Altcoins are cryptocurrencies other than bitcoin . They share characteristics with bitcoin but are also different in other respects. For example, some altcoins use a different consensus mechanism to produce blocks or validate transactions. Or they differ from bitcoin by offering new or additional capabilities, such as smart contracts or low price volatility.
In March 2021, there were nearly 9,000 cryptocurrencies . According to CoinMarketCap, altcoins accounted for over 40% of the total cryptocurrency market in March 2021 . Because they are derived from bitcoin, altcoin price movements tend to mimic the trajectory of bitcoin.
However, analysts say that the maturity of cryptocurrency investment ecosystems and the development of new markets for these coins make altcoin price movements independent of Bitcoin trading signals.
KEY POINTS TO REMEMBER
- The term “altcoins” refers to all cryptocurrencies other than bitcoin.
- As of March 2021, altcoins accounted for 40% of the total cryptocurrency market, with over 9,000 cryptocurrencies and counting.
- Some of the main types of altcoins include mining-based cryptocurrencies, stablecoins, security tokens, and utility tokens.
- Altcoins may only include mining-based cryptocurrencies other than bitcoin in the future as usage continues to expand with technology.
- Ethereum and Binance Coin were the largest altcoins by market capitalization in March 2021.
“Altcoin” is a combination of the two words “alt” and “coin” and includes all alternatives to bitcoin. The basic framework of bitcoin and altcoins is similar. Thus, they share code and function like peer-to-peer systems or like a giant computer capable of processing large amounts of data and transactions at the same time. In some cases, altcoins also aspire to become the next Bitcoin by becoming a low-cost method for digital transactions.
But there are also several differences between the two entities.
Bitcoin is among the earliest iterations of a cryptocurrency, and its philosophy and design served as a benchmark for the development of other currencies. However, its implementation has several shortcomings. For example, proof-of-work (PoW), the consensus mechanism used to create blocks, is energy and time-intensive. Bitcoin’s smart contract capabilities are also limited.
Altcoins enhance the perceived limitations of bitcoin to establish competitive advantage . Several altcoins use the Proof-of-Stake (PoS) consensus method to minimize the power consumption and time needed to create blocks and validate new transactions.
Another example is Ether, the world’s second largest cryptocurrency by market capitalization, which is used as gas (or payment for transaction costs) in smart contracts on Ethereum. Altcoins also respond to traditional criticism against bitcoin. For example, stablecoins do not exhibit the price volatility of bitcoin, making them ideal vehicles for day-to-day transactions.
By distinguishing themselves from bitcoin in this way, altcoins have created a market for themselves. They have thus attracted investors who see them as a potential alternative to bitcoin. These investors hope to profit from the increase in the number of users of these currencies and the appreciation of their price.
The different types of altcoins
Based on their functionality and consensus mechanisms, altcoins fall into several categories. Here is a brief summary of some of the most important:
Namely: It is possible that an altcoin belongs to more than one category.
As their name suggests, mining-based altcoins are mined to exist. Most mining-based altcoins use the Proof-of-Work (PoW) method, a method in which systems generate new coins by solving difficult problems, to create blocks . Litecoin, Monero, and Zcash are examples of alternative mining-based currencies.
Most of the major alternative currencies at the start of 2020 belonged to the category of mining currencies. The alternative to mining-based altcoins is pre-mined coins. These coins are not produced by an algorithm but are distributed before being listed on the cryptocurrency markets. An example of a pre-mined coin is Ripple’s XRP .
The trading and use of cryptocurrencies has been marked by volatility since their inception. Stablecoins aim to reduce this overall volatility by pegging their value to a basket of assets, such as fiat currencies, precious metals, or other cryptocurrencies. The basket is meant to serve as a reserve to redeem holders if the cryptocurrency fails or runs into trouble. Price movements of stablecoins are not meant to go beyond a narrow range.
Examples of stablecoins are USDC and MakerDAO.
Security tokens are similar to securities traded on stock exchanges, except that they have a digital provenance . Security tokens resemble traditional stocks and often promise stake, in the form of ownership, or payment of dividends to holders. The prospect of price appreciation for these tokens is a major draw for investors who want to put their money in them. Security tokens are usually offered to investors through initial coin offerings or ICOs.
Utility tokens are used to provide services within a network . For example, they can be used to purchase services or redeem rewards. Unlike security tokens, utility tokens do not pay dividends or offer ownership participation. Filecoin, which is used to buy storage space on a network, is an example of a utility token.
Are altcoins good investments?
The altcoin market is nascent. This is an unequal pair. The number of altcoins listed on cryptocurrency markets has grown rapidly over the past decade and has attracted hordes of retail investors, betting feverishly on their price performance to amass short-term profits. . But these investors do not have the capital to generate sufficient market liquidity.
The thinness of the markets and the lack of regulation lead to skyrocketing volatility in altcoin valuations.
Take the case of Ethereum’s ether, which peaked at $1299.95 on January 12, 2018. Less than a month later it had fallen to $597.36, and by the end of the year , the price of ether had crashed to $89.52. The altcoin reached record prices of over $2,000 two years later. Scheduled trades can bring many benefits to traders.
But there is a problem. Cryptocurrency markets are not yet mature. Despite several attempts, there are no set investment criteria or metrics for evaluating cryptocurrencies. For the most part, the altcoin market is driven by speculation . There are several cases of dead cryptocurrencies, that is, those that failed to catch on or simply disappeared after collecting money from investors.
Therefore, the altcoin market is for investors willing to take the outsize risk of operating in an unregulated, emerging market prone to volatility. They also need to be able to handle the stress resulting from large price swings. For these investors, the cryptocurrency markets offer excellent returns.
The benefits of altcoins
- Altcoins are “better versions” of bitcoin because they aim to fill in the gaps in cryptocurrency.
- Altcoins, like stablecoins, have the potential to fulfill bitcoin’s original promise of supporting daily transactions.
- Some alternative currencies, such as Ether from Ethereum and XRP from Ripple, have already gained popularity with traditional institutions, leading to high valuations.
- Investors can choose from a wide variety of altcoins that perform different functions in the cryptoeconomy.
The disadvantages of altcoins
- Altcoins have a smaller investment market than bitcoin. In April 2021, bitcoin held a 60% share of the overall cryptocurrency market.
- Due to the lack of regulation and defined investment criteria, the altcoin market is characterized by a small number of investors and low liquidity. Therefore, their prices are more volatile than those of bitcoin.
- It is not always easy to distinguish between different altcoins and their respective use cases, which makes investment decisions even more difficult and confusing.
- There are several “dead” altcoins that have ended up sinking investors’ dollars.
Early examples of altcoins
The first notable altcoin, Namecoin, was based on the Bitcoin code and used the same proof-of-work algorithm. Like bitcoin, Namecoin is limited to 21 million coins. Introduced in April 2011, Namecoin mainly deviated from Bitcoin by making user domains less visible. Namecoin allowed users to register and mine using their own .bit domains, which was intended to increase anonymity and censorship resistance.
Introduced in October 2011, Litecoin was billed as “Bitcoin’s money to gold”. Although fundamentally similar to Bitcoin in terms of code and functionality, Litecoin differs from Bitcoin in several key points. It allows mining transactions to be approved more frequently. It also allows a total of 84 million coins to be created, four times more than Bitcoin’s 21 million coin limit. Some believe that Litecoin might be a better investment than Bitcoin itself.
The future of altcoins
Discussions about the future of altcoins and, indeed, cryptocurrencies have precedent in the circumstances that led to the issuance of a federal dollar in the 19th century. At the time, there were several forms and types of local currencies in circulation in the United States. Each had unique characteristics and was backed by a different instrument. For example, gold certificates were backed by gold deposits in the public treasury. American banknotes, which were used to fund the Civil War, were backed by the government.
Local banks also issued their own currency, in some cases backed by fictitious reserves. This multiplicity of currencies and financial instruments is comparable to the current situation in the altcoin markets. Thousands of altcoins are available in the markets today, each claiming to serve a different purpose and market.
As things stand, altcoin markets are unlikely to consolidate into a single cryptocurrency. But it’s also likely that a majority of the more than 1,800 altcoins listed on cryptocurrency markets won’t survive. The altcoin market will coalesce around a group of altcoins, those with strong utility and use cases, which will dominate the markets.
For investors looking to diversify into the cryptocurrency markets, altcoins are an inexpensive way to expand their horizons beyond bitcoin. Rallies in cryptocurrency markets have produced returns that are multiples of those produced by Bitcoin. But investing in altcoins comes with risks, not the least of which is the lack of regulation. Maturing cryptocurrency markets will likely bring more sophistication and capital into the industry, paving the way for regulation and lower volatility.
To conclude on altcoins
Altcoins are good alternatives for investors in the cryptocurrency market who want to diversify their portfolio. While some, like Ethereum’s ether, are recognizable by name, the majority of the roughly 9,000 altcoins have yet to be talked about. Altcoins are representative of the potential of cryptocurrencies to reshape modern finance. But investors should do their research before investing in it. The risks associated with altcoins are similar or, in some cases, greater than those of investing in bitcoins.