The Bitcoin Fork and its Regulatory Implications

Today is an important day in the history of Bitcoin: It’s the day of the hard fork, the creation of a second Bitcoin token, Bitcoin cash, as a number of miners decided to go ahead with the hard fork that split the most popular cryptocurrency. What this means and more so what the regulatory implications could be is subject of this post.

In the relatively short history of Bitcoin, there have already been plenty of attention-grabbing stories about the cryptocurrency, but apparently today is a special day if only based on the sheer number of posts and articles that focus on the Bitcoin hard fork.

The other Fork

This is not the first fork for Bitcoin though: in March 2013 a miner created a block that was not compatible with a previous software version of the Bitcoin software. This block was considered invalid by the old version and as a result was rejected by anyone using it; users of the latest Bitcoin software, however, simply continued to build on it and thus created a diverging chain, leading to a split in the blockchain. Yet, this was 2013 and the network quickly agreed to rectify the issue by taking a step back, clean the problem up and continue as if nothing had happened.

Why this is different

Still this one is different: discussions about the block size limit of 1 megabyte, which restricts the number of transactions per second, have been going on for a while and there even has been talk about a civil war in the Bitcoin community. Several proposals from different stakeholders in the Bitcoin were made who each seem to have their own agenda and would profit from the implementation of their proposal to solve the speed problem. One model suggested keeping the blocks small but bundle transactions, for instance, to increase execution time, the so-called segregated witness or SegWit model. Another, Bitcoin ABC, intends to increase the block size to 8 MB. The first proposal is still fiercely argued, but the second is an attempt to resolve the problem and will cause the hard fork. It will also create a second Bitcoin token, Bitcoin cash or BCC.

Bitcoin Cash

One mining pool, ViaBTC, invited miners to direct their computers to the new protocol, Bitcoin ABC, but many in the industry rebuffed the advances, which left the project with a limited number of support in comparison to the original blockchain. Therefore, questions were circulating as to whether the split would actually take place. Others point to the fact that the speed problem wouldn’t really be resolved by this solution and thus the real test for Bitcoin was still waiting. For that reason the issue is both technical as it is political as The Economist put the question of “who gets to lead an organisation that is supposed to be leaderless”.

Regulatory Ramifications

In any case, while the fork is a technical event, regulators may still consider regulatory measures as they pose a not insignificant risk for investors. In last week’s announcement, the U.S. Securities Exchange Commission (“SEC”) made it clear that any wrongdoing in the Crypto space, which has often been perceived as anonymous and out of reach of regulators, is likely to have severe consequences.

Especially, during the transition phase there could be an elevated risk for the funds invested in these cryptocurrencies. Because of the violent price fluctuations, ‘bank holidays’ during which funds may not be accessible, and the potential of a loss of investments, for instance, in case a new cryptocurrency like BCC does not succeed, the SEC and other regulators could be tempted to intervene through new legislation or regulatory actions. Similar to investments in ICOs this may be an opportunity to further strengthen the credibility of a cryptocurrency if the new rules do not stifle innovation and instead provide a solid framework.

As for Bitcoin Cash, in the end miners decided to go for it and the fork is underway, though it is likely to take several hours, if not days. BTC has seen violent swings in value and BCC is slowly increasing in value, but it remains to be seen how things pan out. As is for the regulation of Cryptocurrencies…