoin users are likely to stick with Bitcoin on such parameters is quite unlikely.

Impact of the Exchanges

Apart from the operations of the miners, you have to factor in to how the exchanges will react to the fork. For example, Coinbase has declared that they will designated the coin with the longest accumulated difficulty (longest chain) as the BTC ticker.

Given current miner support, that is likely to be the 2X chain. If Coinbase were to call 2X chain “BTC”, it would mean that some of the new investors could be confused thinking that it was the original Bitcoin.

This could create a situation where demand for the 1X coin falls off and the users buy more of the 2X coin. If this does occur it could also be disastourous for the legacy chain.

Future Prices and Opportunity Costs

There is currently a futures market that is open for the 2X and 1X coins. The prices are currently at $1,100 and $6,100 respectively. Hence, in order for the three month adjustment that we talked about above to hold, then these prices would have to remain as is.

This is because this mismatch in the price creates an opportunity cost for the miners who choose to rather mine the 2X chain than the 1X chain. It is indeed quite a large opportunity cost and runs into the millions.

However, this assumes that the prices are as they are at the hardfork and chain split. This may not be the case. It is entirely possible that the value of the 2X coin rises and that of the 1X coin falls. This could mean that the opportunity cost is less and the miners will continue on the 2X chain for longer.

The result will be that the 1X chain will become unusable and undesirable and will collapse.

Much Uncertainty

As we approach the hardfork and chain split in a few weeks, there are many Bitcoin investors who are uncertain as to what will happen. There is a lot of confusion and indeed some of the industry veterans are also undecided on what will result.

Whether the hardfork will be a black swan event that knocks down the value of Bitcoin and kills the legacy chain is rather unlikely. The hope of most investors though is that the economics of mining the legacy chain will incentivize miners to drop 2X and stick with the status quo.

Yet, in finance, we should never be completely complacent when black swans could be present.  

Author: Janet Preston

On the DISPATCH: Headlines  Local  Opinion

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