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What Are Altcoins and How Do They Work?

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What are altcoins?

An altcoin is a cryptocurrency that is not Bitcoin, alternative coins to Bitcoin. According to CoinGecko, there are over 14,000 altcoins in the market. Bitcoin alone accounts for about 40% of the total crypto market capitalization. The rest, 60%, is made up of different altcoins in the market. Altcoins share characteristics with Bitcoin.

However, they are different in many ways. Some are built on Bitcoin’s success, while other altcoins provide additional capabilities to overcome Bitcoin shortcomings. In addition, some altcoins are created with promising applications in the long run, while some have short-lived applications. As a result, their prices differ based on their performance in the market.

How are altcoins different from Bitcoin?

Altcoins and Bitcoin have a similar framework. They all use a blockchain to share code and functions which allow processing and recording a large amount of data and transactions when there is consensus that the transactions are legitimate. Since most altcoins are derived from Bitcoin, they tend to mimic its trajectory while trying to use the new premise to attain a new goal or solve a current problem.

Even so, Bitcoin implementation had its share of shortcomings which sets a benchmark for the creation of altcoins. Some of the shortcomings include high gas fees, energy-intensive, time-consuming and limited smart contract capabilities. Altcoins are created to improve on Bitcoin’s limitations as they try to gain a competitive edge over other coins and hopefully become the next Bitcoin.

For instance, Litecoin was mimicked Bitcoin’s blockchain source code. However, to distinguish itself from Bitcoin, Litecoin used a different consensus to increase the transaction speed and enhance storage efficiency. Litecoin is a peer-to-peer system like Bitcoin only that its developers focused on minimizing the time required to transact.

Ethereum, the second-largest cryptocurrency by market cap, saw an opportunity to make a coin that is more scalable and sustainable than Bitcoin. Other than just recording the transactions, Ethereum network records agreements as smart contracts. Smart contracts that are run on the Ethereum network execute transactions automatically once some preset conditions have been met. Ethereum smart contracts have become popular as they need intermediaries such as copyright management, banking and insurance. Smart contracts make executing online transactions more secure.

Other altcoins in the market have similarly distinguished themselves from Bitcoin by promising to be faster, decentralized, inexpensive, scalable and sustainable. As a result, the altcoins have created a market for themselves, and investors have taken an interest in them as alternative cryptocurrencies to Bitcoin.  As altcoins have varying functions and consensus, they are categorized as follows.

Types of altcoins

Native cryptocurrencies

A native cryptocurrency is a coin that is established to run on a particular blockchain network. An excellent example of a native coin is Bitcoin. Any token or coin that is used in Bitcoin’s network is a native cryptocurrency. Ether, on the other hand, is a native currency on the second-largest blockchain network, Ethereum. Therefore, if you run the application on the blockchain network, you are going to pay using Ether (ETH). It is worth noting that although Ether is the native currency for Ethereum, the blockchain also hosts other cryptocurrencies in form of tokens.

Binance coin is another native currency used on the Binance Chain. BNB (Binance coin) ranks in position four of the leading cryptocurrencies in the world. Currently, it is the largest cryptocurrency exchange on the crypto market. Binance investors derive significant benefits from the blockchain, like when the Binance blockchain reduced BNB trading fees by 25%. Further, the network allows investors to collect untradeable small amounts of cryptocurrencies and convert them to BNB.

Stablecoins

The Crypto market is debated to be the most volatile than other digital asset investments. Stable coins are established to reduce digital currency volatility by securing their value on another existing currency. The existing currency is a reserve to redeem investors in a case where the cryptocurrency does not perform as anticipated. Tether’s USDT is a notable stablecoin as it holds the highest market cap. It is tied to the US dollar and $1=1 USDT. Other stable coins include USD coin and MakerDAO’s DAI.

Stablecoins offer various options for coins that do not add or reduce in value often. However, investors will not earn profit as a result of price appreciation. Some users prefer holding funds that they are actively trading on a cryptocurrency exchange in stablecoins and then convert them to a different coin instead of holding them in U.S. dollars. Other investors hold funds in stablecoins to make international transactions effective.

Significantly, stablecoins are currently more popular in Decentralized Finance. DeFi platforms allow investors to trade stablecoins by lending them to other users. In return, investors earn profit without the need to involve a mediator. In addition, DeFi platforms encourage investors to trade by offering them tokens on top of the interest they earn through lending. Some crypto exchanges allow free conversion from U.S. dollars to stablecoins besides simplifying the process and offering tokens.

Tokens 

A token is a denomination of a cryptocurrency operation on a specific blockchain network. It is the tradable asset that an investor uses for economic activities and investment purposes within the blockchain’s environment. For instance, Chainlink, which is built on the Ethereum network, enables developers to convert real-world data into the network’s format to make it easier for smart contracts to read. Chainlink’s unit of value is LINK, so if you use Chainlink services, you will pay with LINK as tokens. Investors who see potential in Chainlink are going to put their funds in LINK. They believe that as the demand for Chainlink increases, the demand for LINK will garner more traction and its value will appreciate.

Uniswap is another decentralized application built on top of the Ethereum network. It allows users to carry out peer-to-peer transactions resulting from trading activities from one investor’s wallet to the other. The denomination of Uniswap exchange is called UNI and is popularly referred to as a ‘governance’ token. What is more, on the Uniswap exchange is that users can vote on proposals that dictate how the system operates.

Forks

To understand a fork in a blockchain, let’s look at this concept. Any blockchain organizes groups of recorded transactions into a block. Every block is related to the next group of recorded transactions through complex encrypted cryptography. Before the new block is attached to the existing chain, previous groups of transactions in all previous groups must all be verified. In addition, there must be a consensus that all parties agree on the particular chain.

The consensus between different parties is necessary because they have to use standard rules that govern the network and maintain the history of the transaction on the blockchain as well. When the trading parties are not in agreement, for instance, they want to change the rules, a new chain emerges. The new chain is a fork. A fork can be short-lived or long term. Once it emerges, folk start recording transactions based on the new agreement between the users.

Forks can happen on a blockchain unlimited times. Once they happen, they add new features to a network and can also create a new cryptocurrency. Bitcoin Cash and Ehereum Classic are two examples of Forks that happened on Bitcoin and Ehereum blockchains, respectively.  Dogecoin is also a fork that happened on Luckycoin, which interestingly was a fork of Litecoin.

What to consider before investing in altcoins

Altcoins listings have rapidly increased over the years, and it has attracted a massive number of investors who bet their price trajectories will accumulate high returns. However, digital currencies prices are speculative for the most part. Therefore, you should consider the following before investing in any altcoin.

Consider;

  • What is the altcoin’s competitive edge over other listings in the market? Altcoins that successfully solve high gas fees and transaction speed problems perform better in both the short and long term. Some of the coins create new problems for users while trying to solve existing Bitcoin issues.
  • How the stablecoin is beneficial to you. Do you want to buy or sell globally without struggling to make transactions?

The Bottom line 

Altcoins are suitable alternative investments to Bitcoin. Some like Ether are popular and promising to give good returns in future. However, thousands of altcoins are yet to make their mark in the market. That fork altcoin might be short-lived and the token may fail to have a real-world application. That is why researching before investing is vital to avoid losing your funds on a losing coin.

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