Altcoins: Definition, Types, & How They Work

While many people are familiar with Bitcoin, there are tens of thousands of altcoins that you can also add to your cryptocurrency portfolio.

These additional tokens have multiple advantages, including potentially high investment gains and real-world usability.

There are several risks and rewards to consider when deciding if this digital asset is a good investment.

What are altcoins?

An altcoin is any cryptocurrency besides Bitcoin. This term is short for “alternative coin” with the first ones launching in 2011.

Understanding Altcoins

Altcoins function similarly to Bitcoin for investing and transactions.

They allow you to diversify your crypto investment portfolio and can usually be used for transactions instead of fiat currency.

However, due to lower liquidity and more competition, most altcoins are inherently more volatile than Bitcoin.

As an altcoin investor, I have learned to watch trading values closely to avoid losing money, while Bitcoin is more likely to increase in value over the long term. 

Here are several core features of this digital asset:

• Easy to trade: Most cryptocurrency exchanges offer hundreds of popular projects. However, your investment options differ by platform and country. For instance, Coinbase may have several that Gemini doesn’t, and vice versa.
• Flexible storage options: You can store your crypto keys using your preferred exchange’s hot or cold wallets. Hardware wallets let you enjoy the liberty of self-custody and avoid account lockouts or digital theft. 
• Invest or transact: The vast majority of tokens can be invested in to sell at a higher market value. You may also use them to complete purchases or send money to friends bypassing the traditional banking platforms.
• Decentralization: Many allow you to participate in decentralized finance (DeFi), providing voting rights and other ownership incentives. These coins are more flexible but more volatile than centralized tokens, which institutions mostly hold.
• Multiple blockchain networks: These alternative tokens run on non-Bitcoin blockchain networks such as Ethereum and Solana. These newer networks are more efficient, with quicker transaction speeds and lower transaction fees.
• Real-world applications: Most altcoins serve a specific purpose through automated smart contracts such as, completing financial transactions, processing data, and providing gaming rewards. A coin’s use case helps provide long-term investment value.   
• IRA eligible: Cryptocurrencies are subject to capital gains taxes in taxable accounts. A crypto-backed IRA lets you only pay taxes once on your balance.  
• Sentiment: Because of less liquidity, market demand dictates altcoin prices. This sentiment can change quickly and coins that were popular in the previous bull market may not reach their previous highs in the next bull cycle.

Altcoins help diversify and strengthen the cryptocurrency ecosystem with more efficient solutions than Bitcoin, the industry’s gold standard.

You can also earn better short-term gains with the best coins when Bitcoin is in a sluggish period.

However, the ever-changing market presents notable risk, a greater likelihood of scams, and security vulnerabilities that may impact your performance.

Avoiding lackluster or fake projects and timing to buy at a low-yet-rising entry point is crucial.

Types of Altcoins

Cryptocurrencies possess multiple purposes that help determine their market value and compatibility with your investment strategy.

Stablecoins

Stablecoins are considered reliable stores of value and the least risky of altcoins.

Most peg their value at a 1:1 ratio to real-world assets, like U.S. dollars. For example, one stablecoin can convert to $1.

Token prices remain static and don’t appreciate in value. However, you can earn staking rewards from your long-term holdings.

These coins are the equivalent of holding cash. Tether (USDT) and USD Coin (USDC) are the largest stablecoins.

Additionally, many crypto exchanges have their own stablecoin to settle your uninvested funds instead of fiat.

Security tokens

Security tokens allow you to purchase fractional ownership of an investable asset, such as a business or rental property.

However, these tokens are subject to more federal regulations and are usually restricted to high-net-worth accredited investors.

You must use exchanges specializing in security tokens, including tZERO and Securitize.

Tokenizing assets using blockchain reduces operating expenses and increases transparency. The marketplace automatically distributes your dividends and investment performance.

Meme coins

Meme coins don’t have a real-world purpose and their market value sheerly relies on demand and popularity.

People usually make them as a joke, to gain attention, or to make a quick buck from trending Internet memes in popular culture.

Needless to say, these coins are scam-prone with a history of pump-and-dump schemes. It’s also very risky and speculative versus other cryptocurrencies.

Some of the most memorable “meme coins” include:

• Dogecoin (DOGE)
• Official Trump (TRUMP)
• Pepe (PEPE)
• Shiba Inu (SHIB)

Utility tokens

These coins provide access to a particular product or fee discounts within a particular blockchain.

Unlike security tokens, utility tokens are freely available. You can buy them on exchanges or earn them by completing tasks.

Ethereum (ETH) is the most notable utility coin since you can use it to pay transaction “gas” fees. You can also use other services using the Ethereum blockchain network.

Two work utility coins include The Graph (GRT), which helps process blockchain data at competitive costs and FileCoin (FIL) facilitates decentralized data storage.

Payment tokens

A payment token can be used to pay for online or local purchases. Most cryptocurrencies possess this characteristic, as you can pay friends or businesses. 

Interestingly, Bitcoin was originally designed as a peer-to-peer payment alternative although it’s more favored today for its long-term investment potential.

Bitcoin Cash (BCH) is a “fork” of the original cryptocurrency and is more transaction-friendly, albeit with less investing appeal.

Basic Attention Token (BAT) is another prominent utility token. This coin pays advertisers and customers using the Brave browser.

Play-to-earn gaming coins are another example. Axie Infinity (AXS) and The Sandbox (SAND) award members with this virtual currency they can redeem for rewards or convert into other crypto or fiat.

Mining-based tokens

Mining-based cryptocurrencies require solving algorithmic puzzles to add new tokens.

After solving the puzzle, miners earn token rewards, which they can keep or sell on an exchange. 

There are two different mining models:

• Proof of work: Specialized hardware systems that solve complex computational algorithms. This method is more energy-intensive and less common with newer projects. 
• Proof of stake: Users, also known as nodes, set aside a portion of their token balance to validate transactions. This method doesn’t require specialized hardware.

Most cryptocurrencies require mining or staking of some kind. Litecoin (LTC) and Dogecoin (DOGE) are two of the largest proof-of-work coins by market cap.

Governance tokens

Governance tokens provide community members with voting rights to manage decentralized coins, instead of centralizing power with developers. 

Community members can submit proposals and you can vote in favor or against based on your balance size. Typically, one token equals one vote, similar to individual stock shares.

Aave (AAVE), Maker (MKR), and Uniswap (UNI) are three of the most-recognized governance coins. They may also double as utility tokens and can complete tasks within their ecosystem.

Top 10 Altcoins by Market Cap

Coin	Symbol	Price	Market Cap
Ethereum	ETH	$2,690	$324.3 billion
XRP	XRP	$2.46	$142.1 billion
Tether	USDT	$1	$141.9 billion
BNB	BNB	$699.46	$99.6 billion
Solana	SOL	$194.92	$95.1 billion
USDC	USDC	$1	$56 billion
Dogecoin	DOGE	$0.26	$39 billion
Cardano	ADA	$0.79	$27.9 billion
Tron	TRX	$0.24	$21 billion
Chainlink	LINK	$18.98	$12.1 billion

How to Invest in Altcoins

Altcoin investing is significantly riskier than buying Bitcoin. As a result, you need to perform your due diligence and be highly selective about which products you invest in to increase your potential performance.

1. Research extensively: Be sure to understand its current use cases, potential purposes, developer background, and project history. Ensure you’re investing in a legit project versus a get-rich-quick scheme or an irrelevant token.
2. Consider big market caps: You may start with some of the largest altcoins as they have more liquidity and less price volatility. As your confidence increases, consider branching into newer projects with more upside potential.
3. Find an exchange or IRA: Altcoins are not universally available on every exchange. Be sure to choose a reputable platform. Crypto Roth IRAs are also worth exploring to minimize your ongoing taxes, although you are limited to well-established projects.  
4. Make an exit strategy: Some altcoins are suitable for long-term investing, but many are for short-term investing only if their technology becomes outdated or liquidity dries up. Have an idea under what conditions you might sell to limit losses or take profits.
5. Buy tokens: Most trading platforms let you buy or sell cryptocurrency 24/7. You can submit a limit order to buy at a specific price point to improve your success probability. 
6. Small position sizes: Altcoin investing is very speculative and you should only commit approximately 1% to 2% of your portfolio per token for proper risk management.
7. Monitor continually: Cryptocurrency is a volatile industry with many price and technology changes. Close positions when your investment thesis or market conditions change.

I enjoy buying altcoins for many of the above reasons, as they can offer more upside potential than most traditional investments.

However, I’ve learned to focus on a few coins, as a profit can quickly turn into a loss with a lengthy recovery period or never break even.

Should I Own Any Altcoins?

Consider starting with one or two altcoins that fit your investment strategy and appear to have a strong growth outlook.

For a low-volatile income play, consider stablecoins. Be sure to research each potential investment and understand the accompanying risks thoroughly.

If you’re a brand-new crypto investor, starting with Bitcoin can be better as it’s less volatile until you boost your confidence and have more money to allocate toward riskier tokens.

Risk-averse investors should consider less volatile assets.

As altcoin trading can frequent continual trading, compare the best crypto IRAs to only pay taxes once and access the most liquid cryptocurrencies.

FAQs