Altcoin Explained: Pros and Cons, Types, and Future

What Is an Altcoin?

Altcoins are generally defined as all cryptocurrencies other than Bitcoin (BTC). However, some people consider altcoins to be all cryptocurrencies other than Bitcoin and Ethereum (ETH) because most cryptocurrencies are forked from one of the two. Some altcoins use different consensus mechanisms to validate transactions, open new blocks, or attempt to distinguish themselves from Bitcoin and Ethereum by providing new or additional capabilities or purposes.

Most altcoins are designed and released by developers with different visions or uses for their tokens or cryptocurrency. Learn more about altcoins and what makes them different from Bitcoin.

Understanding Altcoins

"Altcoin" is a combination of the two words "alternative" and "coin." The term generally includes all cryptocurrencies and tokens that are not Bitcoin. Altcoins belong to the blockchains for which they were explicitly designed. Many are forks—creating a blockchain from another chain—from Bitcoin and Ethereum. These forks generally have more than one reason for occurring. Most of the time, a group of developers disagree with others and leave to make their own coin.

Many altcoins are used within their respective blockchains to accomplish something, such as ether, which is used in Ethereum to pay transaction fees. Some developers have created forks of Bitcoin and re-emerged as an attempt to compete with it as a payment method, like the fork that created Bitcoin Cash.

Others fork or are developed from scratch, attempting to create a blockchain and token that appeals to a specific industry or group, such as Ripple's attempt to use the XRP Ledger and XRP to attract the banking industry with a faster payment system.

Altcoins attempt to improve upon the perceived limitations of whichever cryptocurrency and blockchain they are forked from or competing with. The first altcoin was Litecoin, forked from the Bitcoin blockchain in 2011. Litecoin uses a different proof-of-work (PoW) consensus mechanism than Bitcoin, called Scrypt (pronounced ess-crypt), which is less energy-intensive and quicker than Bitcoin's SHA-256 PoW consensus mechanism.

Ether is another altcoin. However, it did not fork from Bitcoin. It was designed by Vitalik Buterin, Dr. Gavin Wood, and a few others to be used in Ethereum, the world's largest blockchain-based virtual machine. Ether (ETH) is used to pay network participants for the transaction validation work their machines do. It is also used as collateral (called staking) for the privilege of becoming a validator and block proposer.

Types of Altcoins

Altcoins come in various flavors and categories. Here’s a brief summary of some of the types of altcoins and what they are intended to be used for.

Payment Token

As the name implies, payment tokens are designed to be used as currency—to exchange value between parties. Bitcoin is the prime example of a payment token.

Stablecoins

Cryptocurrency trading and use have been marked by volatility since its launch. Stablecoins aim to reduce this overall volatility by pegging value to another asset. This is accomplished by holding assets in reserve. Some of the assets held by stablecoin creators are fiat currencies, precious metals, or investment assets. Price fluctuations for stablecoins are not meant to exceed a very narrow range.

Notable stablecoins include Tether's USDT, MakerDAO's DAI, and the USD Coin (USDC). In March 2021, payment processing giant Visa Inc. (V) announced that it would begin settling some transactions on its network in USDC over the Ethereum blockchain, with plans to roll out further settlement solutions.

Security Tokens

Security tokens are tokens that represent fundraising efforts or ownership. They could also represent tokenized assets. Tokenization is the transfer of value from an asset to a token. Any asset can be tokenized, such as real estate or stocks. For this to work, the asset must be transparently secured and held. Otherwise, the tokens are worthless because they wouldn't represent anything. Security tokens are regulated by the Securities and Exchange Commission because they are designed to act as securities.

In 2021, the Bitcoin wallet firm Exodus successfully completed a Securities and Exchange Commission-qualified Reg A+ token offering, allowing for $75 million shares of common stock to be converted to tokens on the Algorand blockchain. This historic event was the first digital asset security to offer equity in a United States-based issuer.

Utility Tokens

Utility tokens are used to provide services within a network. For example, they might be used to purchase services, pay network fees, or redeem rewards. Filecoin, which is used to buy storage space on a network and secure the information, is an example of a utility token.

Ether (ETH) is also a utility token. It is designed to be used in the Ethereum blockchain and virtual machine to pay for transactions. The former stablecoin USTerra used utility tokens to attempt to maintain its peg to the dollar—which it lost on May 11, 2022—by minting and burning two utility tokens to create downward or upward pressure on its price.

Utility tokens can be purchased on exchanges and held, but they are meant to be used in the blockchain network to keep it functioning.

Meme Coins

As their name suggests, meme coins are inspired by a joke or a silly take on other well-known cryptocurrencies. They typically gain popularity quickly, often hyped online by prominent influencers or investors attempting to exploit short-term gains.

Many refer to the sharp run-up in this type of altcoins during April and May 2021 as "meme coin season," with hundreds of these cryptocurrencies posting enormous percentage gains based on pure speculation.

Governance Tokens

Governance tokens allow holders certain rights within a blockchain, such as voting for changes to protocols or having a say in the decisions of a decentralized autonomous organization (DAO). Because they are generally native to a private blockchain and used for blockchain purposes, they are utility tokens but have come to be accepted as a separate type because of their purpose.

Pros and Cons of Altcoins

Pros Explained

• Altcoins are "improved versions" of the cryptocurrency they derived from because they aim to plug perceived shortcomings.
• Altcoins with more utility have a better chance of surviving because they have uses, such as Ethereum's ether.
• Investors can choose from a wide variety of altcoins that perform different functions in the crypto economy.

Cons Explained

• Altcoins have a smaller investment market compared to Bitcoin. Bitcoin has generally remained above 40% of the global cryptocurrency market since 2016.
• The altcoin market is characterized by fewer investors and less activity, resulting in thin liquidity.
• It is not always easy to distinguish between different altcoins and their respective use cases, making investment decisions even more complicated and confusing.
• Several "dead" altcoins ended up sinking investor dollars.

Future of Altcoins

Discussions about the future of altcoins and cryptocurrencies have a precedent in the circumstances that led to a federally issued dollar in the 19th century. Various forms of local currencies circulated in the United States. Each had unique characteristics and was backed by a different instrument.

Local banks were also issuing currency, sometimes backed by fictitious reserves. That diversity of currencies and financial instruments parallels the current situation in altcoin markets. There are thousands of altcoins available in the markets today, each claiming to serve a different purpose and market.

The current state of affairs in the altcoin market indicates that it will unlikely consolidate into a single cryptocurrency. However, it is likely that most of the thousands of altcoins listed in crypto markets will not survive. The altcoin market will probably coalesce around a few altcoins—those with strong utility, use cases, and a solid blockchain purpose—which will dominate the markets.

If you're looking to diversify within the cryptocurrency market, altcoins can be less expensive than Bitcoin. However, the cryptocurrency market, regardless of the type of coin, is young and volatile. Cryptocurrency is still finding its role in the global economy, so it's best to approach all cryptocurrencies cautiously.

The Bottom Line

Altcoins are any cryptocurrency that is not Bitcoin (or Ethereum). There are thousands of altcoins on the market, so it is difficult to tell which might be legitimate and which are not. It's best to read all the documentation behind whichever cryptocurrency piques your interest.

If there is a purpose for the blockchain and token, it might be worth watching—if not, consider other coins or investments. If you're unsure, talk to a financial advisor familiar with cryptocurrencies to help you decide if they are suitable for your portfolio.

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