Soft Fork vs Hard Fork: How Protocol Changes Affect Crypto Prices

Soft Fork vs Hard Fork: The Core Difference

The distinction between a hard fork vs soft fork comes down to one question: can the nodes running the old blockchain still participate in the network? If the answer is no, then it is a hard fork, soft forks, on the other hand, are designed for backward compatibility. Even non-upgraded nodes can still run the network, even if they won’t necessarily get all the new features.

In a hard fork, the blockchain splits permanently. Old software no longer supports it. New rules are not compatible with old ones. That is why blockchain inevitably splits into two separate clients (as not everyone transitions at the exact same second). In the most extreme case, new chain even has a new token to run with it, or the old chain has a different legacy token that remains. From one token, there are now two, and their prices can differ by orders of magnitude.

How a Soft Fork Works

A soft fork slightly changes existing rules, but doesn’t break them. Like a language that bans some slang words, but doesn’t change the grammar. People who still use the old words (old network) will be understood, even if they are not considered ‘hip’ or ‘cool’ anymore.

In Bitcoin, the most consequential soft fork was SegWit, activated in 2017. It entirely changed how data about transactions was stored inside a block. It allowed more information to fit on the chain, and improved throughput, but the non-upgraded nodes could still validate new blocks. The only difference for them was that they couldn’t send the new data.

How a Hard Fork Works

A hard fork vs soft fork difference is mainly in the rule change, which makes the new format not compatible with the old one. The grammar itself changes. Nodes running the old software are either forced to continue the old chain, forever, or be phased out of existence. No matter what, for a time, two separate networks emerge.

On the Ethereum network, every major upgrade is a hard fork, although every node quickly transitions to the new chain, to continue earning their fees, so it’s usually not a big deal. The famous exception was the DAO hardfork, which created a separate Ethereum Classic chain, which is still working today, although much less famous than the main Ethereum.

For Bitcoin, the most consequential hard fork was the Bitcoin Cash, also from 2017, where a group of users that wanted larger blocks (8 MB instead of 1 MB) created a separate Bitcoin blockchain. Up till that point, Bitcoin and Bitcoin Cash shared the same history, but from block 478,558, two chains diverged. Holders of BTC at the time of the fork received the same amount of BCH tokens on the new chain, and could continue using both. However, miners were forced to choose one. The BCH update was very volatile for the token price, but ultimately led to BCH declining, and original Bitcoin rising.

Soft Fork vs Hard Fork: Side-by-Side Comparison

Why Protocols Choose One Over the Other

The choice between a soft fork vs a hard fork is determined by developers, but then individual users, mainly miners or holders of nodes (in the case of the Proof-of-Work chain).

If the change requires fundamentally new rules (such as increasing the block size beyond what old nodes can accept, or switching from one consensus mechanic to a different one), hard fork becomes the only option. In other cases, a hard fork is chosen specifically to force the community to separate, and make a conscious choice: which future do they believe will bring them more earnings in the long run. Node operators or miners are forced to adopt the new direction, or remain on the original chain.

How Soft Forks Tend to Affect Price and Trading

Soft forks are usually viewed by the market as simple maintenance. There’s nothing exciting, unless changes are large. No new token phases into existence, no new chain develops. This is why price impact is usually weak. There’s less speculation. Only influence might be from perceived potential improvements to the chain (faster transactions etc), which might bring in new users. This is a gradual effect that might happen over weeks or months.

For traders on Pocket Option, soft forks are a tradable event the moment they are announced. This is hard to predict in advance, unless you are reading specific Ethereum or Bitcoin forums. Long-term trades are fine here, and standard position sizes and risk management rules are typically sufficient, unless a community is in an uproar over a specific soft fork for some reason.

How Hard Forks Tend to Affect Price and Trading

Hard forks are a different beast: a new token is often created, the new chain instantly becomes a competitor to the old one. Traders position themselves to get an airdrop of these tokens, and some immediately sell them, creating a large selling pressure that many new chains don't survive. A drop may even occur in the original token, as its price may be perceived to be tied to the new chain in some way.

The volatility is exacerbated if a fork is contentious, and people are not sure which future the network should follow. This can produce hype-driven, extreme, multi-day price swings, which create a highly unusual, exciting trading environment.

Liquidity and Asset-Duplication Risks From Hard Forks

When a hard fork creates a new token, it creates a cascading effect. Mining power and trading volume that previously congregated on a single blockchain is now split. Some of the users are more interested in the new chain. Liquidity on the original one is reduced. This widens spreads and can create price deviation on some exchanges.

This is where a Quick Trading mode on Pocket Option becomes an even more useful trading tool: there is no need for liquidity, and there are no spreads that can widen. Trading the original token in QT mode during the tumultuous times can be beneficial, compared to using exchanges or DEXes.

Risk Management Around Trading Fork Events on Pocket Option

When a fork is announced or is about to be underway, before any trading decision is made (unless you are trading short-term, purely on TA), you should adjust your mental framework and risk tolerance:

• Stop losses in CFD mode should be widened to accommodate the rise in volatility. But never beyond a limit that would put your account at risk.

• Position sizes should be reduced, ideally by at least half, during the fork window (24-48 hours, before and after fork activation on a specific block).

• If the fork is contentious, employing an even more conservative approach is advised. Consider not leaving any positions open during the time of fork activation.

• After the fork, normal trading parameters can be restored only after the volatility settles, and spreads return closer to their averages.

Conclusion

The hard fork soft fork distinction is not an academic exercise, it’s an important framework for all traders interested in cryptocurrencies and blockchain. Soft forks happen frequently, sometimes a few times a year, and hard forks happen rarely, once every few years at most, but are violent and highly unpredictable. They can reshape the landscape overnight, and be both lucrative and destructive, depending on if you prepare for them, and adjust beforehand.

Disclaimer: None of the information in this article constitutes financial advice. Cryptocurrency trading involves substantial risk, including the possibility of losing your entire deposit. Fork events create elevated volatility and liquidity risk. Past performance does not guarantee future results. Before trading with real funds, assess your financial situation and seek independent advice if necessary.