Corporate Actions and Chain Forks

The crypto asset industry has created a new vocabulary for discussing events that happen in and around blockchains. As part of 21Shares’s mission to make crypto assets as easy to invest in as stocks, we need to find a common language to describe the various ways to interpret relevant data and actions. In our experience, the terms “forks” and “airdrops” in particular, lead to questions and uncertainty from investors regarding their impact on the value of a given asset and how best to think of them conceptually. This article deals firstly with forks then finishes with a brief explanation of airdrops.

Forks

Forks are the essential corporate governance action within the crypto asset world and they can be thought of in a couple of different ways depending on the specifics of the situation. The following categories are not necessarily mutually exclusive but offer an almost exhaustive categorization of the different sorts of forks possible:

A Soft Fork is a system upgrade wherein newly created blocks made under the updated rules of the soft fork are still accepted by nodes running the older version of the software – therefore maintaining their forwards-compatibility. As such, the set of possible valid blocks under a new soft fork ruleset is a proper subset of the group of possible valid blocks on the pre-forked chain. An example is the SegWit fork on the Bitcoin network.

A Hard Fork is similarly a system upgrade but, in this case, the newly created blocks made under the updated rules of the hard fork are not accepted by nodes running the older version of the software – therefore rendering pre-fork clients no-longer forwards-compatible¹. An example of a Hard Fork is the Constantinople fork on the Ethereum Network.

A Contested Fork² is a fork that is not universally accepted by all network participants. If the upgrade isn’t accepted by all of the participants, this can result in a new chain being created, as was the case with the creation of Ethereum Classic following the DAO hard fork. Much like a stock split, these actions result in the creation of a new asset. This new asset is generally distributed to the holders³ of the original asset and may be very different from the original product. This operational process is virtually identical to a stock split (including an ex-date announced in advance and a process for claiming those assets on behalf of holders). However, there are a couple of key differences between a contested fork and a stock split: a hard fork does not change the value of the legacy asset-based off historical evidence and you would not expect to see the corresponding drop in the per unit value of the parent asset that you see in the case of a stock split.

The below charts help illustrate this point by comparing Walmart (WMT) historical 2-for-1 stock splits to the Bitcoin-Bitcoin Cash hard fork respectively. The vertical lines represent the days of the Walmart stock splits in the first chart & the single vertical represents the Bitcoin Cash hard fork date in the second chart:

The second chart helps demonstrate how a hard fork does not intrinsically transfer any value away from the legacy blockchain – despite the high profile Bitcoin Cash fork, little value was diverted from Bitcoin. The parent asset still has all the same intrinsic properties (number of nodes, speed of transaction, number of users etc.) and is generally viewed by the market as unchanged by this event. The newly created asset is just a copy of the client code of the parent network (usually with a few edits) that runs on a parallel network. Any potential value which could be transferred away would be a function of the network effects diverted due to users choosing to switch to the new blockchain. In fact, Bitcoin has forked (including chain & software forks) over 70 times yet none of the forks have had measurable effects on the value of BTC. However, even if these fork assets do not affect the value of the legacy asset, they can have significant value in their own right – as is the case for Bitcoin Cash (and then Bitcoin Cash SV & ABC). In the case of stock splits the case is slightly more interesting, as the price-per-share following a 2-to-1 stock split would halve in theory; this fact, however, is not accurately shown in the data as most historical data providers adjust stock prices for stock splits.

An Uncontested Fork, such as Ethereum’s recent Constantinople Fork, is a client upgrade that all of the participants (predominantly miners) in the network agree with. This is similar to a planned change of a member of the management team at a company – for example, the CEO of Goldman announcing retirement with a planned, capable successor – where the market reaction is likely to be neutral. While investors may have opinions on this shift affecting the valuation of the stock (or crypto asset), this isn’t typically a disruptive event. Similarly, in the blockchain world, an uncontested fork can often be a very positive development that improves some feature of the given network.

A Chain Split relates to cases, similar to Contested Forks, where mutually incompatible chains come into existence for various reasons. For example, they can be the result of Hard Forks, Sybil attacks, or two miners discovering new blocks at similar times. However, a chain split is often not the result of deliberate action but instead due to bugs in client code which cause different versions of a given client (or differing clients of a given single chain) to have conflicting states, such as was the case with BIP-50.

Disambiguation between chain fork and software fork

One important point to mention is the distinction between a chain fork and a software fork. A chain fork can be defined as when a given blockchain splits into two unique chains either intentionally (as with the BCH fork) or unintentionally (due to a bug). A software fork is when a developer forks the Git repository where the code for the given blockchain client is hosted and creates a new crypto asset and blockchain that way.

Governance

Governance is just as important within the crypto asset world as it is in the corporate world. For example, if forks are like corporate actions and can have a range of impacts on a given crypto asset, who are the key stakeholders who make the difference between the fork being contested or uncontested? Analogous to corporate governance where the various shareholders have the ultimate say in matters related to governance, in the case of crypto assets it is those who have a stake in the network – whether this is the person or company that owns the tokens (for systems with on-chain governance⁴ like MakerDAO or Tezos) or the wide range of other mission-critical actors like developers, miners, & community members (for systems with off-chain governance⁵ like Bitcoin).

In the case of on-chain governance, similar to shareholders, the larger the token holdings a given address has, the more voting power one has. Over the last few years, several crypto assets have developed complex governance processes which share many similarities to the typical corporate governance process. For example, consider MakerDAO – a project which has launched a stablecoin backed by a decentralized credit facility. Similar to AGMs, MakerDAO hosts two weekly calls where stakeholders can discuss risk and governance topics. Moreover, like a shareholder voting process, token holders can vote on particular issues.

The below chart shows the breakdown of votes (measured in MKR – a Crypto Asset) for a governance initiative for MakerDAO:

On the other hand, governance in off-chain governance is often much more nuanced than traditional corporate governance. It can be argued, for example, that miners are the most important stakeholder, as they are ultimately the ones who maintain the economic security and integrity of a given crypto asset network’s ledger. As a result, miner sentiment is often an especially important metric used when developers are considering whether to initiate a fork or not. Voting power and control over systems upgrades are some of the more practical reasons why there is such heated debate about ostensibly more centralized networks such as XRP and more decentralized networks such as Bitcoin. While there are a number of ideological reasons for people in the crypto asset space preferring one set up over another, from a practical perspective, the more centralized a network is, the more concentrated the voting power will be in the case of key governance events and the more vulnerable the network of failure. It is similar to having a large activist shareholder in a standard corporate security situation. If you agree with their policies, there is no problem but if you disagree, they nevertheless have a significant amount of power to influence the evolution of the company and its commercial policies – even in ways diametrically opposed to your own interests. Moreover, there remains the possibility that a bad actor could sway the opinion of that activist leading them to appoint someone unsuitable to the board or attempt an ill-advised acquisition resulting in significant loss of value for other shareholders.

Airdrops

Airdrops are another important (corporate) governance action within the crypto asset world and they can also be thought of in a couple of different ways depending on the specifics of the situation. For example, Airdrops can be seen as the dividends of the blockchain space. They are essentially free assets given to incentivize certain types of behaviors on a network (e.g. signing up for a wallet, performing tasks to maintain the network, etc.). Generally, the recipient does not control when or how these are received once the action is completed. Furthermore, this type of action usually only occurs on much smaller networks looking to grow their user base. Unlike dividends, however, you would not necessarily expect to see the same decrease in value at the ex-date.

Another analogy for airdrops would be the bonus miles you are awarded for signing up for a new credit card or bank account. The company wants to incentivize you to do a certain thing (such as opening a wallet or a credit line) and is willing to provide a crypto asset with some monetary value to incentivize that behavior whether it be free crypto assets or credit card points.

Conclusion

The aim of this article has been to serve as a bridge between terminology in the crypto asset world and that of the corporate world. As has been shown, there is a great deal of overlap between the mechanisms for governance across the two and this will continue to be the case as engineers of crypto assets continue to experiment with how best to affect stakeholder politics.