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Bitcoin’s price doesn’t seem to have priced in serious risks of upcoming SegWit2x hard fork.
This is an opinion piece, and the views of this author do not necessarily represent the views of Cointelegraph.
The upcoming SegWit2x fork could generate a black swan event for Bitcoin; that is to say, there is a small chance that the fork could have enormous repercussions. The idea of a “black swan event” was coined by author Nassim Nicholas Taleb to explain:
“The disproportionate role of high-profile, hard-to-predict and rare events that are beyond the realm of normal expectations.”
SegWit2x could be just such an event, particularly because the market seems so complacent right now. Despite soon facing an incredibly contentious hard fork with possibly terrific consequences, Bitcoin price remains just below its all-time high.
The upcoming fork has been written about extensively; if you aren’t entirely sure what SegWit2x entails, feel free to check out some earlier Cointelegraph articles. In this piece, I want to talk not about what SegWit2x is or whether it’s good or bad, but about the potential consequences it could have for Bitcoin.
Let’s begin with Satoshi’s original white paper. In it, the creator of Bitcoin wrote:
“Proof-of-work is essentially one-CPU-one-vote. The majority decision is represented by the longest chain, which has the greatest proof-of-work effort invested in it.”
In case of any confusion, Satoshi followed this statement with:
“Nodes always consider the longest chain to be the correct one and will keep working on extending it.”
In Satoshi’s own words, therefore, the longest of two competing chains is assumed to be the legitimate one. Many have argued that Satoshi would have thought differently in such-and-such situation, or that SegWit2x is an exception to the rule for one reason or the other. Nonetheless, without Satoshi here to guide us personally, it is understood from his white paper that the longest chain is Bitcoin. Full stop.
But Bitcoin’s core developers don’t like SegWit2x! But the SegWit2x code wasn’t created and vetted traditionally! But the upgrade isn’t needed! But many exchanges are going to call the legacy chain “Bitcoin!” But…!
I’m not here to argue any of these points. Whether the block size increase is necessary or proper is beyond the scope of this article. It nonetheless remains true that under Satoshi’s original white paper, the longest chain represents the “winner” - the legitimate Bitcoin. Rightly or wrongly, that’s how Satoshi designed the Bitcoin network.
This brings us to the next point: Bitcoin’s network is going to work exactly as Satoshi programmed it. At present, miner support for the 2x hard fork is running around 83 percent. Bitcoin developer Jimmy Song made some rough calculations, based on 90 percent miner support for the fork. This is reasonable since statistical variance causes miner support to fluctuate.
Song reasoned that, if 90 percent of Bitcoin’s miners follow through with their current plan to mine SegWit2x, then:
“ Block 494784 splits to 1X and 2X. Initially, 1X has 100 minute blocks, 2X has 11 minute blocks on average. 1X and 2X have the exact same difficulty.”
Legacy Bitcoin (which Song calls “1X”) would have 100 minute blocks. This means a single transaction with a high enough fee to make it into the next block would require 10 hours to receive six confirmations. It would take nearly half a day to fully confirm a transaction on the 1X chain!
How is the ecosystem going to react to a nearly two hour block time? Given the great slowness of the network - an order of magnitude slower than pre-fork--how high will fees rise? If the block size remains the same (on the 1X chain) but there are only a tenth as many blocks, fees will have to rise to monstrous levels since there will be 10 times the competition for space in a block.
This will be no brief inconvenience, either. Song estimates that if the mining split remains as it is today, the 1X chain won’t experience a difficulty drop until Feb. 3, and block times won’t return completely to normal until March 10. Die-hard supporters of the legacy chain will be contending with nearly two hour block times and sky-high fees for about three months!
Song points out that in futures trading, legacy (1X) Bitcoins are trading for about $6,100 each, compared to 2X Bitcoins, which are priced at only $1,100 apiece. He argues that this creates a massive opportunity cost, as miners who choose to mine the 2X chain will receive less valuable Bitcoins as a reward than if they mined the 1X chain.
However, this is only the case if, after the fork, the 2X chain remains priced at a sixth of the 1X chain. Assuming that the 1X chain has 100 minute block times and fees an order of magnitude higher than they are currently, it seems unlikely that 1X Bitcoin will maintain its high value relative to 2X Bitcoin.
It’s important to remember that since the 2X chain doesn’t yet exist, the current futures price isn’t merely a bet on whether 2X will supplant 1X. It’s also a bet as to whether the fork even happens at all.
There’s still the possibility of a last-minute compromise, or a falling away of support for 2X, or the conversion of some Bitcoin core devs to the 2X cause. Until the fork happens, the futures price doesn’t mean all that much. Of course, once the fork happens, the futures markets will become moot anyway.
In short, take the futures markets with a grain of salt.
Assuming the SegWit2x hard fork happens under the terms Song suggests (90 percent of mining power backing the new chain, Core devs backing the legacy chain), it’s likely there will be enormous confusion in the marketplace.
Consider that one chain will presumably be functioning just like normal, but with even lower fees due to its higher capacity. This would be the 2X chain. The other chain, the 1X chain, will have only a tenth the hash power of the 2X chain and will have a block time of nearly two hours. The network will quite literally crawl, and its maximum transaction throughput will be slashed by an order of magnitude.
Politics aside, which network sounds healthier? Which sounds more valuable?
Given that the marketplace is likely to be highly confused about which Bitcoin is the “real” Bitcoin, here lies one possibility of a black swan event. Since some exchanges will give the name “Bitcoin” and the “BTC” ticker to the 1X chain, and some will give the moniker and symbol to the 2X chain, it’s likely that buyers will be confused as to what they are buying.
With a lack of replay protection, there is likely to be significant disruption on both networks as transactions on each network are replayed on the other. In short, the first days following the fork will likely be chaos. The price of both 1X and 2X Bitcoin could crash, particularly if excess margin contributes to any flash crashes.
Miners will quickly realize that the chaos must end before the value of both networks hits zero. They will likely, therefore, attack the 1X chain. Considering that 2X miners will have (in our imagined scenario) ten times the hash power of the minority chain, reorg attacks against the 1X chain would be easy to execute and highly effective. Such attacks could reverse huge portions of the Blockchain--perhaps days worth of transactions--undermining confidence in the 1X network.
Bitcoin’s core devs, who unanimously support the 1X chain, have said that in the event of any attacks, they will simply change the proof-of-work algorithm. While this could work, it would require yet another hard fork.
It should be remembered that part of Core’s opposition to SegWit2x is because hard forks are dangerous, yet these same developers propose to foist a risky hard fork on an already unstable 1X network that’s under attack by a larger chain. This seems unwise in the extreme. Not only that, but changing 1X’s proof-of-work algorithm would tend to undermine its assertion that it’s the “true” heir to Satoshi’s original Bitcoin network.
In fact, because people are wildly unpredictable and there are such vast sums of money and pride at stake, nearly any outcome is possible. One chain could destroy the other completely, both chains could co-exist, one chain could be more valuable, or the fork might somehow be avoided altogether. Nobody knows, and if there’s anything the market hates, it’s uncertainty.
Yet with Bitcoin sitting over $7,000 at press time, it seems like the market doesn’t care at all.
Taleb’s theory rests on the assumption that “high-profile, hard-to-predict” events can have far-reaching consequences. But everybody knows that the SegWit2x hard fork is coming, so doesn’t that necessarily negate the “hard-to-predict” aspect of a black swan event?
Not at all. In this case, it’s not the event itself that’s hard to predict, but the outcome. I keep coming back to the market--right now, the market isn’t showing any signs of panic or unusual volatility. In fact, it appears to be merely consolidating in anticipation of another possible surge. This is irrational.
Since the market seems to expect the fork to be a non-event, it’s actually creating the perfect scenario for a black swan outcome. The possibility of mass confusion and price collapse do not seem to be priced in, meaning that if such events did occur, the market would likely react with panic.
Since very few seem to expect any trouble, it’s likely that most traders and investors have failed to make contingency plans. If the fork becomes a black swan event, a great many people are likely to have powerful knee-jerk reactions. Prices could easily tumble.
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