What Are Altcoins And How Do They Function?
Any cryptocurrency which is not Bitcoin is referred to as an altcoins.
The most famous cryptocurrency out there is, of course, Bitcoin. This was the first successful cryptocurrency to launch, and still accounts for around 60% of the money invested in cryptocurrencies.
The remaining 40%? Well, this is invested in other cryptocurrencies. Together, these are referred to as “altcoins”.
Today, there are thousands of cryptocurrencies out there, and hence thousands of altcoins.
In this article, we’ll take a look at the wonderful and sometimes weird world of altcoins. We’ll explore different types of altcoin, and consider whether you should invest in them.
Altcoins: An Introduction
As we’ve said above, the basic definition of altcoins is easy enough to grasp – the term refers to any cryptocurrency which is not Bitcoin.
However, altcoins come in so many shapes, sizes, and types that referring to them with just one word can be a little confusing.
So let’s start with the basics. A simple example of an altcoin is Litecoin. Litecoin is based on the same code that runs Bitcoin, but was designed to make transactions faster.
The purpose of Litecoin is the same as Bitcoin, albeit with very slight differences.
Ethereum is a slightly more complex example. Ethereum is also based on the same kind of blockchain as Bitcoin, but it uses this to record more than just a “ledger” of who owns which coins.
Ethereum also uses the blockchain to record what are referred to as “smart contracts.”
Ethereum advocates say these smart contracts — computer programs that automatically execute an agreement if certain conditions are met — could upend industries that currently rely on costly middlemen, like insurance, banking and copyright management.
Both of these examples are fairly well established altcoins with well-understood objectives.
But in the past five years we’ve seen the emergence of many thousands of new altcoins, each claiming to solve a problem or provide a new application for blockchain technology.
Types of Altcoin
Altcoins now come in many shapes and sizes, but they can be roughly broken down into four types.
Native Cryptocurrencies
Native cryptocurrencies are the coins that were created to be run on a specific blockchain network. The native coin of Bitcoin, somewhat confusingly, is also called Bitcoin.
The native coin of Ethereum is called Ether, and Binance coin (BNB) is the native coin of the Binance chain.
These coins are best understood as variants on Bitcoin. They operate as cryptocurrencies, albeit with slight differences from Bitcoin, and can trade at different prices than their better-known competitor.
Tokens Altcoin
Tokens operate like mainstream cryptocurrencies, but you can only use them within specific environments.
Think of a token altcoin as like the physical tokens you sometimes get when you go to the arcade or the fair. You swap some real currency into tokens, and these can then be used to buy specific goods and services.
Tokens can be an investment as well, but you should be careful when buying them, because most have fairly speculative value propositions.
Chain Link is a good example of this. Chain Link uses the Ethereum blockchain, and developers can use it to convert real-world data into a blockchain-friendly format that can be read by smart contracts and vice versa. LINK is the token that’s used to pay for Chainlink’s services.
So, if an investor believes demand for smart contract-based services is going to rise, they might buy LINK; the more Chainlink technology is used, the thinking goes, the higher the demand for LINK, which could send its value higher. But at the moment, this is just a supposition.
Stablecoins
Stablecoins were designed to overcome the price volatility that is inherent to most other altcoins, and even to bitcoin itself.
Stablecoins are tied to an existing currency – and generally one overseen by a state – in order to make them as stable as possible.
For instance, Tether is a stablecoin that is tied to the value of the US dollar.
It might seem strange to hold cryptocurrencies that are tied to existing markets, because you will not make any money from the coin increasing in value.
But stablecoins do have a useful function. They allow you to hold money in crypto exchanges in a way that is more stable than keeping this money in other altcoins.
Then, when you spot an opportunity, it’s easy to convert your stablecoins into other cryptocurrencies.
Forks
In a blockchain, groups of recorded transactions (the public ledger) are organized into blocks, and each block is connected to the next via complex cryptography.
For a new block to be appended to the existing chain, all the previous transactions in all the previous blocks must also be verified, and there must be a consensus that all is right with the chain.
This consensus is required for the list of transactions as well as the rules that govern the blockchain network. And when a group decides it wants to change the rules, it can validate a split in the chain; this is a fork.
A new chain emerges, ready to start logging transactions under the new rules agreed upon by those who chose to validate the fork. Meanwhile, the other prong of the fork keeps going on as normal.
Forks can happen over and over again, creating new protocols and cryptocurrencies all the while. Bitcoin cash is a fork of the original Bitcoin blockchain, while Ethereum Classic is a fork of the Ethereum system.
Dogecoin is a fork of Luckycoin, which was a fork of Litecoin, which was a fork of Bitcoin.
So, as an investor, if you like the ideas, rules and changes found in a fork of an existing blockchain, you could buy that fork’s currency in the hope that it rises in value.
The Bottom Line
Altcoins are still a fairly new market, and are a very volatile one. For this reason, investors should be very careful with them. If an altcoin appears to solve a problem with Bitcoin, or if a token has a real-world use case, they can be a profitable investment.
But if you think that an altcoin’s value is based mainly on publicity and hype, you should stay well clear.
