What are altcoins and how do they work?
The alternatives to Bitcoin explained
But there's more to cryptocurrency than just Bitcoin. Altcoins — a portmanteau of "alternative" and "coins" — are any cryptocurrency that isn't Bitcoin. Each of these alternative cryptocurrencies operates under its own rules but also shares some characteristics with Bitcoin.
What is an altcoin?
In essence, altcoins are alternative cryptocurrencies to Bitcoin, a decentralized digital currency that could eventually replace fiat money, such as the dollar.
Cryptocurrencies are decentralized, meaning central banks do not issue them, and their value doesn't hang on bank policies. Namecoin is widely considered to be the very first altcoin. Since then, the rate of altcoin launches started to grow at a phenomenal rate.
Like Bitcoin, they use blockchain as a means of securing peer-to-peer transactions. How these altcoins use blockchain can differ greatly from Bitcoins, as different consensus mechanisms are used to validate transactions or create blocks.
Not only that, but altcoins also take the Bitcoin concept further with unique features, such as "smart contracts" that can automatically perform agreements between two parties using blockchain technology.
In addition, altcoins have improved on Bitcoin in many other ways. Processing transactions can be faster or can scale better. Bitcoins are mined every 10 minutes, whereas an altcoin, such as Litecoin, produces coins every 2.5 minutes, speeding up transactions on this coin over Bitcoin.
How does an altcoin work?
Altcoin works similarly to Bitcoin. A private key is used to send payment from one digital wallet to another, and a blockchain acts as a recording ledger to permanently record the transaction so it can't be altered. The blockchain is secured by mathematics proofs, which ratify transactions in blocks.
What are the different types of altcoins?
Some of the main types of altcoins include mining-based cryptocurrencies, stablecoins, security tokens, and utility tokens. There are around 9,000 cryptocurrencies, and altcoins make up over 40% of the market as of April 2021. Some of the most familiar altcoins are Ethereum, Ripple, Tether, Bitcoin Cash, Bitcoin SV, and Litecoin.
Certain altcoins do more than just allow the exchange of money for goods and services. These are usually called utility tokens or security tokens for example. Some altcoins offer better anonymity, while others target specific industries.
Stablecoins are cryptocurrencies pegged to either another cryptocurrency, fiat money (i.e., Dollars), or an exchange-traded commodity (i.e., precious metals), which minimizes price volatility compared to a particular "stable" asset or array of assets.
Stablecoins aren't subject to turbulent, daily price fluctuations, meaning they're useful in practical everyday cases, such as payments, investments, and loans.
These altcoins are mined into existence using proof-of-work (PoW), which creates new coins by solving difficult problems, to create blocks. There are several PoW coins, such as Litecoin, Monero, Bitcoin Cash, and Bitcoin SV.
Alternative to mining-based coins are pre-mined coins. These are distributed rather than created through an algorithm. Ripple is an example of this.
This type of coin is used within a platform to receive a service. A common type of utility token is the ERC20 Ethereum standard. These tokens are created to be spent within a certain blockchain ecosystem. An example of this is Sia, a decentralized peer-to-peer cloud storage solution.
Security tokens operate as investment contracts. The token's purchaser expects future profits from dividends, revenue share, or market appreciation. These differ from utility tokens in that security tokens follow stringent rules on who can buy and transfer them.
A non-fungible token (NFT) is a cryptographic asset on a blockchain with unique identification codes and metadata that differentiate them from each other and are stored in smart contracts.
Users can't duplicate or divide NFTs. Some of the use cases for these tokens include collectibles, music, artwork, and video game tokens.
In contrast, fungible tokens, such as Bitcoin, are identical; they have the same characteristics and value when traded.
How does altcoin compare to Bitcoin?
Bitcoin is widely regarded as the original cryptocurrency. It was created in 2009 by Satoshi Nakamoto, introducing the world to blockchain technology and the principle of proof of work.
Most altcoins are a variation (fork) of Bitcoin and are created using Bitcoin's open-sourced, original protocol and then changed to create a new cryptocurrency with new features, although tokens come in all shapes and sizes today.
Every altcoin has a unique way of being created, the number of coins available, and how difficult it is to create them. While Bitcoin now takes hefty computing power to mine — it's said Bitcoin consumes 'more electricity than Argentina' — many altcoins still only need the power of a desktop computer and some specialized software to mine a coin.
The advantages and disadvantages of altcoins
One of the main advantages of altcoin is it's an alternative to Bitcoin. Should Bitcoin's value plummet, altcoins are generally good as a fallback option, although you might find that larger shifts that affect Bitcoin also hit everything else on the market. In a sense, they provide competition to Bitcoin.
Altcoins generally offer improvements to Bitcoin's problems, such as the speed and cost of mining. There are also lower transaction costs with altcoins.
However, one major disadvantage of each altcoin is its lack of public acceptance and exposure relative to Bitcoin. As altcoins are newer than Bitcoin, their value can change dramatically, so they're not for the faint-hearted or the risk-averse investor.
Another major issue with altcoins is that they're often used in scams to fleece unsuspecting victims, such as pump and dump schemes.
Lastly, many altcoin trading sites don't provide customers with the means to convert to Bitcoin before converting it yet again to USD.
Aren't altcoins a risky investment?
We can't give investment advice on altcoins. Different cryptocurrencies fall in and out of fashion and you can easily lose some or all of your money invested in shady altcoin schemes, as these are mostly unregulated. A lot of sleazy marketing exaggerates the benefits and investment potential of almost every altcoin project.
What we can say is that you should always seek independent financial advice before parting with any money to buy altcoins.
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