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Altcoins

Altcoins: Definition, How They Work, and Examples

Learn what altcoins are, how they work, famous examples, and what the future might hold.

Satoshi Nakamoto’s Bitcoin may be the most popular cryptocurrency in the world, but altcoins have been steadily gaining popularity. These coins offer various features, from privacy and security to clever blockchain innovations. But, with more than 22,000 altcoins in the market, it’s easy to feel confused and overwhelmed by opportunities.

Let’s look at what altcoins are, how they work, famous examples, and what the future might hold.

What is an Altcoin?

The term “altcoin” – a combination of the words “alternative” and “coin” – describes any cryptocurrency other than Bitcoin.

The cryptocurrency ecosystem has grown to include more than 22,000 coins worth a total of more than $1 trillion since Bitcoin’s launch in 2008. That said, Bitcoin accounts for roughly half of the crypto market, with a market capitalization of about $500 billion. And Ethereum is the only other cryptocurrency worth more than $100 billion.

Altcoins
Bitcoin remains the most popular coin by a wide margin. Source: ExplodingTopics

While crypto enthusiasts and businesses launch new altcoins daily, most fail to gain traction. As a result, you should exercise caution when trading or investing in new altcoins because they may lose value. Before investing in any altcoins, you should take the time to understand the project, how the coin works, and any potential risks.

How Altcoins Work

Bitcoin operates on a peer-to-peer network that records transactions on a public ledger known as the blockchain. Cryptography helps ensure the blockchain’s integrity by forcing users to solve complex mathematical problems to add new entries. In exchange for solving these problems, Bitcoin miners receive bitcoin as a reward.

Some altcoins take a very similar approach, but there’s been a lot of innovation over the past decade and a half. For example, Ethereum 2.0 abandoned proof-of-work entirely in favor of proof-of-stake algorithms. Using this approach, Ethereum anticipates achieving greater transaction throughout with less energy usage than Bitcoin’s algorithms.

Ultimately, altcoins employ different techniques under the hood. Altcoin founders typically outline these techniques in a “whitepaper” they publish before their launch. It’s always a good idea to read these whitepapers to understand how a project works before investing in it. However, no regulatory authority reviews these whitepapers for accuracy.

Types of Altcoins

Altcoins fall into several categories depending on their use case. While there are hundreds of possible categorizations, most altcoins fall into a handful of buckets, making it easy to wrap your head around them.

Stablecoins

Stablecoins aim to maintain a stable value tied to a fiat currency – like the U.S. dollar – or a basket of assets. For example, a stablecoin protocol may deposit one U.S. dollar for each unit of cryptocurrency it mints. Then, if the value of the stablecoin drops, it can sell some of the U.S. dollars to buy back the stablecoins and maintain a peg to the U.S. dollar.

There are three types of stablecoins:

  1. Asset-backed Stablecoins – Asset-backed stablecoins hold a reserve of fiat currencies or related assets (e.g., commercial paper) and increase or decrease the supply of stablecoins based on the amount of currency reserves. E.g., Tether or USD Coin.
  2. Crypto-backed Stablecoins – Crypto-backed stablecoins hold a reserve of cryptocurrencies like Bitcoin or Ethereum. Then, they adjust the supply of stablecoins based on the value of the underlying crypto assets. E.g., BitShares or Dai.
  3. Algorithmic Stablecoins – Algorithmic stablecoins use an algorithm to regulate the supply of stablecoins and maintain a stable value. But, as Luna/TerraUSD demonstrated, there are challenges maintaining a peg. E.g., Empty Set Dollar or Frax.

Examples: Tether, USD Coin, Binance USD

Privacy Coins

Privacy coins prioritize transaction privacy and anonymity by obscuring the identity of users and transaction details. For example, a privacy coin may mask a sender’s identity by allowing a group of users to sign a message, making it impossible to separate individual transactions. However, some privacy coins have come under regulatory scrutiny.

Examples: Monero, zCash, Dash

Utility Tokens

Utility tokens provide a means of exchange within a specific decentralized application or service. For instance, a crypto exchange may have a utility token to pay transaction fees, or a decentralized hosting service may have a utility token to access computational power. Importantly, the intention isn’t for them to be investments like other cryptocurrencies.

Examples: Binance Coin, Chainlink, Uniswap

DeFi Coins

Decentralized finance coins facilitate activities on DeFi platforms. For instance, a DeFi coin may “wrap” another cryptocurrency to facilitate cross-chain transfers. Doing this might enable a user to take advantage of Ethereum’s smart contract capabilities while still holding Bitcoin as an underlying asset from an investment standpoint.

Examples: Aave, Maker, Compound

Governance Tokens

Governance tokens enable holders to vote on changes to a blockchain network, such as protocol upgrades or new features. For example, a decentralized finance platform may use governance tokens to set interest rates or add new features since there’s no centralized group responsible for the platform’s development and operations.

Examples: Maker, Compound, Aragon

Meme Coins

Meme coins are cryptocurrencies designed and launched for humor or social experiment purposes. While they have no practical purpose, speculation can drive their values to outrageous levels. For example, Dogecoin was originally a meme with a market capitalization of more than $12 billion.

Examples: Dogecoin, Shiba Inu, Safemoon

What’s Next for Altcoins?

Altcoins continue to innovate on Bitcoin’s original premise and unlock new capabilities and opportunities. In particular, decentralized finance platforms continue to disrupt traditional financial services, from lending and borrowing to trading on exchanges. And investors have a chance to earn competitive interest rates via staking or lending.

Despite the frigid Crypto Winter, venture capitalists have continued to pour money into the space. For example, Earn Alliance raised $4.75 million, Ramp Network raised $70 million, and Matrixport (a crypto derivatives exchange) hopes to raise $100 million at a $1.5 billion valuation – all signs the market remains alive and well.

With new altcoins coming out daily, you have numerous opportunities to build a diverse portfolio of investments or participate in the next big platform. First, it’s essential to conduct due diligence and take the time to understand the project, how it works, the economics underpinning the altcoins, and who’s backing it before investing.

The Bottom Line

The term “altcoin” refers to any cryptocurrency other than Bitcoin. While that may seem like a broad definition, there are several categories of altcoins to help wrap your head around them. In aggregate, these altcoins are worth more than $300 billion and range from meme coins to tokens powering decentralized finance platforms.

ZenLedger can help you stay organized for tax time if you buy, sell, or trade altcoins. Our platform automatically aggregates transactions across wallets and exchanges, computes your capital gain or loss, and populates the tax forms you need to file. In addition, you can identify opportunities to save through tax loss harvesting and other techniques.

Get started for free today!

The above is for general info purposes only and should not be interpreted as professional advice. Please seek independent legal, financial, tax or other advice specific to your particular situation

Justin Kuepper

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