What is Altcoin & Should You Invest?

If you’re new to cryptocurrency, you might be wondering, “what is altcoin?”. The term is thrown around a lot by cryptocurrency investors.

In short, altcoin is any cryptocurrency that isn’t Bitcoin.

Why is there a distinction between Bitcoin and altcoin? And are altcoins worth investing in?

What is Altcoin?

Altcoin refers to any kind of cryptocurrency other than Bitcoin. In other words, they are “alternatives to Bitcoin.”

Bitcoin and altcoins work similarly. Both use blockchain technology to enable you to make secure peer-to-peer transactions.

When you make a payment from your digital wallet to another person’s digital wallet, the transaction is recorded in the blockchain, which is similar to a ledger. The blockchain is secured by mathematical proofs that confirm each transaction. Users are given private keys to access their funds that are recorded on the blockchain.

Altcoins share many characteristics with Bitcoin, but they may use different mechanisms to create or validate transactions. Each altcoin has its own variation of blockchain rules to appeal to different kinds of users.

As of 2021, there are nearly 9,000 cryptocurrencies. Altcoins account for over 40% of the total cryptocurrency market.

Altcoin vs. Bitcoin

Why is there a distinction between Bitcoin and altcoins in the first place?

Bitcoin was one of the first cryptocurrencies to hit the market, and it was the first cryptocurrency to achieve mainstream success. For that reason, Bitcoin set the benchmark for what a cryptocurrency can be and how it can operate.

Bitcoin has done some things very well. It created an extensive blockchain network and proved it could be as streamlined as a brokerage.

But Bitcoin also has some limitations. It uses a Proof-of-Work (PoW) mechanism to create blocks, which is no longer the most cost-effective or efficient method of validation. Bitcoin also has limited functionality with smart contracts.

Many altcoins were designed to improve upon the limitations of Bitcoin or to provide blockchain services other than monetary transactions.

However, most altcoins still follow the price trajectory of Bitcoin—if Bitcoin prices rise, then altcoin prices will rise. If Bitcoin prices fall, altcoin prices will fall.

But investors have been drawn to the unique characteristics of altcoins, and new markets are developing. It’s possible that in the near-future, altcoin markets will no longer be influenced by the Bitcoin market.

Types of Altcoins

Some altcoins were developed as passion projects by cryptocurrency enthusiasts, while others were developed as businesses. Some altcoins are intended to facilitate payments, while others are intended to power applications and online marketplaces. Altcoins come in many different variations.

Generally, you can categorize an altcoin as one of the following:

• Mining-based altcoins

• Stablecoins

• Security tokens

• Utility tokens

Mining-Based Altcoins

Mining is a core component of cryptocurrency. The blockchain uses complex mathematical calculations to validate transactions, but it needs computer power to run those calculations. Anyone can volunteer their computer to perform blockchain calculations, a process called “mining.” Miners are rewarded with coins.

Mining-based coins are coins that are generated through mining. Most of these cryptocurrencies use a Proof-of-Work model, in which miners volunteer their computers to solve math problems and receive coins for their efforts. Bitcoin pioneered this model, and most altcoins are mining-based as of 2021.

Some cryptocurrencies use “pre-mined coins.” These coins are not produced by mining. Instead, they’re created and distributed before they become available for trading. Ripple’s XRP is an example of a pre-mined coin.

Stablecoins

Cryptocurrencies are volatile, which means that the prices can fluctuate dramatically in just a short time. Some altcoins were designed to reduce volatility. These are called stablecoins.

Stablecoins try to reduce volatility by tying their value to an index or a basket of goods. Fiat currencies and precious metals are often used to back Stablecoins.

The price of the stablecoin should not be much different from the price of the goods backing it. But if there is a major discrepancy, the basket will be used as collateral to redeem investors.

When the cryptocurrency market is experiencing significant fluctuations, it’s not uncommon for investors to transfer all their holdings into stablecoins to protect them from price falls. (Stock investors do the same thing with commodities.)

Popular stablecoins include Tether, Diem, USDC, and MakerDAO.

Security Tokens

A security token is a coin that represents a security—primarily stocks. A company can transfer an ownership stake onto the blockchain, where it’s represented by a coin. If you own the coin, you own the security. Like standard securities, security tokens may pay out dividends to the investor holding them.
Security tokens are uncommon, and they confuse many stock investors—why invest in a security token when you can invest in the security itself?

Security tokens are beneficial if you want to transfer your security to another investor. Making a transfer over the blockchain is easier and cheaper than doing it through a brokerage, especially if you’re going to make a lot of these transactions.

Utility Tokens

Utility tokens are used to gain access to services within a blockchain network.

Not all blockchain networks are designed for money transfers. Some blockchains are used for messaging apps, marketplaces, or online storage. For example, Filecoin is a blockchain network in which you can store your personal data. The coin is used to purchase storage space on the network. This is an example of a utility token.

Utility tokens are much more common than security tokens. Many new blockchain networks are service-oriented. They use utility tokens for payment or to incentivize miners to run security checks on the blockchain.

Pros of Altcoins

Altcoins may have a few benefits that Bitcoin does not. Let’s review the advantages of investing in altcoins.

• Bitcoin Improvements: Many altcoins build upon the Bitcoin model and have a refined structure. The Proof-of-Work model is one of the disadvantages to Bitcoin. Proof-of-Work consumes a lot of computer power (something Elon Musk recently criticized), and the system is plagued by “mining pools.” Some cryptocurrencies, like Ethereum, have introduced a “Proof-of-Stakes” model, which is far more equitable and offers stronger incentives for miners.

• New Markets: Altcoins are driving new cryptocurrency markets. Many startups are using blockchain for smart contracts or to offer blockchain-driven services. It’s possible that these markets could generate substantial profits and growth.

• Wide Availability: There are over 9,000 cryptocurrencies available around the globe. If you live in the United States, you may only have access to 50-60 cryptocurrencies as of 2021. But that’s plenty of options for an investor, and it’s likely the government will allow more cryptocurrencies in the future.

• Risk Management: Security tokens give crypto investors a new way to protect their holdings—by transferring their holdings to security tokens when the market is struggling. Furthermore, the wide variety of altcoin variations make it easier for you to diversify your holdings.

• Short-Term Trading: The most successful crypto investors are short-term investors—active traders who time the market to buy low and sell high. There are lots of altcoins on the market, and so there are more ways to make money.

Cons of Altcoins

Altcoins have some drawbacks that Bitcoin may not have. Let’s review the disadvantages of investing in altcoins.

• Less Liquidity: While Bitcoin makes up 60% of the cryptocurrency market, altcoins collectively make up the remaining 40%. And each altcoin is bound to have a much smaller market share. As of 2021, there are no altcoins that can hold a candle to the massive market share that Bitcoin enjoys. Thus, altcoins are going to have far less liquidity. It may be more difficult to buy and sell your altcoin at a moment’s notice, and since cryptocurrency success depends on timely trading, this could be a major hindrance. Popular altcoins, like Ethereum and Litecoin, are easier to trade, but you may run into problems when you invest in the less popular altcoins.

• New Market Risk: New markets are exciting, but they do not always materialize into profitable, growing industries. They may also face regulation as they grow, which could affect their profitability. You don’t want to pour too much money into a market that will soon peak.

• Potential Regulation: As an altcoin increases its market share, it’s bound to catch the eye of the federal government and may face heavy regulations. In some cases, the altcoin may be banned outright in the United States or elsewhere.

• Highly Volatile: Cryptocurrency—whether it’s Bitcoin or an altcoin—is a volatile asset that makes for a risky investment. Most cryptocurrency involves a substantial amount of speculation, and most coins carry no intrinsic value. Not even stablecoins are immune from volatility.

The 5 Best Altcoins in 2021

Want to invest in Bitcoin alternatives? Here are the best altcoins for investors in 2021.

1. Ethereum (ETH)

Ethereum is a decentralized software program that allows developers to create decentralized applications (dApps) and smart contracts. The goal is to make financial products accessible to people worldwide, even in places where there’s little state infrastructure or product availability.

Ethereum’s coin is called Ether. Ether is a utility token that’s required by developers to create and run applications within the blockchain. But investors can also purchase Ether even if they’re not building applications within Ethereum.

Ether is the second-largest cryptocurrency in the world behind Bitcoin. Although it has a larger market share than many other altcoins, it still trails behind Bitcoin by a significant margin in terms of market share. But the application-first nature of Ethereum has made it an exciting prospect for investors.

The Ethereum blockchain is unique in that it uses a Proof-of-Stake model rather than a Proof-of-Work model. You can learn more about it in our blog, Ethereum vs. Bitcoin.

2. Litecoin (LTC)

Launched in 2011, Litecoin was one of the first Bitcoin alternatives to hit the market. Litecoin is a decentralized payment network where you can exchange money without going through a central authority.
Overall, Litecoin is very similar to Bitcoin, but it’s much faster at generating blocks. That means that your transactions will be completed much faster than if you were trading on Bitcoin. Since many crypto investors are timing the market, speed is a very important factor in your success. The speedy block generation also makes it appealing for crypto miners.

Litecoin is the sixth largest cryptocurrency in the world, with a market capitalization of over $10 billion.

3. Cardano (ADA)

Cardano is a fierce competitor of Ethereum and was one of the first cryptocurrencies to use a Proof-of-Stake model. It was designed by a handful of engineers, mathematicians, and cryptography experts, not to mention a few former members of the Ethereum team.

The group researchers conducted a heavy amount of research on blockchain technology and wrote over 90 peer-reviewed studies on blockchain technology, covering a wide array of topics. They combined their knowledge to create Cardano.

Like Ethereum, Cardano aims to be a financial operating system with a range of decentralized products. It also strives to use blockchain technology to tackle a wealth of other issues.
Cardano does not have as many dApps as Ethereum, but its highly advanced blockchain has many investors dubbing it the “Ethereum killer.”

4. Polkadot (DOT)

Polkadot is a Proof-of-Stake cryptocurrency that aims to make blockchains compatible with one another. Most blockchains are either “permissioned” or “permissionless.” In other words, they require permission from a network administrator, or they don’t.

These blockchains are generally incompatible with one another. Polkadot uses protocols that enable different blockchains to work together by using parallel blockchains (parachains) or single-use native tokens.

These mechanisms give developers an added layer of security. Developers can create two blockchains for their dApps—their own private blockchain, and the Polkadot blockchain.

Polkadot has a market capitalization over $11 billion, and it’s an exciting prospect for investors interested in the emerging market for dApps and blockchain-driven software.

5. Bitcoin Cash (BCH)

Bitcoin Cash is the result of a “hard fork” in the Bitcoin blockchain. Developers and miners had disagreements about the direction and mechanisms for Bitcoin, and so the cryptocurrency was split into two separate blockchains to appease both sides.

Bitcoin Cash was created to be more scalable than the original Bitcoin. Bitcoin limits the size of blocks, which means there can only be so many transactions in a single block. Bitcoin Cash increased the block size from 1 MB to 8 MB so it can handle many more transactions. There are some other changes, too, like the removal of the Segregated Witness protocol (which also impacts block size).

Bitcoin Cash is a great alternative for investors who desire faster transaction speeds with the same block generation process of Bitcoin.

Should You Invest in Altcoins?

Before you invest in altcoins, consider the following:

• Your Financial Goals: Ask yourself why you want to invest in cryptocurrency in the first place. Crypto is not the safest investment. It’s considered a high-risk investment, just like individual stocks, and you may lose the money that you put into it because of crypto’s high volatility. If you’re looking for a high-risk investment, make sure that you have a diverse portfolio of safer investments and never invest more than you’re willing to lose. If passive income or retirement savings are your goals, you’re better off investing in real estate or index funds.

• Your Crypto Goals: If you’re interested in the emerging markets for decentralized apps, altcoins may be a better investment for you than Bitcoin. If you’re an active trader, Bitcoin may be a better option because it’s more liquid and has a higher market capitalization.

• Whether You Want to Be a Miner: If you’re interested in crypto mining, you might prefer investing in altcoins because the Proof-of-Stake model prohibits unfair mining pools.

Summary

An altcoin is any cryptocurrency other than Bitcoin. Bitcoin was the first commercially successful cryptocurrency, and it set the benchmark for future blockchains. Altcoins build upon Bitcoin by improving the block generating mechanisms. Some altcoins are designed to facilitate money transfers, while others power blockchains for decentralized software programs. Altcoins give investors a wider array of trading options, and they’re driving a new industry of blockchain-related companies. However, altcoins do not have as much market share as Bitcoin, so they have less liquidity and are riskier.

Sources

https://cleartax.in/g/terms/altcoin

https://bitcoin.org/en/how-it-works

https://litecoin.org/

href=”https://www.cftc.gov/media/2731/TAC100319_Stablecoins/download”rel=”nofollow”>https://www.cftc.gov/media/2731/TAC100319_Stablecoins/download

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