What are Altcoins?
Bitcoin is the granddaddy of all cryptocurrencies. It was the first cryptocurrency and is by far the most popular. But it has many followers and copycats, generally referred to as altcoins. An altcoin is an alternative coin to Bitcoin. As of today, it is estimated that there are more than 10,000 different altcoins in the cryptocurrency marketplace.
As an investor, perhaps you are curious as to how altcoins differ from Bitcoin, or perhaps you are seeking a better understanding of the various types of coins that exist in the crypto marketplace. Either way, this general guideline will help you in gaining an understanding of these alternative coins.
How Are Altcoins Different from Bitcoin?
To explain how altcoins differ from Bitcoin, it is important to first provide a general overview of some Bitcoin fundamentals.
Bitcoin is a virtual coin or digital currency that exists in the form of computer code. Bitcoin has a limited or “capped” supply of coins: 21 million. Because of this capped coin supply, people have associated a certain value with these virtual coins. This is similar to how people have associated a value with gold or silver.
All Bitcoin transactions are recorded in a block of data and all these blocks are chained or linked together in a blockchain. You can think of this blockchain as being created by a large interconnected number of decentralized computers.
These interconnected computers maintain a common record of each Bitcoin transaction. Transactions will be recorded by every single interconnected computer that is working to place the next block into the blockchain. Transactions are not controlled or influenced by any central bank, government, or organization.
Blocks must first be verified and then they are entered into the blockchain. This blockchain functions like an electronic ledger where entries cannot be changed or modified, similar to a ledger that a bank uses to log the flow of money into and out of the bank.
Bitcoin uses a consensus known as Proof-of-Work (PoW). With PoW, block verification occurs by way of “miners” who compete with one another to add the next verified block onto the blockchain.
To become a successful miner, the miner must initially verify a transaction block. The miner must then solve complex mathematical puzzles. There can only be one successful miner for each verified block. The successful miner will then write the verified block to the blockchain, thereby earning financial rewards.
New transactions will form a new block and the block verification process will begin again.
Altcoins
Altcoins operate similarly to Bitcoin. They use a blockchain as an incorruptible, distributed public ledger for on-chain transactions. Transactions are recorded only if there is a consensus in the platform that the transaction is indeed valid and legitimate. Some altcoins use a PoW consensus like Bitcoin, while others use a different type of consensus mechanism called Proof of Stake (PoS). There are also other hybrid consensus mechanisms.
What is the Purpose of Altcoins?
Altcoins serve a similar purpose as Bitcoin but usually serve this purpose differently or uniquely. For example, altcoins operate by way of a secured blockchain but may create new coins either by mining or perhaps by way of a different method.
Altcoins may also offer certain advantages over Bitcoin and its operating platform. For example, they may offer a more scalable platform or one that can process more transactions per a given timeframe. Other altcoins are described as having a more decentralized or more secure platform.
In addition, other altcoins have been developed that can perform activities that Bitcoin is not capable of performing. The execution of smart contracts by way of the Ethereum blockchain is just one example of how second-generation blockchains provide enhancements over the Bitcoin blockchain.
What are the Different Types of Altcoins?
As already noted, quite a few altcoins are circulating in the marketplace. Most of these altcoins can be classified into one of four different types of coins or tokens.
Security Tokens
The most common type of altcoin is the security token. Security tokens, often referred to as equity tokens, grant the token holder some type of ownership right in a company or organization. For example, this might be a right to profit-sharing, or even a right to vote on certain organizational issues.
Security tokens are similar to how US securities or company shares operate on a major stock exchange. Gains in the pricing of security tokens are the primary driver behind investor interest in these types of tokens.
Because they operate similarly to US securities, security tokens are regulated by security laws. What this means is that there are stricter guidelines on the sale, purchase, and transfer of security tokens than with other types of altcoins. This regulation provides a greater sense of security to investors and purchasers of these types of assets.
A popular security token is The INX Token, which was the first SEC-registered blockchain security token. With a market cap of about $250 million, the INX Token is also the most valuable security token as of today.
INX token holders receive an astonishing annual 40% distribution of any positive net operating cash flow generated by the INX organization.
Mining Type Altcoins
Altcoins can be bought like traditional currency but they can also be mined. In short, mining requires the user (or miner) to validate a transaction. Block validation ensures the block’s authenticity and updates the blockchain after each validation. Miners are rewarded for maintaining the blockchain by earning these new coins.
Most mining-based altcoins use the PoW consensus mechanism, similar to Bitcoin.
Examples of mining-based altcoins include Litecoin, Monero, and ZCash. Most of the top altcoins in early 2020 fell into the mining-based category.
The alternative to mining-based altcoins is pre-mined and often part of an initial coin offering (ICO). Such coins are not produced through an algorithm but are distributed before they are listed in crypto markets.
Stable Coins
Cryptocurrencies are a volatile form of currency where valuations fluctuate based on investor perceptions, potential regulatory threats, and even social media statements. The result is that cryptocurrencies undergo severe volatility, with price changes occurring over days or even in a matter of hours.
Take Bitcoin for example. In 2017, Bitcoin started at $2,000 and skyrocketed to $20,000. Its price then plummeted 75% over the next 12 months only to then push its way back up to an all-time high of over $68,000. However, its current price has now dropped by more than 30% from its all-time high.
Stablecoins are designed to dampen these types of volatile price fluctuations. To stabilize its value, a stablecoin is linked or “pegged” to an underlying stable asset.
Stablecoins use this underlying stable or non-volatile asset as a form of collateralization. For example, a stablecoin may be linked to a popular financial asset like a fiat (government-backed) security or a commodity, like gold. However, other forms of collateralization may also be used.
Tether (USDT) is the number one stablecoin based on a market cap valued at $82B USD. This stablecoin is pegged to the US dollar and is collateralized by an asset pool comprising commercial paper, fiduciary deposits, cash, money market funds, and treasury bills.
Utility Tokens
Utility tokens provide a user with access to a product or service.
For example, BNB is both a cryptocurrency coin and a utility token. With BNB, Binance users who pay with the BNB token receive a substantial discount on certain trading fees. These tokens can also be used to pay for all sorts of goods and services, including hotel expenses, airline tickets, entertainment, and virtual gifts.
Another popular utility token is offered by Decentraland. Decentraland is the most popular metaverse that is built on the Ethereum blockchain. Decentraland has two utility tokens: MANA and LAND. MANA are fungible tokens that operate as Decentraland’s currency and can be used to pay for several virtual items including avatars, names, wearables, and digital art in the Decentraland metaverse. LAND are non-fungible tokens that can be used to purchase plots of land or estates.
Meme Coins
Most altcoins have some degree of utility. That is, they have some type of use case: they solve a problem or they offer a new service or an enhanced product.
Not so with meme coins. The genesis of a meme coin is typically a meme, a joke, trend followers, or an Internet fad. Or even the Twitter statements by someone famous, like Elon Musk.
Take, for example, Dogecoin. Dogecoin was one of the first meme coins created based on a popular meme of a Japanese Shiba Inu dog. It was intended to poke fun at Bitcoin. Publicity stunts have helped drive community awareness of the coin.
Dogecoin’s sibling meme coin is Shiba Inu. Like Dogecoin, Shiba Inu is based on a meme featuring a Shiba Inu dog and calls itself the “Dogecoin killer.”
Meme coins have certain common traits. For example, meme coins typically have an unlimited or uncapped token supply. For example, Dogecoin has an uncapped supply and already has over 100 billion tokens in circulation.
And Shiba Inu has a total supply of 1 quadrillion tokens. That’s 1,000 trillion coins! Compare that to Bitcoin which has a capped supply of 21 million coins.
An unlimited or massive coin supply is perhaps a primary reason why the price of meme coins is so low compared with other altcoin types. For example, take a look at the chart below of the top meme-styled coins and compare these prices to today’s price of other altcoins, like Ethereum ($3,022) or Salano ($101).
Top Memes Tokens by Market Capitalization
Another common trait among meme coins is that they are very volatile since their value is mostly community-driven. Statements made on social websites can affect these coins at a moment’s notice, either going to the moon or tanking quickly.
What Altcoins Have Long-Term Potential?
There are many different altcoin options to choose from as a potential investment. How can investors choose which altcoin is a good investment option for them?
Well, one way to identify an altcoin that has a valid long-term potential is to focus on its use case. That is, what added value or unique feature does the altcoin present with respect to other coins in the marketplace?
Several altcoins that appear to have long-term potential given their strong use cases are summarized below.
Ethereum
Ethereum was introduced in 2015 as a second-generation blockchain. It is now the world’s most actively used blockchain supporting more than 3,000 decentralized applications (dApps). It is also the number two cryptocurrency based on today’s market capitalization.
Ethereum currently implements a PoW consensus mechanism similar to Bitcoin’s consensus mechanism. Ethereum is a blockchain network that utilizes a decentralized public ledger.
Ethereum distinguishes itself from first-generation blockchains like Bitcoin as being “the world’s programmable blockchain.”
Ethereum was created to allow developers to build-out smart contracts and distributed applications (dApps). For example, a smart contract is a self-executing contract where the terms of the contract between a first party (a buyer) and a second party (a seller) are captured within the written lines of computer code.
Importantly, Ethereum’s programmability as a blockchain continues to attract the attention of DeFi developers. For example, Ethereum ranks as the number one DeFi protocol with over $116 billion in total locked value (TLV) with over 415 active on-chain projects. This is quite a bit more than any other blockchain.
Ether (ETH) is the cryptocurrency of the Ethereum platform. ETH prices can be volatile. The market value of one ETH eclipsed an all-time high of $4,891 just five months ago and now having gone through a bit of a bearish market (like practically all other financial markets and cryptocurrencies) sits at about $3,000.
If you can stomach volatility, then you should consider purchasing ETH. It is the number two crypto riding the coattails of the well-known Bitcoin. And because it is the “programmable blockchain,” developers will continue to demand its functionalities for NFT, smart contract, Web3.0, blockchain gaming, and dApp projects as these technologies continue to experience explosive growth.
And looking toward its immediate future, the Ethereum Foundation has developed Ethereum 2.0 (Eth2.0) which is a multi-phased plan to upgrade the Eth1.0 ecosystem.
Ethereum 2.0 is directed towards enhancing Ethereum’s scalability, increasing its speed and security, while also drastically reducing its energy consumption.
Cardano
Cardano (ADA) is a new generation blockchain that builds upon Ethereum. Cardano enhances those things that the second generation blockchain Ethereum excelled at: scalability, efficiency, and security.
Cardano is an open-source blockchain which means that its records are made public and are readily available. Cardano is a decentralized blockchain network that, like Ethereum, supports self-executing computer programs by way of smart contracts.
Cardano currently has a circulating supply of 33.5M ADA coins. The maximum supply of the ADA has a hard cap of 45 billion tokens which are to be released over time through minting.
Much like the Bitcoin coin supply hard cap, ADA’s hard cap acts as a deflationary measure. ADA runs on Ouroboros which is a PoS-styled consensus protocol.
Among cryptocurrencies, Cardano presently has the eighth-highest market value at $32 billion. In 2021, Cardano experienced a decent year-to-date market value gain of 200x, having reached an all-time high of $3.10 last September.
Solana
Solana (SOL) is directed to decentralized blockchain architecture.
Solana is an extremely fast and secure, open-sourced blockchain. It differentiates itself from other blockchains by processing transactions as they arrive into the network, rather than processing these transactions in a block by block fashion.
To achieve its processing rates, Solana utilizes a novel blockchain structure that implements both a Proof of History (PoH) coupled with a Proof of Stake (PoS).
Since its initial release, Solana’s price has been nothing short of meteoric, hitting an all-time high of $260 last November. With a market cap of just over $32 billion, Solana now ranks in sixth place among the largest cryptocurrencies by total value.
Solana has been placed into a category of potential Ethereum killers, shared by other smart contract projects such as Binance Smart Chain, Cardano, and Avalanche.
The high throughput that Solana achieves through its innovative ecosystem makes it ideal for decentralized applications (dApps). Simply put, it offers a more scalable platform with lower transaction costs.
How Do Altcoins Move in Relation to Bitcoin?
With Bitcoin being the original cryptocurrency, do altcoin prices move relative to Bitcoin’s price movements? Well, it appears that a 2019 academic paper answered this question in the affirmative. That is, at least certain types of altcoins follow the price movements of Bitcoin.
The question is: why do some altcoins move with Bitcoin? Several reasons have been proposed.
First, practically all centralized exchanges use Bitcoin as a primary trading partner or trading pair for other cryptocurrencies. So, for example, if you wanted to trade your Litecoin (LTC), you had to trade it for the most popular crypto – Bitcoin. Therefore, to trade for LTC, you had to purchase Bitcoin first to then trade for LTC. Purchasing Bitcoin would drive its price up, and the subsequent purchase of LTC would drive its price up as well.
Second, Bitcoin was the original cryptocurrency and is by far the number one cryptocurrency based on market capitalization. If the original, number one cryptocurrency Bitcoin experienced a bullish market move, this was perceived as bullish news for the remainder of the crypto marketplace.
One accepted measure of this market interrelationship between Bitcoin and the rest of the crypto marketplace is the Bitcoin Dominance Ratio.
Bitcoin Dominance is a metric used to understand the interplay between Bitcoin and altcoins. An important characteristic of this computed ratio is that it can help investors understand if altcoins are in a downtrend or uptrend against Bitcoin.
The Bitcoin Dominance Ratio is computed as the ratio of Bitcoin’s Market Capitalization to the Cryptocurrency’s Total Market Capitalization.
Therefore, when the Bitcoin Dominance increases, altcoins will be expected to lose value against Bitcoin. Similarly, when the Bitcoin Dominance decreases, altcoins will be expected to gain value against Bitcoin.
Generally speaking, Bitcoin will lose market dominance in bullish markets since investor interest in altcoins grows at the expense of Bitcoin in bullish markets. Similarly, Bitcoin surging versus the altcoin market cap is typically a bearish market signal.
1-Year Market Cap Bitcoin Dominance (source: tradingview.com)
To gain a general understanding of this ratio, note the 1-year Market Capitalization Bitcoin Dominance graph reproduced above.
As can be seen, altcoins underwent a bearish trend since the start of 2022 where the Bitcoin Dominance increased from about 40% to its current value of about 42%.
If you are interested in investing in either Bitcoin or altcoins, you may find the following table informative as to how you can apply purchase or sale signals based on the Bitcoin Dominance ratio.
Bitcoin Dominance: Bitcoin’s Price: Potential Investment:
Increasing Price increasing Purchase Bitcoin
Increasing Price decreasing Liquidate altcoins
Decreasing Price increasing Purchase altcoins
Decreasing Price decreasing Liquidate Bitcoin
Another reason that altcoins tend to move with Bitcoin is that many traders make their decisions to enter or exit crypto-related trades based on the fluctuations of Bitcoin’s price. If Bitcoin’s price goes up, traders will purchase altcoins on the belief that if Bitcoin’s price is bullish, other altcoins will follow suit and also trend higher.
In addition, some derivative Bitcoin-related altcoins are structured to mirror Bitcoin’s ecosystem. Therefore, these derivative-styled altcoins typically follow Bitcoin’s price action. Bitcoin-related altcoins include Litecoin, Bitcoin Cash, Bitcoin Gold, and Bitcoin Diamond.
Take, as just one example, Litecoin (LTC). Litecoin was established in 2011 as a peer-to-peer (P2P) cryptocurrency and is considered by many to be the first “alternative” coin to Bitcoin’s open-source code.
Since its introduction, Litecoin has slowly moved down to 21st place in the rankings despite its respectable current market capitalization of almost $8 billion.
Litecoin’s original design purpose was to become a cost-effective and faster processing blockchain alternative to Bitcoin. Indeed, Litecoin forked off of Bitcoin’s original codebase.
When Litecoin was first launched, Litecoin’s founder Charlie Lee referred to his trimmed down version of Bitcoin as “the lite version of Bitcoin.”
1-Year Price Comparison Litecoin versus Bitcoin (source: yahoo.com)
As can be seen from the comparison chart provided above, there appears to be a close correlation between Bitcoin’s price action (blue) and Litecoin’s price action (red).
Conclusion
Altcoins are alternative options to Bitcoin, the number one cryptocurrency. These coins might be a good investment but it depends on an understanding of the different types of cryptocurrencies and someone’s investing objectives. Altcoins can carry a substantial risk where the less established altcoins (such as meme coins) generally pose the most amount of risk. And stablecoins carry the least amount of risk. Before investing in any altcoins, be sure to do your research, just as you would with any traditional security. As they say in crypto, DYOR: do your own research.