What Is An Altcoin?

While Bitcoin has become the world's most visible digital currency, there are many other cryptocurrencies out there. Digital currencies other than Bitcoin are frequently referred to as altcoins, which essentially translates to alternative to Bitcoin.^[1]

An altcoin is a digital currency that relies on a protocol, or set of rules, different from the Bitcoin protocol. Some of the more prominent examples include Ether, Litecoin and Ripple.

Benefits of Altcoins

Altcoins can potentially be used for a great many purposes. While Bitcoin was the first digital currency to scale, its technology has in many ways been surpassed by the technology of other protocols.

For example, while one major intention of Bitcoin was providing anonymous transactions, the digital currency's technology has been ineffective at doing so. Bitcoin transactions are pseudonymous, meaning they take place between Bitcoin addresses that are randomly generated strings of letters and numbers.

Over time, many transactions can attach to an address. Because these transactions are recorded on the blockchain, they are publicly available and provide interested parties with a glimpse into an individual's buying patterns.

One altcoin that has provided far greater privacy is monero, which has become the dominant cryptocurrency of the Dark Net.^[1] To ensure user anonymity, Monero leverages ring signatures, which protect the identity of senders^[2], and stealth addresses, which are one-time addresses that senders create for recipients.

Another example of a currency that provides superior privacy to Bitcoin is Zcash, which leverages complicated mathematical formulas called zero-knowledge proofs to confirm senders and recipients without revealing their identity.^[4] Zcash specifically uses zero-knowledge proofs called zk-SNARKs.

While the aforementioned digital currencies focus on providing strong anonymity, other altcoins have prioritised offering users different benefits, such as greater transaction capacity or more rapid transactions.

The traditional Bitcoin is currently limited by a block size of 1MB, whereas Bitcoin Cash came into existence on 1 August 2017 as an alternative that offers 8MB blocks. Because of its greater block size, Bitcoin Cash can handle far more transactions than the more traditional Bitcoin.

Several altcoins with faster block times than Bitcoin have been created, including Ripple, Litecoin and Ether. Litecoin, for example, completes blocks every 2.5 minutes on average, which is four times the speed of the Bitcoin network.

In addition, some altcoins use a different hashing algorithm than Bitcoin. While Bitcoin uses a hashing algorithm called SHA-256, many others use an algorithm named Scrypt.^[1]

Bitcoin gold, a digital currency that came into existence in October 2017, is an altcoin designed to help democratise mining by making this process available to a wider range of processors.^[6] Bitcoin mining requires application-specific integrated circuits (ASICs), and because these ASICs are expensive, it makes it so that only certain industry participants can take part in mining.

As a result, large mining firms are responsible for much of Bitcoin's transaction processing.^[6] This situation has drawn the ire of certain industry participants who have complained that too much power has managed to rest in the hands of too few. With this in mind, developers launched Bitcoin gold, which lowers the bar and makes it so a wider range of nodes can process its transactions.

Compelling Returns

One major perk of altcoins is the compelling returns that some have provided. There are many stories of individuals who have become Bitcoin millionaires as a result of the digital currency's sharp price gains.

However, Bitcoin is not the only cryptocurrency that has provided users with sharp gains. Many organisations have held digital token sales, and in some cases, the altcoins that they sold enjoyed sharp increases in value.

Ether tokens, for example, were sold for US$0.311 during a token sale in 2014, and rose to as much as US$414.76 in June 2017, representing a more than 130,000% gain.^[7] Ether, the second-largest digital currency by market capitalisation, is used to power ethereum, a platform used for building decentralised applications that rely on smart contracts.

NEO, previously referred to as Antshares, generated an even larger return, climbing more than 160,000% between its ICO price of US$0.032 and an all-time high of US$52.63.^[7]

Diversification

Another potential draw of altcoins is diversification. The basic idea behind diversification is not putting all your eggs in one basket. Ideally, if an investor has a basket with five components, a 20% decrease in one component should correspond with a 20% increase in another.

However, such ideal situations rarely happen. Investors can benefit significantly from looking at existing research that reviews the correlations—or price relationships—that exist between different currencies.

Such research has found, for example, that Bitcoin and Litecoin frequently follow each other in terms of their price movements. However, the relationship between Bitcoin and other altcoins has frequently been more complex.

Sometimes, several altcoins—as well as Bitcoin—move in the same direction. However, there are other times when individual altcoins rise and fall independent of other digital currencies.

Investors who are considering altcoins should keep in mind that these assets are highly risky. As a result, they should be sure to conduct significant research before investing in them.

Summary

Simply put, altcoins are digital currencies other than Bitcoinbitcoin. These altcoins can be used for a great many purposes, including making transactions that are rapid or anonymous. Some have also produced very strong returns, making them appealing to many investors.

Investors may find altcoins compelling, but they can benefit from conducting significant due diligence before buying, selling or otherwise investing in it.