What Investors Need to Know

What Are Altcoins?

Altcoins are cryptocurrencies other than Bitcoin (BTCUSD). They share characteristics with Bitcoin but are also different in other ways. For example, some altcoins use a different consensus mechanism to produce blocks or validate transactions. Or they distinguish themselves from Bitcoin by providing new or additional capabilities, such as smart contracts or low price volatility.

As of October 2021, there are over 12,000 cryptocurrencies. According to CoinMarketCap, altcoins accounted for nearly 60% of the total cryptocurrency market in October 2021. Because they are derived from Bitcoin, altcoin price movements tend to mimic Bitcoin’s trajectory. However, analysts say the maturity of cryptocurrency investing ecosystems and the development of new markets for these coins will make price movements for altcoins independent of Bitcoin’s trading signals.

Understanding Altcoins

« Altcoin » is a combination of the two words « alternative » and « coin » and includes all alternatives to Bitcoin. The basic framework for Bitcoin and altcoins is similar. Thus, they share code and function as peer-to-peer systems or as a giant computer capable of processing large amounts of data and transactions at the same time. In some instances, altcoins also aspire to become the next Bitcoin by becoming an inexpensive method for digital transactions.

But there are also several differences between Bitcoin and altcoins. Bitcoin is among the first iterations of a cryptocurrency, and its philosophy and design set the benchmark for the development of other coins. However, its implementation has several shortcomings. For example, Proof-of-Work (PoW)—the consensus mechanism used to create blocks—is energy-intensive and time-consuming. Bitcoin’s smart contract capabilities are also limited.

Altcoins improve upon Bitcoin’s perceived limitations to establish a competitive advantage. Several altcoins use the Proof-of-Stake (PoS) consensus method to minimize energy consumption and the time required to create blocks and validate new transactions.

Another example is that of ether (ETHUSD), the world’s second-biggest cryptocurrency by market capitalization, which is used as gas (or payment for transaction costs) in smart contracts on Ethereum. Altcoins also address traditional critiques against Bitcoin. For example, stablecoins do not exhibit Bitcoin’s price volatility, making them ideal vehicles for daily transactions.  

By distinguishing themselves from Bitcoin in this manner, altcoins have created a market for themselves. In turn, this has attracted investors who see potential in them as alternatives to Bitcoin. The investors expect to profit as altcoins garner more traction and users and appreciate in price.

Types of Altcoins

Depending on their functionalities and consensus mechanisms, altcoins come in various flavors and categories. Here’s a brief summary of some of the more important ones:

Mining-Based

As their name indicates, mining-based altcoins are mined into existence. Most mining-based altcoins use Proof-of-Work (PoW), a method in which systems generate new coins by solving difficult problems, to create blocks. Examples of mining-based altcoins are Litecoin (LTCUSD), Monero (XMRUSD), and Zcash (ZECUSD). Most of the top altcoins in early 2020 fell into the mining-based category. The alternative to mining-based altcoins is pre-mined coins. Such coins are not produced through an algorithm but are distributed before they are listed in cryptocurrency markets. An example of a pre-mined coin is Ripple’s XRP (XRPUSD).

Stablecoins

Cryptocurrency trading and use have been marked by volatility since launch. Stablecoins aim to reduce this overall volatility by pegging their value to a basket of goods, such as fiat currencies, precious metals, or other cryptocurrencies. The basket is meant to act as a reserve to redeem holders if the cryptocurrency fails or faces problems. Price fluctuations for stablecoins are not meant to exceed a narrow range.

Social media behemoth Facebook, Inc.’s (FB) Diem is the most famous example of a stablecoin. It is a dollar-backed coin. Other examples of stablecoins are USDC and MakerDAO. In March 2021, payment processing giant Visa Inc. (V) announced that it would begin settling some transactions on its network in USDC over the Ethereum blockchain, with plans to roll out further stablecoin settlement capacity later in 2021 and early 2022.

Security Tokens

Security tokens are similar to securities traded in stock markets except they have a digital provenance. Security tokens resemble traditional stocks and often promise equity, in the form of ownership, or a dividend payout to holders. The prospect of price appreciation for such tokens is a major draw for investors to put money into them. Security tokens are generally offered to investors through initial coin offerings (ICOs).

Meme Coins

As their name suggests, meme coins are inspired by a joke or a silly take on other well-known cryptocurrencies. They typically gain popularity in a short period of time, often hyped online by prominent crypto influencers and retail investors attempting to exploit short-term gains.

For example, Tesla, Inc. (TSLA) CEO and cryptocurrency enthusiast Elon Musk regularly posts cryptic tweets about leading meme coins Dogecoin (DOGEUSD) and Shiba Inu that often substantially move their prices. In October 2021, Shiba surged 91% in a 24-hour period after Musk tweeted a picture of his pet Floki, the Shiba Inu puppy, on a Tesla. Many refer to the sharp runup in these particular altcoins during April and May 2021 as « meme coin season, » with hundreds of these cryptocurrencies posting enormous percentage gains on pure speculation.

Utility Tokens

Utility tokens are used to provide services within a network. For example, they might be used to purchase services, pay network fees, or redeem rewards. Unlike security tokens, utility tokens do not pay out dividends or part with an ownership stake. Filecoin, which is used to purchase storage space on a network, is an example of a utility token.  

Are Altcoins Good Investments?

The market for altcoins is nascent. It is an unequal pairing. The number of altcoins listed in cryptocurrency markets has rapidly multiplied in the past decade and attracted hordes of retail investors, feverishly betting on their price movements to amass short-term profits. But such investors do not have the capital necessary to generate sufficient market liquidity. Thin markets and an absence of regulation produces quicksilver volatility in altcoin valuations.

Consider the case of Ethereum’s ether, which reached its prior peak of $1,299.95 on Jan. 12, 2018. Less than a month later, it was down to $597.36, and by the year’s end, ether’s price had crashed to $89.52. Yet, the altcoin reached record prices of above $4,000 two years later. Timed trades can provide a wealth of profits for traders.

But there is a problem. Cryptocurrency markets are not yet mature. Despite several attempts, there are no defined investment criteria or metrics to evaluate cryptocurrencies. For the most part, the altcoin market is driven by speculation. Several cases of dead cryptocurrencies, those that failed to gain enough traction or simply vanished after collecting investors’ money, exist.

Therefore, the altcoin market is for investors willing to take on the outsized risk of operating in an unregulated and emerging market that is prone to volatility. They should also be able to handle stress resulting from wild price swings. For such investors, cryptocurrency markets can offer great returns.

Early Examples of Altcoins

The earliest 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 primarily diverged 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 branded as the « silver to Bitcoin’s gold. » While fundamentally similar in code and functionality to Bitcoin, Litecoin differs from Bitcoin in several essential ways. It allows mining transactions to be approved more frequently. It also provides for a total of 84 million coins to be created—exactly four times Bitcoin’s 21 million coin limit. Some think Litecoin could be a better investment than Bitcoin itself.

Future of Altcoins

Discussions about the future for altcoins and, indeed, cryptocurrencies have a precedent in the circumstances that led to the issue of a federally issued dollar in the 19th century. Back then, there were various forms and types of local currencies circulating in the United States. Each had unique characteristics and was backed by a different instrument. For example, gold certificates were backed by deposits of gold at the Treasury. U.S. notes used to finance the civil war were backed by the government.

Local banks were also issuing their own currency, in some cases backed by fictitious reserves. That multiplicity of currencies and financial instruments parallels the current situation in altcoin markets. There are thousands of altcoins available in the markets today, each one claiming to serve a different purpose and market.

The current state of affairs in the altcoin markets is unlikely to consolidate into a single cryptocurrency. But it is also likely that a majority of the more than 1,800 altcoins listed in crypto markets will not survive. The altcoin market will coalesce around a bunch of altcoins—those with strong utility and use cases—which will dominate the markets.

For investors looking to diversify within crypto 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 there are risks involved in altcoin investing, not least of which is the absence of regulation. The maturation of cryptocurrency markets will likely bring more sophistication and capital into the industry, paving the way for regulation and less volatility.

Altcoin FAQs

What Is an Altcoin?

The term altcoin refers to cryptocurrencies other than Bitcoin. Such coins distinguish themselves from Bitcoin by extending their capabilities and plugging their shortcomings.

What Are the Top 10 Altcoins?

The top 10 altcoins are Ethereum, Cardano (ADAUSD), Binance Coin (BNBUSD), Tether (USDTUSD), Solana (SOLUSD), XRP, USDC, Polkadot (DOTUSD), and Dogecoin as of October 2021.

How Much Is an Altcoin?

Altcoins have a pretty wide price range from a couple of cents to thousands of dollars. For example, in October 2021, Ethereum was trading at $3,565, while Ripple’s XRP, the sixth-most valuable cryptocurrency, was trading for $1.08.

What Is the Best Altcoin to Invest In?

Based on market capitalization, ether is the biggest and most well-established altcoin. Its smart contract capabilities have proven use cases, and it is part of Ethereum, arguably one of the most sophisticated blockchain platforms in recent times.

Are Altcoins Good Investments?

Altcoins have many of the same investment risks associated with Bitcoin. In addition, many of the small altcoins are illiquid. But well-established altcoins, such as ether and XRP, are competitors to Bitcoin.

The Bottom Line

Altcoins are good alternatives to cryptocurrency market investors interested in diversifying their portfolio. While some, like Ethereum’s ether, are recognizable by name, a majority of the almost 9,000 altcoins are still to make a mark. Altcoins are representative of the potential for cryptocurrencies to reshape modern finance. But investors should do their research before investing in them. The risks associated with altcoins are similar or, in some cases, greater than those for Bitcoin investing.