Everyone in bitcoinland is in a tizzy about the pending airdrop of “BitcoinCash” (BCC) on August 1 to all bitcoin holders. The (highly illiquid and no doubt manipulated) futures market at ViaBTC is pricing in BCC at 14% of bitcoin’s current value — about $388 per BCC at time of writing — although it has traded between 8% and 21% in the last week. Bitcoin is rallying and altcoins are getting crushed as people race to get access to BTC in time for the big airdrop. (If you don’t know what BitcoinCash is, read this first.)

As far as PR goes, promising everyone “free money” is a great way to get attention to your project, even if it is not viable. However, there are holes in the free money story.

I’m writing this post to put concrete figures on the value of network effects and the damage done by a network split. While the decoupling of the big-block BCC from the Segwit-enabled BTC may ultimately prove healthy for the entire network, in the short term, it will be a damaging split if it attracts a substantial number of users. This can be argued from first principles. I’ll do that first, and then plug in some numbers.

The importance of Metcalfe’s law

Notice how the connections increase nonlinearly with nodes

If you have paid any attention to bitcoin recently, you have probably heard the phrase “network effect.” This refers to the tendency of networks to gain value in a nonlinear way as more users join those networks. In fact, it can be formalized mathematically.

Metcalfe’s law, first defined in the 80s with reference to Ethernet connections, theorizes that the value of a network is proportional to the square of the number of nodes on the network.

It can be simply expressed as:

V = C * N², where V is value, C is a constant, and N is the number of users or nodes. Metcalfe himself used Facebook’s data to demonstrate the power of his law in 2013, and Zhang, Lui, and Xu found that it held for Facebook and Tencent in 2015 (paper here).

Since bitcoin relies on interconnected users and nodes, it seems like a good candidate for the Metcalfe property to apply. We can therefore model the damage of a network split quite simply. We don’t even need real numbers to do this. I’ve done so in the following chart:

This table models, in a very simplistic way, what happens to the value of a network if a competing faction takes some of the users. The constant employed doesn’t matter. So, if a network loses 20% of its users, the original network’s value is reduced to 64% of its original value, the new network is only worth 4% of the original, and they combine for a measly 68%. This is due to the synergistic effects of connected networks. Additional users bring connections to every existing member; and when subtracted, all these connections are lost.

In a worst case, the network splits down the middle; both new networks are worth one quarter of the original, and the total value of both new networks added together is only half of the original. The sum of the parts is worth less than the whole.

What does this mean for Bitcoin/BitcoinCash?

We can naively insert some numbers to get an idea of the damage a split would do. This, of course, relies on the assumption that bitcoinCash users will defect from bitcoin (and haven’t done so already), and stay in their new BCC network; and bitcoiners won’t use BCC. This isn’t quite the case, so we’re modeling the worst case here.

Let’s make some wild guesses. There are 48,893 subscribers on /r/BTC and 270,349 on /r/bitcoin. BitcoinCash has a small amount of hashpower at present, although I imagine it will increase, and the futures market give us some idea of what the price might be (although probably an unreliable one).

If we imagine that the /r/bitcoin to /r/btc ratio is a reliable bellwether of pro-and anti-Core bitcoin users, and assume the worst case, that this ratio will be a guide to the number of users transitioning to bitcoin cash, and that these users are currently invested in bitcoin, this converts to a roughly 18% loss in userbase. Of course, these are pessimistic assumptions, as many anti-core bitcoiners aren’t presently invested in bitcoin, and not all of them will be tempted by BitcoinCash. But we’re looking at the worst case.

Hashpower is negligible in this analysis, and hard to predict. Looking at the futures market on ViaBTC, it puts the value of BitcoinCash at just over 13% of Bitcoin’s value. It’s important to note that a well-off BCC supporter could trivially inflate this figure to give it an outsize perceived value — 24h volume is a mere 2600 BTC. So let’s pessimistically say that BCC could seize 15% of the userbase from BTC.

If the Metcalfe property held, this would decrease Bitcoin’s marketcap by 27.75%, taking the price from $2730 to $1972. In this simulation, BCC would be worth $61.4 with 15% of the users. So a 85/15 split destroys 25.5% of the value of the original network. Put into other words, while BTC owners would received a cash “dividend” from the BCC airdrop (assuming they sold immediately), the money gained from this dividend is outweighed by the network value destroyed. In fact, any split whatsoever is a value-destroying activity in the short term, no matter the ultimate ratio of BTC to BCC.

Important caveats

Predicting the value destruction of network splits requires a lot of guesswork. Since markets aren’t particularly rational, value may be conserved in the split. In fact, if I had to guess, I’d say that the aggregate value of both chains will exceed bitcoin’s value today, a month from now. This isn’t to say that BCC is good for the network, but rather that the market isn’t doing a good job of pricing these networks. Ultimately, if BCC, or any other fork, obtains a significant share of hash power and users, network effect theory tells us that value has been destroyed.

There is also the “value unlock” effect to consider. One can imagine a situation where BTC, freed from big-block activism, efficiently unites around small blocks and quickly builds a second layer payment solution. Or one in which big-block BCC, unshackled, is able to realize its dream of on-chain scaling. In this scenario, value is “unlocked” from the divorce, and this outweighs the damage done by lost users. This is a highly plausible solution, and probably explains what happened in the ETH/ETC split.

Let’s briefly look at that precedent. After TheDAO and the contested hard fork, Ethereum Classic launched at at price of $0.75 before settling at $2.85 within the first 72 hours of trading. Ethereum itself experienced volatility, trading at around $15 immediately prior to the fork, before crashing after the ETC launch to a low of $7 before ultimately settling in the $11–12 range for the next two months. In the short term, the ETH+ETC value was roughly equivalent to ETH before the fork, in the medium term it actually dipped below that initial figure, and then ultimately, of course, both networks experienced colossal growth. Therefore, ethereum behaved as one might expect according to network theory, as the fork was a value-destroyer in the medium term.

So the Ethereum case study seems to confirm both the value-destruction property of a split, and the “value-unlock” theory, in the long term. An interesting precedent indeed.

To sum up, your BCC dividend/spinoff is not to be taken lightly — any value you obtain from selling your BCC for more BTC requires a buyer on the other side; and that buyer most likely is deserting the BTC network in the first place. Eventually, the decoupling may prove to be a harmonious split, through the value-unlock device, but in the short and medium term, it is likely to destroy value.