Ethereum Hard Fork, an inconvenient truth
Bitcoin, the blockchain’s currency use-case is succeeded by Crypto 2.0, a trend that brings blockchain and cryptography in the non-financial space while improvising on its existing applications in finance
Satoshi Nakamoto, in 2009, released an open-source software which enabled peer to peer transactions, verifiable by network participants (or nodes) and recorded in a distributed ledger called the blockchain. Bitcoin, embraced the currency use-case of blockchain, seeing a peak market capitalization of around $12B in early 2014. However, Bitcoin observed a limited scalability potential, owing to its fundamental nature, bypassing traditional centralized banking systems and government regulated currencies, eventually operating on the sidelines as a parallel cryptocurrency market, with a two-way peg to the regulated fiat currency markets. In early 2015, Blockchain, or the distributed ledger technology, saw a popular following among many crypto-developers and enterprises, this can be owed to the protocol’s ability to create an immutable record of information. Drawing inspiration from Satoshi’s 2008 white paper, the industry next witnessed the introduction of public blockchains, made with an intent of catering to use-cases in addition to currency, also referred as the Crypto 2.0 wave, the most widely adopted platform of which is Ethereum.
Ethereum, a blockchain parallel to bitcoin’s blockchain, except with an entirely different set of functionalities altogether
Ethereum is a programming language running on a blockchain, helping developers to build and publish distributed applications, it has its own Turing complete internal code, meaning that given enough computing power and enough time, anything can be calculated, Bitcoin lacks this kind of flexibility. Ether, its cryptocurrency, is used broadly for two purposes i.e. traded as a digital currency exchange like other cryptocurrencies and is used inside Ethereum to run applications and monetize work. According to Ethereum, it can be used to “codify, decentralize, secure and trade just about anything.” On the ownership side, Ethereum was crowd funded whilst for Bitcoin, the early miners own most of the coins that will ever be mined.
As per Tracxn database, there are close to 80 companies (100+ upon including idea stage startups) building on Ethereum, of which, 11 companies have received a total of $30M in funding.
Decentralized Autonomous Organization or DAO, an entity whose actions and reactions are encoded on the blockchain, thereby, enabling it to operate independently
Decentralized Autonomous organization is a piece of code that is executable on a shared database (blockchain) and is capable of executing actions autonomously, subject to fulfillment of certain conditions specified in the code. This, in its simplest form, is the definition of a smart contract, but DAO adds a layer of democracy over the aforementioned conditions, which effectively allows its stakeholders to vote upon tasks and execute them. DAO can be any democratic organization, i.e. where users collectively decide on the outcome of any event, or a company’s board which votes on key corporate decisions. Implementations of DAOs can include sophisticated combinations of rights and powers encoded through smart contracts that emulate the activities of business entities or regulated financial contracts, including insurance, futures, options, etc. However there have been legal hurdles regarding accountability of a DAO’s actions, owing to the fact that there’s no supreme owner except proportional stakeholders
The DAO, is one such investment organization governed by smart contracts, it was hacked on 17th June, 2016 when the hacker exploited a vulnerability in its code drawing out funds worth $60m
The DAO (https://daohub.org) is an investment vehicle (venture fund) built by the team behind the German startup, Slock.it, for supporting Ethereum-based projects. As mentioned before, developers need ether (a.k.a gas) to execute smart contracts on the Ethereum platform, this code might be an application enabling transfer of insurance premium, periodic payment, title deed or any other digital asset/agreement. The DAO collectively pools ether from its investors and in turn, issues them “DAO tokens” which can be used to cast votes on investment decisions open for discussion by DAO. The DAO will then be investing in various Ethereum projects which are solving problems across industries, all the transactions take place without any human intervention except their voting to build consensus of all stakeholders.
However, DAO being a one of its kind project, was not without technical loopholes. On June 12th, The DAO team identified a ‘recursive call bug’ affecting some of its functions, one of such functions, splitDAO exposed the system to a major vulnerability. SplitDAO was intended to avoid 51% attacks by splitting the DAO into children DAOs so that the attacker is left with his/her share of funds only, but a recursive call bug in the SplitDAO function enabled the hacker to send funds to a child DAO repeatedly, effectively spending the same ether once, twice, thrice ad infinitum. On June 18th, the hacker managed to drain 3.6m ether or $60m according to the day’s rates. This event led to a loss of sentiment among DAO stakeholders and Ethereum in general, culminating into an ether price drop from $20 to under $13.
Ethereum community acted at once, coming up with a temporary fix, the soft fork followed by a permanent, though controversial fix, the hard fork
Though there wasn’t any vulnerability in Ethereum’s code, the DAO being based on their platform, Ethereum’s creators had to intervene, since the DAO contained a considerable percentage of total ether in circulation. Vitalik Buterin, Ethereum’s creator proposed a two pronged approach to solve the problem, i.e. the soft fork and the hard fork. Since the child DAO, where the funds were locked, had the characteristics and constraints of the parent DAO, one of which dictated that the funds could not be spent till 28 days, the Ethereum community had some leeway. The immediate step, i.e. the soft fork blacklisted all transactions involving the DAO’s address, while the miners were asked to run the soft fork and resume operations as usual. This effectively worked like a temporary fix which froze all DAO activities, buying time to implement the hard fork within 28 days.
The next step, the hard fork is however a more controversial solution which would be similar to resetting the game, i.e. returning stolen ether (now $40m) from the hacker’s account to a new address from where it would be redistributed to its rightful owners. But this approach was condemned by a part of the community that argued that this exception would conflict with blockchain’s immutability and Ethereum’s proposition of following “the code is the new law”. The Ethereum creators put the proposed hard fork proposal on vote, to gauge the community’s response, which was supportive to a good extent, though it was plagued by a low turn-out as many miners did not participate.
Subsequently, on July 20, 2016, Ethereum blockchain was hard forked at the 192000th block, which effectively meant there were two blockchains branching out after this block, one with the fork (Ethereum, ETH) and one without the fork (Ethereum classic, ETC). Majority miners mined on the forked chain, while, interestingly, there was still a 5% market capture by the classic chain, meaning some miners still continued on the older chain. This created a chaotic situation, with users now holding both ETH/ETC, aggravated by Poloneix, one of the prominent crypto exchanges, trading ETC. By the basic principle of demand/supply this proliferated into a falling ETH price and a rising ETC price. ETC started trading with <5% of ETH price, opened up multiple arbitrage opportunities:
Sell ETH, hold ETC — 5% profit
Sell ETH, sell ETC — 5% profit
Convert ETH to ETC — Increase ETC’s market cap leading to its adoption while doubling their balance
Buy ETC, sell ETH — Increase ETC’s market cap hoping to make profits when the chain wins
Users have exhausted all of the above and as of 5th Aug, 2016, ETC traded at 20% of ETH, the problem doesn’t seem to end anytime soon, unless a total consensus is reached on one of the chains. The immediate implications of these events stands to create a price volatility in ETH or the gas used to execute code on Ethereum, thus affecting any blockchain initiatives run by banks/enterprises on the Ethereum’s live platform. Meanwhile the Ethereum classic hasn’t shown any signs of retreat, gaining the second highest market capitalization propelled by users who expect a second chance at the missed investment opportunity in the 2015 Ether crowdsale, paying peanuts for the exposure.
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