What are altcoins in cryptocurrency and how do they work?

Bitcoin is not the only cryptocurrency in the market. In fact, there are thousands of so-called “altcoins” that traders could trade or invest in.

Read on to learn everything traders need to know to get started with altcoins, or jump ahead to a specific section below:

• What are altcoins?
• How do altcoins work?
• What is the difference between Bitcoin and altcoins?
• Types of altcoins
• Pros and cons of altcoins
• Should traders invest in altcoins?
• How to trade altcoins
• What are the top 10 altcoins?
• How many altcoins exist?
• Future outlook for altcoins

What are altcoins?

Altcoins, which is short for alternatives to bitcoin, are cryptocurrencies that were created after bitcoin. They serve as an alternative to bitcoin for performing peer-to-peer transactions in a trustless manner, among other use cases.

Since 2011, thousands of altcoins have hit the market, although the list of the top altcoins by market capitalisation keeps changing as new entrants try to dethrone bitcoin as the largest cryptocurrency in the world.

Litecoin (LTC), which launched as a lighter, faster version of bitcoin a decade ago, was the most established altcoin in the early years of the crypto market and is still a popular coin.

Today, however, altcoins from smart contract-enabled blockchains, such as Ethereum, Cardano, Binance Smart Chain, Solana, and Tron dominate the altcoin market as the demand for decentralised applications has skyrocketed in the last few years.

How do altcoins work?

Altcoins differ in their functionality and use case from coin to coin but just like bitcoin, they make use of blockchain technology to provide a secure infrastructure to make peer-to-peer transactions. 

Through the use of cryptographic techniques, traders can conduct digital transactions without a central authority. Transactions are bundled into blocks and are linked together forming sequential links of unalterable chains.

Altcoins also make use of consensus mechanisms in securing and taking decisions concerning the state of their respective blockchains. And since blockchains run on peer-to-peer networks, breaking the system with attacks is very difficult.

What is the difference between Bitcoin and altcoins?

Bitcoin was the first cryptocurrency, launched in 2009 to enable anyone with an internet connection to store, send, and receive money in digital form.

As the pacesetter for cryptocurrencies, Bitcoin holds over 50% of the total market capitalisation of the crypto markets (often referred to as Bitcoin Dominance). Altcoins, on the other hand, leveraged the success and technology of Bitcoin to widen the crypto market.

Oftentimes, altcoins are focused on improving Bitcoin's method of processing transactions. Bitcoin uses a 'Proof-Of-Work' consensus method for confirming transactions, which is currently being criticised for its environmental implications. Adding to that is the scalability issues of the Bitcoin network, causing high on-chain transaction fees and slow transaction time during times of high network usage. 

Many altcoins address these issues by offering faster transaction speeds than Bitcoin with less energy-intensive consensus mechanisms. Altcoins are used to fuel blockchain networks that are focused on building an ecosystem of decentralised, autonomous applications.

The Ethereum blockchain, for example, has emerged as the home of decentralised finance (DeFi), non-fungible tokens (NFTs), and blockchain gaming.

Types of altcoins

Not every altcoin exists for the sole purpose of serving as a secure means to make digital payments. Some altcoins are created for governing a crypto protocol, tackling volatility, accessing services within a blockchain protocol, and the list goes on.

In essence, altcoins are classified based on what they do. Listed below are the main types of altcoins.

Utility tokens

A utility token is used for accessing the services of a blockchain platform. 

Most of the decentralised services that run on Ethereum, for example, require users to use the platform’s own ERC-20 token to access their services. Hence, the term utility token.

Utility tokens are typically not geared towards investors but are mainly for users interested in receiving a service.

One of the most popular use cases of utility tokens is for decentralised gaming platforms. Players of Axie Infinity, for example, use the game’s AXS token to purchase in-game items.

Stablecoins

Stablecoins are cryptocurrencies whose values are pegged to fiat currencies like the US dollar or commodities like gold. They are backed by reserves but can also be maintained by algorithms to ensure their price is almost the same as the asset they are pegged to.

Stablecoins have enabled people to avert the risk of crypto price volatility when transacting with cryptocurrencies. Stablecoins can also be used in crypto lending platforms to provide liquidity and earn interest.

The total market capitalisation for stablecoins is over $125 billion and some of the popular ones include Tether (USDT), USD Coin (USDC), and Binance USD (BUSD).

Governance tokens

These are cryptocurrencies that are used to exercise voting rights on a blockchain protocol. People who hold the governance token of a blockchain project can propose and vote for changes, ensuring a project maintains decentralisation as the decision-making is spread across several individuals.

Most DeFi platforms rely on governance tokens to ensure there are constant innovations in their protocols agreed upon in a decentralised manner. Sometimes, a protocol might be hacked or plagued by bugs. Governance tokens allow users to vote on how to best handle such situations. 

Beyond voting, governance tokens can be traded, staked, and used for yield farming. A few of the top governance tokens are Maker (MKR), Compound (COMP), Curve token (CRV), and Aave (AAVE).

Mining-based

Mining coins use a Proof-of-Work (PoW) consensus protocol for confirming transactions in their blockchains. To enable them to function effectively, mining is carried out where miners solve difficult mathematical problems with computing power.

People are incentivised to do this as they are rewarded with new units of the cryptocurrencies as well as transaction fees. Some cryptocurrencies require intense computing power for mining while others can be mined with just a CPU. A few mining-based altcoins are Dogecoin (DOGE), Ethereum Classic (ETC), and Zcash (ZEC).

Staking-based

Staking-based altcoins use a Proof-of-Stake (PoS) consensus mechanism to keep their blockchain protocol secure. This method is more energy-efficient than the Proof-of-Work algorithm employed by Bitcoin.

Instead of solving cryptographic puzzles with computing power, network participants are required to lock their coins in a wallet with the hope of gaining rewards, if chosen to validate transactions. The higher the number of coins staked, the higher the chance of being selected.

Most people who hold staking coins are passively earning staking rewards daily from staking. Examples of staking coins include Algorand (ALGO), Cardano (ADA), Tezos (XTZ), and Tron (TRX).

• Read more: What is staking in crypto?

What are the pros and cons of altcoins?

Pros

Altcoins bring many benefits to the crypto market, especially since Bitcoin has several shortcomings. Below are some of their benefits:

• Altcoins - as the same suggests - serve as an alternative to bitcoin. Many altcoins address the flaws of Bitcoin, which might discourage people from getting involved with cryptocurrencies.
• Altcoins with high transaction speeds, low fees, and low volatility have helped cryptocurrency to gain more acceptance as a means of payment.
• Altcoins are unlocking a new world on the internet with several innovations to finance, gaming, and content creation.
• Altcoins tend to have more room for price appreciation than bitcoin since a lot of them are relatively new and trader have the chance to get in early.

Cons

Although altcoins are helping the crypto markets to grow, they also come with risks and uncertainties:

• Apart from stablecoins, altcoins are, in general, very volatile and are considered largely to be a risky investment.
• Most altcoins have thin liquidity, which can result in price manipulation by a few market participants.
• Altcoins can sometimes be used in pump and dump schemes.
• Some altcoins are just copied versions with a few tweaks, making them essentially cheap copies of the original.

Should traders invest in altcoins?

The altcoin market is quite risky, very volatile, and full of pitfalls. Therefore, tread carefully when entering the brave new world of crypto.

However, high risk can result in not only high rewards but also high losses. It’s not uncommon for altcoins to make 1,000% gains in a matter of weeks, as investor attention is attracted to a new crypto venture. But the opposite can also happen, with a coin that goes up quickly also dropping in price quickly and significant losses can happen.

That’s why it's necessary to research (DYOR) to properly understand an altcoin, its use case, the technology behind it, and its popularity, before investing in it.

Traders can invest in altcoins if they want to take risks, but its important to spend time researching exactly what traders are investing in. Choosing to invest in cryptocurrencies that are among the top ten altcoins by market capitalisation may pose less risk than buying small-cap coins, and may be a good place to start looking for altcoin investments.

How to trade altcoins

There are two ways to trade altcoins and make money from them: trading altcoins outright on crypto exchanges or trading cryptocurrency CFDs.

Trading altcoins outright:

Most crypto traders use digital asset exchanges to buy and sell altcoins and then store their holdings in a cryptocurrency wallet. 

To purchase an altcoin, traders need to have a cryptocurrency wallet and an account with a crypto exchange. Some exchanges require identity and two-step verification before trading can start. On these exchanges, traders can buy altcoins with a credit/debit card or by funding an account with a bank transfer.

There are also decentralised exchanges that leverage smart contracts to enable anyone with an internet connection and a crypto wallet to exchange tokens in a decentralised manner.

Trading cryptocurrency CFDs:

CFDs, which is short for contracts for difference, are financial products that allow traders to trade on the price of the instrument, such as cryptocurrencies, without actually owning the underlying asset.

As a result, crypto CFDs trading has become highly popular among traders who prefer to speculate on crypto prices without having to deal with the technicalities of buying and securely storing dozens of altcoins. 

What’s more, with CFDs, traders can also short an altcoin and benefit from falling prices in a cryptocurrency. 

Additionally, traders and investors with little capital can benefit from CFDs since they provide leverage, allowing users to increase their exposure to an asset without having to put down a large sum of money.

What are the top 10 altcoins?

According to Coinmarketcap, as of June 22nd 2022, the top ten altcoins are: 

• Ethereum (ETH)
• Tether (USDT)
• USD Coin (USDC)
• Binance Coin (BNB)
• Binance USD (BUSD)
• Cardano (ADA)
• Ripple (XRP)
• Solana (SOL)
• Terra (LUNA)
• Dogecoin (DOGE)

Check out the best performing cryptocurrencies and stay up to date with moving trends in the crypto space.

How many altcoins exist?

More altcoins are making their way into the crypto market every day. Currently, there are over 9,000 altcoins in the market.

While some offer excellent use cases, most will likely trend towards zero in the long term.

What’s the future outlook for altcoins?

Altcoins are still a new asset class and less established than bitcoin. Most professional and institutional investors are currently still more interested in bitcoin because of its track record and strong brand recognition.

However, the allure of potentially making tenfold gains in a matter of weeks or even days will continue to drive speculators to the altcoin market, likely pushing up prices of the most popular assets in this crypto market segment.

While traders need to be extra cautious when investing in altcoins due to their riskiness, they provide smart traders with the opportunity to profit from the high volatility of a new digital asset class, but please remember to DYOR as there is the possibility for losses to exceed deposits.

Explore the altcoins available for trade with Axi, including: Ethereum, Bitcoin Cash, Litecoin, Cardano, Dogecoin, EOS, Chainlink, Stellar Lumens, Polkadot and Ripple. Sign up and start trading cryptocurrency CFDs today.