The Legal Basis of Cryptocurrency Forks

Prologue: The recent confusion in comments I’ve seen about legal property rights and cryptocurrency forks, led me to write this post. This post has some passing relationship to my previous post on Blockchain Consensus, but I’ve focused this post on the legal implications rather than the social ones, and I’m also writing this more for the general reader rather than for cryptocurrency people (but it still assumes some small knowledge of cryptocurrency).

How does a cryptocurrency get started?

Before I talk about the primary legal basis for cryptocurrency forks, I need to cover a little basic background about how and why cryptocurrency networks exist.

A new cryptocurrency is born when someone writes some software that defines the rules for that cryptocurrency, and then one or more people decide to run that software on their computers. For most cryptocurrencies, the people running this software do this on an entirely voluntary basis: they sign no contracts to run the software.

The cryptocurrency software is generally open-source licensed by the developers so that anyone is allowed to run it and that anyone can modify the software as they like and run their own modified form of the software.

Why does a cryptocurrency coin have value?

In most cases, a cryptocurrency coin only has value because people decide to agree it has value (by being willing to exchange it for other goods). In such cases, the price of the coin rises and falls relative to other goods purely based on people’s sentiment about the coin.

There are exceptional cases, however, such as when a corporate entity will legally back a coin’s value by promising to allow the coin to be exchanged for some fixed good at any time, but these types of cryptocurrency are much less common.

At first, all the above may seem really strange. Based on what I’ve said above, you would be right in concluding that anyone can potentially create their own cryptocurrency, create as much of it as they like, convince people it has value, then use that newly minted cryptocurrency to buy food, land, etc. This is exactly what happens whenever a new cryptocurrency is created.

But the trick is to convince people that the newly created currency has some value. You either have to have a lot of charisma, or your cryptocurrency has to offer some utility (some capability) that wasn’t available from the existing currencies (having both charisma and a coin with utility helps even more).

What is a cryptocurrency fork?

A cryptocurrency fork results when someone decides to take an existing cryptocurrency software, modify the rules of the cryptocurrency, then convince other people to run that modified software. In fact, technically speaking you don’t even need to convince someone else to run the software you’ve modified in order to create a fork: you can just run it on your own computer. But as mentioned in the previous section, the value of a coin depends on what value people decide it has, so if you’re the only one running the software, fewer people are likely to decide it has value.

As a side note, forks happen all the time in the cryptocurrency ecosystem. They can happen because people are unhappy with the distribution of the coins, because of some perceived technical weakness of the existing coin (for example, it takes too long to send it), or just because someone decides they have enough charisma to get people to value a new coin which will make the new coin creator rich (there’s actually a technical term for this in cryptocurrency: shitcoin). In fact, there’s a reasonable size group of people that believe that only bitcoin has value, and all other coins are just “shitcoins” created to enrich greedy coin creators.

The legal basis of a cryptocurrency fork

Ok, with the background information out of the way, lets move on to analyze the legal basis for someone to operate a fork (a modified version) of an existing cryptocurrency network. In practice, forks happen all the time, but are they legal?

Given the legal climate in the US, it is worth making a few short disclaimers at this point: I am a not a lawyer, and this is not legal advice: it is purely my opinion developed over time, and based on my understanding of US law combined with an expert understanding of cryptocurrency software.

For the sake of this post, I’m only going to address US law, primarily because I know it better than the laws of other countries. Even if I don’t directly say it every time hereafter, all the legal analysis that follows should be assumed to be with regard to US law.

As a first point, it is legal to run cryptocurrency software on your computer that operates as a node in a cryptocurrency network in the US. I’m not going to go into any more depth on this issue, since it’s well established elsewhere.

The key issue around cryptocurrency forks is software licensing

But the next question that emerges is, can someone run a modified form of a cryptocurrency software (i.e. a cryptocurrency fork) on their computer? To legally do so, the computer operator must clear several legal hurdles: 1) did the original creator of the software license the software in such a way that the computer operator can run a modified copy and 2) did the computer operator enter into any contract that prevents him from running a modified copy.

For most cryptocurrency software, both these hurdles are easily cleared and forks pose no legal problems. Most cryptocurrency software is licensed by the creators in such a way that anyone can run the software, either in it’s original form or in a modified form. And most computer operators will not have signed a contract that enforces they run a particular form of the software. In fact, most computer operators that run cryptocurrency software do so on an entirely voluntary manner, without contractual obligations of any kind.

Also note that even if some computer operators do sign a contract to not run a modified form of the software, this isn’t likely to stop a fork of the software if the software license itself doesn’t explicitly forbid forking: there’s always other computer operators who haven’t signed any contract that can run a modified form, in that case.

But what about property rights and harm to property holders from a fork?

One claim I’ve seen recently is that someone who creates a fork that doesn’t include another user’s stake has infringed on that other user’s property rights and is therefore liable for harming that other user. But, in my opinion, this is a flawed analysis due to a basic misunderstanding of cryptocurrency operation and/or the value of cryptocurrency itself.

If someone creates a fork that doesn’t contain a user’s stake from a previous fork of the software, the user who “lost” his stake can simply start another version of the software on his own computer that still has his stake (he creates a fork where his stake still counts) and optionally convince others to run his version that has his stake, instead of the fork that doesn’t have his stake.

Even if the person running the fork was previously running a different version of the software that recognized the user’s stake, he has no liability for running the new software, assuming he is under no contractual obligations that prevent it: any benefits that users derived from his voluntary operation of a previous version that don’t exist with the new version were simply “freebies”.

As a non-cryptocurrency example of this, consider the case where you used a voluntarily-operated social media site where you got reputation points for answering questions. If the social media operator decides to close down or just eliminate the point system, you lose all your points. But if the operator had no contractual obligations to you, then it was a just a free benefit, that you’ve now lost.

But compared to the social media example above, cryptocurrency has a nice advantage due to it’s distributed nature: unlike in the social media site case, the software and data will generally still be available for a while on someone’s computer, so that you (and others) still have the option of running the software on your own computers, regardless of what the old operator does with his computer.

In the above scenario, there are now two cryptocurrency forks running on separate computer networks. In this case, both coins may or may not have value: it solely depends on whether other people are willing to accept the coins from either network in exchange for other goods. This is one of the really interesting things about cryptocurrency: valuations are set purely by the users, and this means that people are able to voluntarily decide what currency has value and what people they want to associate with via the mechanism of cryptocurrency exchange.

Beyond the legal realm

At this point, I’ve addressed all the legal issues surrounding a fork that I can think of right now. But the above scenario of two forks operating simultaneously with differing stakes may leave you wondering about why people might choose to accept one or the other fork as the one they want to operate on. I thought about addressing some reasons at the end of this post, but after some thought, I’ve decided to leave it to a separate post tomorrow, to keep separate the comments on two fundamentally separate issues.