Inblockchain, afork is defined variously as:
Forks are related to the fact that different parties need to use common rules to maintain the history of the blockchain. When parties are not in agreement, alternative chains may emerge. While most forks are short-lived some are permanent. Short-lived forks are due to the difficulty of reaching fastconsensus in a distributed system. Whereas permanent forks (in the sense of protocol changes) have been used to add newfeatures to a blockchain, they can also be used to reverse the effects ofhacking such as the case withEthereum andEthereum Classic, or avert catastrophicbugs on a blockchain as was the case with thebitcoin fork on 6 August 2010.[citation needed]The concept of blockchain technology was first introduced in 2008 by an unknown person or group of people using the pseudonym “Satoshi Nakamoto” in a white paper describing the design of a decentralized digital currency called Bitcoin.Blockchain forks have been widely discussed in the context of thebitcoin scalability problem.[4][5][6]
Forks can be classified asaccidental orintentional.Accidental fork happens when two or moreminers find a block at nearly the same time. The fork is resolved when subsequent block(s) are added and one of the chains becomes longer than the alternative(s). The network abandons the blocks that are not in the longest chain (they are calledorphaned blocks).
Intentional forks that modify the rules of a blockchain can be classified as follows:
For example, Ethereum was hard forked in 2016 to "make whole" the investors inThe DAO, which had been hacked by exploiting a vulnerability in its code. In this case, the fork resulted in a split creating Ethereum andEthereum Classic chains. In 2014, theNxt commun[7]ity was asked to consider a hard fork that would have led to a rollback of the blockchain records to mitigate the effects of a theft of 50 million NXT from a majorcryptocurrency exchange. The hard fork proposal was rejected, and some of the funds were recovered after negotiations and ransom payment. Alternatively, to prevent a permanent split, a majority of nodes using the new software may return to the old rules, as was the case with Bitcoin split on 12 March 2013.
Asource code fork orproject fork is when developers take a copy of source code from one cryptocurrency project and startindependent development on it, creating a separate and new piece of blockchain. Such examples are;Litecoin a source code fork ofBitcoin,Monero fork of Bytecoin andDogecoin fork of Litecoin.
Ahard fork is a change to the blockchain protocol that is not backward compatible and requires all users to upgrade their software in order to continue participating in the network. In a hard fork, the network splits into two separate versions: one that follows the new rules and one that follows the old rules.
For example, Ethereum was hard forked in 2016 to "make whole" the investors inThe DAO, which had been hacked by exploiting a vulnerability in its code. In this case, the fork resulted in a split creating Ethereum andEthereum Classic chains. In 2014, theNxt community[7] was asked to consider a hard fork that would have led to a rollback of the blockchain records to mitigate the effects of a theft of 50 million NXT from a majorcryptocurrency exchange. The hard fork proposal was rejected, and some of the funds were recovered after negotiations and ransom payment. Alternatively, to prevent a permanent split, a majority of nodes using the new software may return to the old rules, as was the case with Bitcoin split on 12 March 2013.
A more recent hard-fork example is of Bitcoin in 2017, which resulted in a split creatingBitcoin Cash.[8] The network split was mainly due to a disagreement in how to increase the transactions per second to accommodate for demand.[9]
Asoft fork is a backward-compatible change to the blockchain protocol that allows new rules to be introduced without requiring all users to upgrade their software. In a soft fork, a majority of the network’s miners implement the new rules and begin following the updated version of the blockchain. The rest of the network can continue to follow the blockchain, but they will be unable to validate that new blocks follow the updated rules. Because a soft fork is backward-compatible, it does not result in the creation of a new blockchain or the splitting of the network. Instead, it allows the network to gradually transition to the new rules while still maintaining compatibility with the old rules.[10]
Apermanent chain split is described as a case when there are two or more permanent versions of a blockchain sharing the same history up to a certain time, after which the histories start to differ.[11] Permanent chain splits lead to a situation when two or more competing cryptocurrencies exist on their respective blockchains.[11]
The taxation of cryptocurrency splits varies substantially fromstate to state. A few examples include:
TheATO does not classify cryptocurrency splits as taxation events.[11] The ATO classifies the versions of the blockchain coming from the splits as the "original blockchain" and the "new blockchain"[clarification needed]. In relation to the cost base, the cryptocurrency on the original blockchain should be assigned all the original cost base, while the cryptocurrency on the new blockchain should be assigned cost base zero.[11]
The UKHMRC does not classify cryptocurrency splits as taxation events. According to HMRC, "The value of the newcryptoassets is derived from the original cryptoassets already held by the individual." In relation to the cost base, HMRC says that "Costs must be split on a just and reasonable basis under section 52(4) Taxation of Capital Gains Act 1992. HMRC does not prescribe any particular apportionment method. HMRC has the power to enquire into an apportionment method that it believes is not just and reasonable."[12]
As of September 2021, it is believed that more than 2.3 million people in the UK own a cryptoasset. As these assets do not physically exist, HMRC has been forced to issue guidance stating that cryptoassets will follow the residence of the beneficial owner. Residents in the UK who trade cryptoassets, no matter where these assets are "held", will be liable to UK taxes. However, there is a growing belief that this guidance may well be challenged in the courts. This could impact future HMRC tax income from those not domiciled in the UK for tax purposes."[13]
TheUSInternal Revenue Service (IRS) classifies cryptocurrency splits as "airdrops" and as taxable events. According to the guidance published by IRS, provided the taxpayer is in possession of the keys, they are obliged to pay tax for the new cryptocurrency using the fair market value of the cryptocurrency as their income.[14][15]
