What is the difference between "soft" forks and "hard" forks? What will happen to your cryptocurrency if it is stored in a hot wallet and will soon be faced with a hard fork? Why did the opinions of the crypto exchange teams about the hard forks divide so diametrically, and what could Themis offer to the holders who are left with no access to their assets? Let us examine these questions in our material.
Soft Forks vs. Hard Forks
A hard fork is a modification of the encryption protocol that makes valid blocks and transactions invalid and vice versa, thereby forcing users to update to the latest version. Thus, the hard fork divides the blockchain, and the new branch begins to function by following a new set of rules. In fact, this is an analog of the "reset" button. Then there are soft forks with the main difference being that they can interact with older versions of the blockchain.
Why initiate a hard fork? One of the reasons for the launch of the hard fork can be the elimination of security threats that were present in older versions of the software. Moreover, hard forks can serve the purpose of adding new features.
At the moment, there are about 116 forks, 74 of which are the "branches" of Bitcoin. The most famous forks are Litecoin, Bitcoin Cash (BCH), Ethereum Classic (ETC), and Bitcoin Gold (BGD). They are completely independent, they successfully compete with top coins, and they are traded on the world's largest crypto exchanges. But there are also small ones, whose price does not rise above a few cents, and it is unlikely that we will be able to see them on large platforms.
"With the ETC and BCH hard forks, it was clear that those two coins would be the minority fork, so it was safe to use a wait-and-see approach. So Coinbase didn’t support those forks initially, and now they only will if those forks gain traction. This is the only time Coinbase would spend the time and resources to support those forks and let people access their coins on the minority chain," said Litecoin creator Charlie Lee.
The Terrible Example of DAO
The DAO was conceived as a venture capital fund for a decentralized space. The period of creation was marked by unprecedented success, which made it possible to collect about $150 million at that time. The release of the DAO also passed without incident.
On June 18, members of the Ethereum community noticed that their funds were withdrawn from the DAO, and the total balance of ETH in the smart contract began to decline. The hacker who stole the funds spent about 3.6 million Ether in only a few hours. The attack was possible because of an exploit in the function of splitting. The attacker managed to withdraw the Ethers from the DAO smart contracts several times using the same DAO tokens.
After this, the community and the Ethereum team took control of the situation and suggested several solutions to the problem.
The community voted for a soft fork, but just a few hours before the launch, some members of the community discovered a bug in the implementation, which opened the opportunity for another hacker attack.
This soft fork was designed for blacklists of all transactions generated from the DAO, but such a decision would imply censorship, which was opposed by many members of the community.
Then a new, more radical, but at the same time, more effective solution to the problem in the form of a hard fork was brought to the vote. This hard fork had to have a single function, which was the return of all the Ethers taken from the DAO. DAO token owners had the ability to request 1 ETH for every 100 DAO.
Investors who paid more than 1 ETH per 100 DAO can request the price difference from the original address. This proposal caused a lot of controversy within the Ethereum community, which was subsequently divided into two groups. There were many arguments against such a decision, among which was the following: Code is law is the initial wording of the DAO conditions, and the conditions must be upheld under any circumstances. This law, however, did not protect the DAO from the fact that most (89 percent) voted "in favor” of the fork.
As a result, people who stored their Ethers got the right to demand an equivalent amount, and in order to do this, they had to access MyEtherWallet and download their JSON files that contained the private keys for coin storages. As you can see from this example, users can only get coins if they provide private keys as proof of the legitimacy of their claim.
How to Get Your Savings Back
Providing secret keys is a simple action if coins are stored in a hot or cold wallet. In the case of hard forks, however, the keys are stored on the platform along with the coins. In this case, the crypto exchange will decide on the distribution among its customers. As a result, the entire process of legitimizing coins becomes more difficult. For example, in the case described above, the Kraken exchange declared its support, noting that it will credit its users' accounts if they had Ethers at the time of the fork.
During the Bitcoin diamond (BCD) hard fork, Binance was one of the few crypto exchangers to recognize the new fork, while other exchanges completely ignored this event.
Nevertheless, most exchanges do not even tell their users about whether they will support the fork or not. All decisions are announced post factum. But some exchanges seek to support all forks by default, as in July, Binance announced support for hard forks as long as the project team contacts the platform directly.
In April, Coinbase announced that they would support the withdrawal of all forks of Bitcoin across Coinbase products (although there was no mention of trading). Other exchanges take a radically negative stance towards forks. In May, the Dutch exchange BL3P delisted BCH, referring to the requirements for altcoins and warning their users in advance about the upcoming event.
What about the Legal Point of View?
Even if a crypto exchange supports this or that hard fork, there can be difficulties. It was so with a Chinese investor, known under the pseudonym of Feng Bin, who recently filed a lawsuit against his local crypto exchange OKCoin. Bin argued that the platform did not allow him to get Bitcoin Cash after the Bitcoin hard fork in August 2017. Although the Feng Bin case is the first of its kind in China, a group of five Japanese lawyers has already challenged local exchanges. "The virtual currency that you are listing should not belong to the exchange, but to the user," the lawyers said, stressing that when a crypto exchange decides not to provide divided coins to customers or release them after a delay, they deprive them of their profits.
The issue of hard forks and crypto exchanges is still open. Many exchanges still try to stay away from them, motivating such a decision by their ambiguous legal status. Clients of the exchanges are often outraged by this state of affairs, and sometimes even suffer from such short-sighted decisions of the exchange administrations. On the legal side, this issue has not yet been resolved like many others in the crypto industry. Therefore, exchanges have to pursue an independent policy regarding this or that hard fork, which cannot be predicted by all users.