In the previous article, we have already read about cryptocurrency forks. We now know that a cryptocurrency system is basically software.

Just like the software on our phones and laptops cannot stay static, the software responsible for cryptocurrencies cannot stay static either. It needs to be changed from time to time.

The changes are done based on the votes of the miners that use the software. Every time, they successfully mine a block, they may be asked to cast a vote. This may go on for a certain predefined amount of time. However, after some time, the votes are counted and the change may be made. When there is no clear consensus, cryptocurrencies get split up. This process is called forking and can be done in two ways.

In this article, we will have a closer look at what a “soft fork” is and what are its implications.

What is a Soft Fork?

Understanding the meaning of a soft fork can be difficult for people who are not well versed with technological jargon. This is because soft forks are often defined as being backward compatible. They may also be defined as being a temporary split which is different when compared with hard forks. This may confuse some investors instead of providing more clarity.

In order to understand the meaning of soft fork, we need to think of it in layman’s terms.

When soft forking happens, the rules which govern the acceptance of a block to the blockchain are changed. In the case of soft forks, these rules are said to be backward compatible.

In simple terms, this means that the new rules which are included in the latest version are a subset of the old rules. For example, if the speed limit on a road was changed from 40 miles per hour to 60 miles per hour, those driving below 40 miles per hour would still be obeying the rules!

Hence, blocks mined using the new rules will also be valid under the old rules’ framework. However, the opposite of this may not be true and the blocks mined under the old framework may or may not be acceptable under the new framework.

This change is much less disruptive to the blockchain. This is because the nodes need not change all the blocks which they have already mined in order for these blocks to stay valid once the new framework has been announced. Instead, they will automatically be accepted as per the new rules.

Also, all nodes which are processing the blocks need not update their software in order to continue processing the coins. The system automatically follows the longer chain. After a software upgrade by the majority, the system will automatically consider the longer chain to be the valid chain. This also means that after a soft fork there won't be two separate instances of the same cryptocurrency. The older instance will simply cease to exist and will be replaced by the newer instance.

Another important characteristic of soft work is that it does not require all the nodes on a network to agree. Since other nodes can continue using the old version of the software and keep mining, the changes can be made when a majority of the people on the network agree to make a change.

It is also important to realize that technically, it is possible to reverse the changes made by a soft fork. However, reversing those changes would require undertaking a hard fork which can have more severe consequences.

For simplicity’s sake, it is better to understand soft forking as a semi-permanent form of divergence in the blockchain system. Since the changes are semi-permanent, they are less drastic and do not lead to huge changes in the market value of the cryptocurrency. Also, these changes can be easier to reverse. In the vast majority of cases, these changes might be reversed automatically over time.

Financial Impact of a Soft Fork

Forks can have a significant impact on the value of cryptocurrency. This is because the underlying fundamentals undergo a major change.

• For instance, in the case of a soft fork, a major change may be made to the security network or consensus mechanism of the currency. These changes may make the currency more or less valuable based on how favorable or unfavorable, the market perceives these changes to be.

• If the miners of a cryptocurrency network make an attempt to introduce a soft fork and fail to do so, they end up causing a fall in the value of the asset. This is because the market perceives the mining community as rigid and hostile which causes prices to drop.

• Since soft forks do not end up splitting the blockchain, the amount of volatility is not very high

The bottom line is that soft forks maybe not be as disruptive as hard forks are. However, they can still have a significant impact on the financial viability of any cryptocurrency. It is for this reason that cryptocurrency investors need to be well aware of how soft forks work since it could impact their net worth.