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Ethereum is Now Unforkable Thanks to Defi: by Dragonfly Research, 2019
Click here to read the full article. Please credit the original for insights you take away; I claim all faults and silly logic.
Context:
When a protocol makes an update that is not backward compatible, the existing network splits into two chains. This process is called a “hard fork”. If the community agrees on the update, all participants will update their software to proceed with the new chain, and the “old chain” will cease to continue. However, a minority coalition can decide to make their own update or not accept an update in opposition to the majority: resulting in two independent chains.
The DAO Hack and Ethereum’s Hard Fork
In 2016, a hacker noticed a vulnerability in an Ethereum smart contract and stole $60M Ether. This was called The DAO Hack. The (one-year-old) Ethereum community was faced with the decision to roll back the chain - recover the stolen funds - or progress the current chain and maintain the "immutable" ethos.
The majority of the community elected to revert the chain via a hard fork, restoring all lost funds: the reverted chain is the "Ethereum" network we know today ($478B market cap). A minority elected to continue with the existing chain: this chain is now called "Ethereum Classic" ($7B market cap).
When a hard fork occurs, the blockchain's current state (smart contracts & token balances) is copy/pasta'd to the new chain. If the minority chain successfully perpetuates, users will initially have identical token balances on both chains.
In the DAO Hack fork, a user with 10 Ether on the old chain received 10 Ether on the new chain. Typically, only the assets on the majority chain retain value, but Ethereum Classic was a rare successful minority fork. Which was the real Ether? Which Ether are you buying when you hit “buy” Ether on Coinbase? This was eventually settled through coordinated effort where the majority chain retained the ETH ticker, and the minority chain was assigned the ETC ticker (Ethereum Classic).
Some participants began to root for these successful minority forks because it essentially meant they received free tokens. Sure, these contentious forks lead to short-term volatility to the community/asset prices, but if prices recover, it’s free money.
Good Luck With The Fork
In 2016, Ethereum was still a proof of concept. Ethereum revolved around Ether the asset and not the applications built on top. Fast forward to today, and primitives like stablecoins, smart contracts, decentralized finance, NFTs and composability ARE Ethereum. This transformation has led to an overlooked side-effect: successful minority forks on Ethereum are a thing of the past.
Imagine that a new proposed upgrade - say, to increase the Ether inflation rate - has divided the Ethereum community. 70% favor the upgrade, and 30% are against. Stakeholders are polarized, and a community split looks imminent.
Ethereum wallets, infrastructure providers and operators intensely watch the situation unfold. If the Ethereum community can't decide on a particular path, a hard fork will occur where one chain accepts the upgrade (Chain A) and one does not (Chain B). Operating on or launching your application on the wrong chain (the one that doesn't survive/thrive long term) will be devastating. If the chain splits, who decides which chain is THE Ethereum chain?
It might be a company you've never heard of: Centre
Centre’s Power
Centre, founded by Coinbase & Circle, is behind the centralized stablecoin USDC that trades on Ethereum. All USDC is backed by actual dollars in a bank account, meaning USDC on Ethereum is simply an IOU. Despite its centralization, USDC has emerged as the trusted stablecoin on Ethereum: utilized as a primary trading pair and collateral asset in borrowing/lending applications.
If the community splits, USDC user balances will appear on Chain A and Chain B. In the DAO Hack fork, the minority chain simply renamed its asset to ETC, and the market continued to assign a smaller but real value. This can’t happen with USDC, as the tokens are IOUs for dollars in a bank. If Centre decides to support Chain A, all USDC tokens on Chain B become unredeemable for cash: worthless.
Defi apps that don’t side with the Centre-kissed-chain will face a nearly insurmountable coordination problem. Sure, Ethereum can exist without USDC, but can a minority lead a successful fork? Good luck. All loans, trading pairs and collateral tied to USDC will collapse. Arbitrageurs and astute users will sell any tokens and NFTs that temporarily hold value during the tumult: driving prices to zero. Apps, wallets, block explorers, exchanges and oracles will quickly abandon the minority chain.
All roads lead to a pre-ordained wasteland.
Most Ethereum stakeholders aren’t concerned that these minority forks are no longer feasible, and it could be seen as a feature. Many stakeholders ARE worried about the network’s reliance on centralized stablecoins (e.g. USDC). Could these stablecoins serve as chokepoints by regulators to shut down decentralized finance? We’ll chat about that later.
See you next time!
Garrett