Bitcoin – to fork or not to fork?

Anyone following the crypto-currency markets this past two weeks will be fully aware that this has been a turbulent time for Bitcoin and other blockchain assets. First, the SEC published its Report on the DAO.  Second, there was a significant arrest in connection with the Mt Gox failure. And third, Bitcoin underwent a fork which has resulted in a new version, known as Bitcoin Cash. Meanwhile, at the time of writing, the price of Bitcoin itself is testing renewed highs, and continues to enjoy a 3-month long rally.

What implications do each of these developments have for the digital asset industry?

Photo by Andre Chinn – Image sourced from Flickr under Creative Commons

The Mt Gox-related arrest came as Japanese authorities began separate criminal proceedings against the former head of the failed exchange. These developments underscore two things: 1) as with any complex financial fraud investigation, bringing the culprits to justice takes time. 2) exploiting the financial system for ill-gotten gain is not exclusive to crypto-currencies – just ask investors in Australia’s CBA bank how they feel about losing nearly 4 per cent of the value of their shares in one day on the back of a money laundering scandal.

It also means that as regulators play catch-up, exchanges, brokers and other participants in the crypto-currency markets will need to ensure that they are updating their security and privacy systems (to prevent future hacks) while ensuring they comply with AML/KYC/CTF provisions. No bad thing, to instil confidence and trust in this emerging asset class, which is entering a new phase of maturity.

The SEC Report on the DAO, meanwhile, has put ICO’s (Initial Coin Offering) and TGE’s (Token Generation Event) on notice that in some cases, these products will be treated as securities, and will be subject to the same regulation as public offers of shares etc. As a result, token issuance programs will need to structure their sale processes to be either fully compliant with, or exempt from, the regulations; at the very least, they must remove any suggestion that these tokens are capable of creating security interests in financial or dividend-bearing assets, unless that is the express intention. (In some cases, these tokens are sold as membership services, software and IP licenses, or as network access permits. Any “return” to the buyer comes from the network value effects, service discounts or user rewards, similar to frequent flyer schemes and customer loyalty programs.)

Again, this suggests a coming of age for digital assets, and a growing maturity in the way token sales can be used as an alternative to VC funding and other traditional sources of raising operating capital and project financing.

The Bitcoin fork was hugely anticipated, with a mix of fear and excitement – fear because of the unknown consequences, excitement at the prospect of Bitcoin holders getting “free money” in the form of “Bitcoin cash“, via a 1:1 issue. Without getting into the technical details, the fork was prompted by the need to increase Bitcoin’s blockchain processing speed and transaction capacity; and while nearly everyone connected to Bitcoin’s infrastructure agreed on the need to accelerate block performance, there was a schism as to how this should be achieved. Some exchanges said they would not recognise the new currency, and only some Bitcoin miners said they would engage with it (especially as the cost of mining the new asset was more expensive than Bitcoin core). In addition, most exchanges were advising their customers not to attempt performing any Bitcoin transactions for several days, before and after the fork, until the system settles down again.

In the aftermath of the fork, at least one more exchanges has said it will probably offer some support Bitcoin cash; while due to the nature of the fork, Bitcoin cash’s own block processing time was something like 6 hours – meaning transactions could not be confirmed, and holders of the new asset could not easily transfer or sell it, even if they wanted to. It feels like a combination of a liquidity squeeze, a trading halt, and a stock split resulting from a very complex corporate action.

So far, the value of Bitcoin has held up, while the value of Bitcoin cash has steadily declined (despite an early spike), almost flat-lining to less than one-tenth of the value of Bitcoin:

Relative value of Bitcoin cash (BCH) to Bitcoin (BTC) – Market Data Chart sourced from Brave New Coin

I’m not a “Bitcoin absolutist“, as I think different currency designs and technical solutions will continue to emerge based on specific use cases. These products will continue to co-exist as markets come to understand and appreciate the different attributes and functionality of these digital assets.

As a consequence of recent events, some new token projects are refining the design of their issuance programs, more legal opinions are being commissioned, and raise targets are being adjusted in light of the current climate. But the number of new projects coming to market shows no sign of abating, and the better projects will have successful and sustainable sales. The total market cap of all digital assets is now well over $100bn (although the data reveals something of an 80:20 scenario – the top few assets account for the bulk of that value); and more institutional investors and asset managers are taking a greater interest in this new asset class.

NOTE: The comments above are made in a purely personal capacity, and do not purport to represent the views of Brave New Coin or any other organisations I work with. These comments are intended as opinion only and should not construed be as financial advice.

Next week: Bringing Back Banter