Bitcoin’s Big Compromise Is Unravelling

On Thursday, major Bitcoin network operator (or ‘mining pool’) F2Pool formally withdrew its support for the next stage of a planned Bitcoin upgrade known as SegWit2x. Yesterday, Mexican Bitcoin exchange BitMEX did the same. The moves highlight persistent tensions dividing supporters of the decentralized digital payments system, which are expected to trigger a Bitcoin network split, or ‘fork,’ on or around November 18.

The consequences of that split are hard to predict, but they could be disruptive enough to end Bitcoin’s massive ongoing rally. Broadening investor interest pushed the price of each Bitcoin token up by 160% in the first six months of 2017, and the momentum has held. From around $2,500 per coin in early July, a single Bitcoin’s value has rocketed to above $5,700 as of Friday (all numbers courtesy CoinMarketCap).

That rally was at least partly based on the sense that SegWit2x had effectively solved one of Bitcoin’s most enduring problems, but it now appears that was wishful thinking. Like most things Bitcoin, understanding the impending fork requires untangling a wild scrum of arcane tech and complex political wrangling. But here are the basics.

Segwit2x emerged in May as a compromise agreement among major Bitcoin services and miners after years of debate over how to scale the network up. As Bitcoin has become more popular, its current small block size has made transactions slower and more expensive.

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Segwit2x is a two-stage plan to fix that by borrowing solutions from two competing factions.

First, in August, Bitcoin got the Segwit upgrade, a proposal supported by Bitcoin’s Core development team, which slightly increased transaction throughput and opened the door for advanced features. Its implementation was to be followed by a doubling of the “block size,” a hard-coded cap on the number of transactions allowed to move through the Bitcoin payments network, and on the computing power it demands. Increasing the block size is supported by a faction associated with entrepreneur Roger Ver.

But the Core team and a minority of other miners and developers continue to oppose the second part of Segwit2x. The Core team is now describing the currency that will emerge from SegWit2x as an “alternative currency,” and not the ‘real’ Bitcoin.

Bitcoin governance is decentralized, with each miner and service more or less freely choosing which version of the host software to use. Because Segwit2x is incompatible with the current version of Bitcoin, the competing factions will wind up “forking” into two separate networks.

On the plus side, most people currently holding Bitcoin will then have currency on both networks, potentially creating a vast new pool of value, seemingly out of thin air. That’s what happened in an earlier fork this year, when a network now called Bitcoin Cash spun off. Bitcoin Cash has seen a steady selloff, but it still has a total market value of more than $5 billion. Some of the current Bitcoin rally may be fueled by expectations of a similar ‘doubling’ of holders’ digital money.

But the fork could also come with major downsides. The fork seems likely to leave the ‘original’ Bitcoin with a thin sliver of its previous network power – more than 85% of minersare still saying they will adopt the Segwit2x upgrade. Because Bitcoin’s value is at least notionally tied to its network power, that could put serious downward pressure on the price of the ‘original’ Bitcoin.

There are also some security risks, and the Bitcoin Core team strongly cautions users against using so-called web wallets, such as Coinbase, to store or transact with their coins during the fork. Others are warning that a potential security issue with Segwit2x makes it a bad idea to transact any Bitcoin at all in the immediate aftermath of the fork. And transactions on the ‘original’ Bitcoin network are likely to be slower and more expensive for some time.

But the bigger threat is market confusion.

Based on network power alone, Segwit2x will have a plausible claim to being the ‘real’ Bitcoin, and at least two wallet providers have said they will refer to the largest network as “Bitcoin” after the fork. But other services, including exchanges where cryptocurrency is bought or sold, have remained silent on the question of which fork they will consider “Bitcoin” proper.

Bitcoin Magazine recently wrote that the conflict could even lead to “some kind of cyber-battle . . . perhaps even escalating to the point where all exchange rates drop sharply.”

Nearly as troubling, though, is that the long-trusted developers at Bitcoin Core seem likely to be left guiding a much-weakened fragment of the network. While they have no formal authority over Bitcoin, the Core team has successfully shepherded the system through a period of massive growth. Expertise in cryptocurrency engineering is still somewhat rare, so their absence could weaken the Segwit2x fork, even if it does succeed in earning the Bitcoin name.