What are altcoins?

The term altcoin is short for ‘alternative coin’, in the context of any cryptocurrency other than bitcoin. The emergence of altcoins can be traced to communities seeking to address perceived limitations of bitcoin, and its underlying protocol. As a result, altcoins are a type of digital asset that operate in a similar way to bitcoin, in terms of their principles, but are built on a separate blockchain. 

There’s a few key ways in which altcoins differentiate themselves from bitcoin. The first, and most obvious, is in terms of age. When we consider that bitcoin was released in 2009, we know it's the ‘oldest’ cryptocurrency on the market, whereas altcoins made their first appearance from 2011 onwards. 

From a technical perspective, altcoins can be deemed as more developed considering they’re built on more advanced technology than bitcoin. For example, many altcoins offer faster transaction speeds, enhanced privacy features, alternative consensus mechanisms and lower costs of transactions, which can provide the altcoins with a competitive advantage over bitcoin.
Similarly, if we consider the use cases and purpose of the cryptocurrencies, altcoins can be thought of as serving a wider variety and more specific use cases. For example, some altcoins are designed for decentralized finance (DeFi), others for smart contracts, gaming, AI or even supply chain management.

These use cases are typically developed by communities, and when it comes to altcoins community and governance is key. Each altcoin typically has its own unique community and associated governance structure, which steers the direction in which the altcoin progresses in terms of future development. Considering Bitcoin’s more conservative approach when it comes to change and experimentation, it can mean altcoins adapt and evolve at a faster rate.

When we weigh up risk, reward and volatility, although bitcoin can be considered as volatile, it is a well established market leader in the crypto space when we focus on factors such as market capitalization and mainstream adoption. Though altcoins have plenty of room for growth, this also comes with risks.

There are a lot of different types of altcoins, each of which have their own unique purpose, features and functionality. Some common types include;

• Platform Coins: These altcoins act as the native currency of a specific blockchain platform. Typically, they are used to power decentralized applications (DApps) and execute smart contracts. For example, Ethereum (ETH) and Binance Coin (BNB).
• Privacy Coins: Privacy-focused altcoins aim to enhance anonymity and confidentiality in transactions. Often, they are incorporated into advanced cryptographic techniques to obfuscate transaction details. For example, Monero (XMR) and Zcash (ZEC).
• Stablecoins: These altcoins are designed to maintain a stable value by pegging their price to a fiat currency (like the US dollar) or a commodity (like gold). Stablecoins provide a hedge against the volatility of other cryptocurrencies. For example, Tether (USDT) and USD Coin (USDC).
• Utility Tokens: These altcoins provide access to specific products or services within a blockchain ecosystem. They are used for functionalities such as voting rights, access to DApps, or obtaining discounts on platform fees. For example, Chainlink (LINK) and Basic Attention Token (BAT).
• Asset-backed Tokens: These altcoins are backed by real-world assets such as gold, real estate, or commodities. Each token represents ownership or a share in the underlying asset, providing a digital representation of traditional assets on the blockchain. For example, Paxos Standard (PAX) and Tether Gold (XAUT).
• Gaming Tokens: Altcoins designed specifically for the gaming industry, used for in-game purchases, rewards, or trading virtual assets. For example, Enjin Coin (ENJ) and Chiliz (CHZ).
• Governance Tokens: These altcoins grant holders the right to participate in the governance and decision-making processes of a blockchain network. Holders can propose and vote on protocol changes, upgrades, or funding allocations. For example, Maker (MKR) and Compound (COMP).

Though altcoins can be considered as offering diversification, and potentially a more innovative approach than bitcoin, there’s a range of considerations that should be accounted for when understanding the associated risks and rewards of an altcoin project.

Advantages:

From a diversification perspective, altcoins can be seen to offer investors the opportunity to diversify their cryptocurrency portfolios beyond bitcoin. In this sense, they could be able to spread risk across multiple assets and benefit from different market trends.

In terms of innovation, altcoins drive innovation within the cryptocurrency space by introducing new technologies, features, and use cases. They serve as platforms for experimentation and exploration of new ideas, which can lead to advancements in blockchain technology. In a similar sense, the specific use cases the altcoins are designed for can cater to a specific niche, such as DeFi, gaming or supply chain management. This specialization can provide more bespoke solutions to unique challenges.

Finally, when it comes to return on investment some altcoins have the potential to deliver higher returns on investment compared to bitcoin. When we consider that there can be periods of rapid growth or market cycles where specific altcoins can be seen to outperform the broader market.

Disadvantages:

With risk comes reward, typically altcoins exhibit higher levels of risk and volatility when compared to bitcoin. This can be attributed to factors such as lower liquidity, smaller market capitalization, and greater susceptibility to market sentiment and speculation. 

Similarly, altcoins can sometimes struggle to achieve widespread adoption and network effects compared to bitcoin as a result of limited usage, infrastructure, and community support. Thus,  potentially hindering the long-term viability and value proposition of certain altcoins.

Alongside the rise of altcoins comes concerns for security and the increased number of scams. Some altcoin projects may lack proper security measures, undergo hacks or exploits, or turn out to be fraudulent schemes, posing risks to investors and users.

Finally, when we consider the volume of altcoins that are now available in the market, this can lead to fragmentation and interoperability challenges. Meaning, it increases the difficulty in which users can transfer value or interact seamlessly across different blockchain networks. This fragmentation can hinder adoption and usability for mainstream users.