FUNDAMENTALS OF CRYPTO

What Is a Hard Fork vs Soft Fork in Crypto?

Blockchain networks are governed by rules: a set of consensus protocols that every participant agrees to follow. These rules determine what constitutes a valid transaction, what constitutes a valid block, how disputes are resolved, and how the network evolves over time. When those rules need to change, whether to fix a vulnerability, add new functionality, or resolve a fundamental disagreement within the community, the mechanism for doing so is a fork.

Understanding what forks are, the critical difference between hard and soft forks, why they happen, and what they mean for investors is foundational knowledge that explains some of the most significant events in Bitcoin’s and Ethereum’s history and helps investors navigate future fork events with clarity rather than confusion.

What a Fork Is

In software development, a fork occurs when a codebase is copied and developed independently, creating two separate versions of the same original project. In blockchain networks, a fork refers to a change in the network’s consensus rules: the rules that all nodes must follow to consider a block valid.

When a fork is proposed and implemented, not all nodes upgrade simultaneously. Some nodes upgrade to the new rules. Others continue running the old rules. The behaviour of the network during this transition period, and whether the old and new rule sets are compatible with each other, is what distinguishes a hard fork from a soft fork.

A useful analogy: imagine a group of people playing a card game. A rule change is proposed. In one scenario, the new rule is compatible with the old rules: players who know the new rule can still play with those who only know the old rules, and the game continues without splitting. In another scenario, the new rule fundamentally changes how the game works: players using the new rules and players using the old rules can no longer play the same game together, and the group splits into two separate games. The first scenario is a soft fork. The second is a hard fork.

What Is a Soft Fork?

A soft fork is a backwards-compatible change to a blockchain’s consensus rules. The new rules are a tightening or restriction of the old rules: blocks that are valid under the new rules are also valid under the old rules, but some blocks that were valid under the old rules are now invalid under the new rules.

This backwards compatibility means that nodes running the old software can still participate in the network and accept blocks produced by upgraded nodes, even without upgrading themselves. They won’t produce valid blocks under the new rules, but they won’t be rejected from the network either. The network does not split as long as the majority of the network’s mining or staking power upgrades to the new rules, because the upgraded majority produces the longest chain that all nodes follow.

Soft forks allow blockchain networks to add new functionality or tighten rules without requiring every participant to upgrade simultaneously. They are a lower-disruption upgrade mechanism that preserves network continuity.

Segregated Witness (SegWit) is the most significant soft fork in Bitcoin’s history. Activated in August 2017, SegWit changed how transaction data is structured by separating the signature data (the “witness” data) from the transaction data, effectively increasing Bitcoin’s transaction capacity and fixing a known vulnerability called transaction malleability. Nodes that didn’t upgrade to SegWit could still participate in the network: they simply didn’t take advantage of SegWit’s benefits. The upgrade was backwards compatible by design.

What Is a Hard Fork?

A hard fork is a non-backwards-compatible change to a blockchain’s consensus rules. The new rules expand or fundamentally change what is considered valid, meaning blocks produced under the new rules are not valid under the old rules. Nodes running the old software will reject blocks produced by upgraded nodes, and vice versa.

If a significant portion of the network’s participants don’t upgrade to the new rules, the blockchain splits into two separate chains: one running the new rules and one running the old rules. Both chains share the same transaction history up to the point of the fork, but diverge completely from that point forward. This creates two separate cryptocurrencies from what was previously one.

Hard forks can be either planned or contentious.

Planned hard forks occur when the community broadly agrees on an upgrade that requires non-backwards-compatible changes. In this case, the old chain is typically abandoned as participants migrate to the new chain, and no lasting split occurs. Ethereum’s transition from proof-of-work to proof-of-stake, known as The Merge, required a hard fork in the technical sense but was not contentious: the overwhelming majority of participants upgraded and the old proof-of-work chain was effectively abandoned.

Contentious hard forks occur when the community is fundamentally divided about the direction of the network and a minority of participants refuse to upgrade, maintaining the old chain as a separate ongoing project. These are the forks that create two distinct cryptocurrencies with an ongoing separate existence and are the most significant fork events from an investor perspective.

The Most Significant Forks in Crypto History

Several fork events have had lasting significance for the crypto ecosystem and are worth understanding as case studies in how forks unfold and what they produce.

The Ethereum / Ethereum Classic fork (July 2016). The most significant contentious hard fork in Ethereum’s history arose from the DAO hack of 2016. The DAO was a decentralised autonomous organisation that was exploited by an attacker who drained approximately $60 million USD in ETH through a vulnerability in its smart contract. The Ethereum community faced a choice: implement a hard fork to reverse the hack and return funds to victims, or maintain the principle that blockchain transactions are immutable and irreversible. The majority chose to implement the fork, reversing the hack. A minority rejected this intervention as a violation of blockchain immutability and continued the original chain as Ethereum Classic (ETC). Both chains exist today, though Ethereum is vastly larger by market capitalisation and adoption.

Bitcoin / Bitcoin Cash fork (August 2017). The most significant contentious fork in Bitcoin’s history arose from a multi-year debate about how to scale Bitcoin’s transaction capacity. One faction favoured keeping Bitcoin’s block size at 1MB and scaling through second-layer solutions like the Lightning Network. Another faction favoured increasing the block size directly to allow more transactions per block. When the SegWit soft fork was activated without the block size increase some participants wanted, a faction created Bitcoin Cash (BCH) with an 8MB block size limit. Bitcoin Cash subsequently forked again in November 2018, producing Bitcoin SV (BSV) in a further contentious split. Bitcoin (BTC) has retained the overwhelming majority of the original network’s value, developer activity, and adoption.

Ethereum’s Merge (September 2022). The Merge was Ethereum’s transition from proof-of-work to proof-of-stake consensus, one of the most technically complex upgrades ever executed on a live blockchain network. While technically a hard fork, it was broadly accepted by the Ethereum community. A small group of miners created a fork called EthereumPoW (ETHW) to preserve proof-of-work Ethereum, but it attracted minimal adoption relative to the main Ethereum chain.

What Happens to Investor Holdings During a Fork?

One of the most practically important questions for investors is: what happens to the cryptocurrency they hold when a fork occurs?

In a contentious hard fork that creates two separate chains, holders of the original asset at the time of the fork typically receive an equivalent amount of the new forked asset. Because both chains share the same transaction history up to the fork block, every address that held the original asset before the fork holds the same amount on both chains after it. The fork in effect creates a snapshot of holdings and distributes the new asset to all pre-fork holders.

This means that holding Bitcoin before the Bitcoin Cash fork gave holders an equivalent amount of Bitcoin Cash. Holding Ethereum before the Ethereum Classic fork gave holders an equivalent amount of Ethereum Classic.

The critical requirement for receiving forked assets is that you must hold the original asset in a wallet where you control the private keys at the time of the fork. As covered in our risks of keeping crypto on an exchange resource, exchange-held assets are in wallets controlled by the exchange, not by you. Whether you receive forked assets for exchange-held crypto depends entirely on whether the exchange chooses to support the fork and distribute the new asset to its users. Some exchanges do, some don’t, and some take time to make that decision. Self-custody through a hardware wallet gives you direct control over both the original asset and any forked assets.

Tax Treatment of Forked Assets in Australia

The receipt of forked assets through a blockchain fork has specific tax treatment implications for Australian investors that are worth understanding.

The ATO’s general position on receiving new cryptocurrency through a chain split is that the new asset is received with a cost base of zero at the time of the split. There is no ordinary income event at the time of receipt, unlike staking or yield farming rewards. Instead, a capital gains tax event occurs when the forked asset is eventually disposed of, with the entire disposal proceeds being the capital gain given the zero cost base.

The holding period for the 50% CGT discount on forked assets is generally calculated from the date of the fork rather than from the date the original asset was acquired. This is an important detail: forked assets received today and held for more than 12 months before disposal should qualify for the 50% discount, but the clock starts at the fork date, not the original purchase date of the underlying asset.

As with all complex cryptocurrency tax situations, the specific circumstances matter and professional tax advice is recommended. Our cryptocurrency tax Australia, capital gains tax for cryptocurrency in Australia, and ATO crypto reporting resources provide the broader framework.

How to Evaluate a Fork as an Investor

When a fork is announced or occurs, several questions help investors assess its significance and decide how to respond.

Is it planned and broadly accepted, or contentious? A planned upgrade that the community broadly supports is a technical event, not an investment decision. A contentious fork that creates two competing chains requires assessing which chain is likely to retain the majority of developer activity, economic activity, and institutional support, which is the chain most likely to retain and grow value.

What is the motivation for the fork? A fork motivated by a genuine technical improvement or security fix has a different character to a fork motivated by commercial interests, ideological disagreement, or a desire to create a new asset from the existing community’s holdings. Understanding the motivation helps assess the long-term viability of both chains.

What is the developer and community response? The vast majority of developers and community members following one chain over the other is the most reliable signal of where long-term value and development effort will concentrate. In every major fork to date, the chain with the majority developer and community support has retained the majority of value.

What are the security implications? When a blockchain forks, the hash rate or staking power that previously secured one chain is now split across two. Both chains are temporarily more vulnerable to attack than the original was. The minority chain is significantly more vulnerable, as it may have only a small fraction of the original security budget. This is a real risk consideration for the minority chain post-fork.

Applying the DYOR and researching altcoins frameworks to fork events, particularly to the new asset created by a contentious fork, provides the analytical discipline to evaluate them on their merits rather than on the excitement that fork announcements typically generate.

Replay Attack Risk

One technical risk specific to hard forks that investors should be aware of is the replay attack.

When a hard fork creates two separate chains sharing the same transaction history, a transaction that is valid on one chain is technically also valid on the other, because both chains share the same address format and private key cryptography up to the fork point. A replay attack occurs when a transaction broadcast on one chain is maliciously or accidentally rebroadcast on the other chain, causing an unintended transfer on the second chain.

Well-designed forks implement replay protection: a modification to the transaction format that makes transactions on one chain invalid on the other, preventing replay attacks. Investors should verify that any hard fork they’re navigating has implemented adequate replay protection before moving assets on either chain post-fork.

Key Takeaways

A soft fork is a backwards-compatible change to blockchain consensus rules that restricts what is valid without splitting the network, provided the majority of participants upgrade. A hard fork is a non-backwards-compatible change that can split the network into two separate chains if a significant minority refuses to upgrade. Planned hard forks with broad community support typically don’t produce lasting splits. Contentious hard forks driven by fundamental disagreements create two separate cryptocurrencies from one, as seen in the Bitcoin / Bitcoin Cash and Ethereum / Ethereum Classic forks.

Investors holding assets in self-custodied wallets at the time of a fork receive both the original asset and the forked asset. The forked asset has a zero cost base for Australian tax purposes, with capital gains tax applying on disposal. Evaluating fork events requires assessing community support, developer activity, motivation, and security implications rather than reacting to the noise that fork announcements typically generate.

For everyday investors who want to understand how blockchain upgrades work and how to navigate fork events with clarity, our Runite Tier Membership provides the education and market insights to do exactly that. For serious investors who want personalised guidance on managing their portfolio through protocol upgrades, fork events, and the broader technical evolution of the networks they’re invested in, our Black Emerald and Obsidian Tier Members receive direct specialist support.

Find out more at shepleycapital.com/membership.

WRITTEN & REVIEWED BY Chris Shepley

UPDATED: MARCH 2026