Understanding Cryptocurrency: What Are the Different Types of Cryptocurrencies?
The Basics of Cryptocurrency Coins
For someone with access to the internet in 2023, cryptocurrencies are hard to miss. You will almost certainly have heard of Bitcoin, and thousands of other cryptocurrencies have similar potential. Before diving into various investment strategies and opportunities, let’s understand these currencies and how they operate.
What Is a Cryptocurrency?
Cryptocurrencies or cryptos are digital currencies based on decentralized systems that help validate transactions and maintain security. Normally, you’d require a bank to carry out your transactions, but the crypto space works on a peer-to-peer network that validates and supports the transactions on a digital ledger.
Since no centralised authority controls this network, the security is ensured by cryptographic hashing algorithms, which help avoid double spending and fraudulent transactions.
The Role of Blockchain in Cryptocurrency
Blockchain is a buzzword that overwhelms newbies in the crypto space. Although it sounds like jargon, it’s easy to grasp.
Cryptocurrencies run on a distributed ledger called a blockchain. In simpler words, this digital database contains the data of all transactions on the network. The architecture of this database can be visualized by a set of blocks linked to each other. Each block contains a set of transactions.
A copy of this database is stored and maintained on each network node, which users volunteer to run. This enables them to lend their computing power to the network, which is used to validate transactions by solving cryptographic problems. This process is called mining. Upon successfully adding a block to the chain, miners are rewarded with the native token, incentivizing the maintenance of network security.
How Many Cryptocurrencies Are There?
There are thousands of currencies in the crypto market. This reflects astonishing growth, considering the market had only 7 currencies around a decade ago. This exponential rise in the number of currencies has brought several use cases to the digital space, giving birth to different types of cryptos.
The Main Cryptocurrency Coins
Due to the number of existing cryptocurrencies, it is essential to understand their differences. These coins are categorized based on utility and purpose. That said, most of these currencies are categorized under one of the following umbrellas.
Bitcoin – The Pioneer of Cryptocurrencies
Origin and Impact
Bitcoin was the first currency to come into being back in 2009. It was launched by a programmer or a group of programmers who operated under Satoshi Nakamoto’s pseudonym. The identity of this person or group of people remains a secret to date.
The birth of Bitcoin introduced the concept of digital decentralized currencies. Hence, it is also known as the pioneer of cryptocurrencies.
As the oldest currency, bitcoin dominates the whole market by a mile. The entire crypto market cap is around $1.75 trillion, out of which bitcoin’s dominance is 47.69% ($834 billion).
Characteristics of Bitcoin
Bitcoin serves as a store of value like gold. However, due to the ease of transfer and reliability, it is also being used as a medium of transfer. What makes this special is the key characteristics that it possesses.
- Limited supply: Bitcoin has a total supply of 21 million. This number is set in stone and can not change.
- Supply and demand: The value of Bitcoin, like any store of value, is driven primarily by supply and demand.
- Privacy: The Bitcoin network is anonymous. So, knowing who is behind a wallet address that made a network transaction is impossible.
- Irreversible: A transaction made using Bitcoin cannot be reversed. You can only claim your funds if the receiver agrees to send them back.
Altcoins – The Alternative Options
Altcoin is an umbrella term that encapsulates all currencies other than Bitcoin. The term altcoin is an amalgamation of two words, alt meaning alternate and coin referring to cryptocurrencies. These currencies were created to fill the gaps created by Bitcoin and to explore other use cases and categories within this umbrella (discussed later in this article).
The Rise of Altcoins
There are more than 23,000 altcoins, as reported by CoinMarketCap. This number is due to the rising popularity of cryptocurrencies and the need for decentralized systems. These digital assets have also seen an exponential rise due to their unique feature sets, including technical innovation, investment opportunities, programmability, and decentralization.
The blockchain behind Ethereum, for example, is programmable. This allows developers to code self-executing contracts. This laid the foundations for decentralized applications. Similarly, the technology associated with currencies like Tether, XRP, Solana, and Polygon has a unique value proposition.
Stablecoins, as the name suggests, are coins that hold their value. Usually, this value is tied to another asset class like fiat or gold.
Fiat-collateralized vs. crypto-collateralized stablecoins
A collateralized stablecoin is a cryptocurrency that mimics the value of an asset held in reserve. There are generally two types of collateralized stablecoins:
- A fiat-collateralized stablecoin holds a 1:1 peg with a sovereign currency like GBP or USD. An example of such a currency is Tether (USDT), which has historically maintained a value of $1.
- On the other hand, crypto-collateralized stablecoins mimic the price of another cryptocurrency. The prime example of such a stablecoin is Wrapped Bitcoin (WBTC).
Collateralized stablecoins are frequently audited for compliance to avoid de-pegging.
Algorithmic stablecoins rely on complex algorithms to maintain their value. This algorithm is created using transparent and auditable code, which makes these stablecoins more decentralized. However, since an asset doesn’t back them, they aren’t the most reliable in terms of stability.
Central Bank Digital Currencies (CBDCs)
CBDCs are centralized digital currencies issued by a country’s central bank. Since these stablecoins are regulated, they can be accepted as legal tender in a country. While CBDCs aren’t decentralized, they represent a step towards mass crypto adoption.
If you’re new to the crypto space, chances are you have heard the name of dogecoin. Dogecoin is considered to be the pioneer of meme coins.
As the name implies, a meme coin is a currency created as a meme or a joke. These currencies generally have no intrinsic value. So, their value is backed merely by a community of enthusiastic traders and believers. Examples of such coins are Dogecoin, Shiba Inu, and Pepe.
Tokens – Beyond Currencies
Tokens and coins are generally used interchangeably for cryptocurrencies, but both have unique characteristics that make them different.
Defining Tokens: Utility vs Value vs Security
The term token generally represents non-cash assets like ownership stake, access, utility, etc. Although these tokens have a certain value, they are more than currencies. The most common types of tokens are utility and security tokens.
- Securities: Securities or security tokens represent shares in a company.
- Utility tokens: Utility tokens are assets that give holders access to services, features, or preferential treatment in a decentralized product.
How Tokens Differ from Coins
Crypto coins are digital currencies that run autonomously on their blockchains. Coins are generally used as a store of value or a medium of exchange. On the other hand, tokens are digital assets that run on top of an existing blockchain. These tokens are generally diverse in functionality and have one or more specific utilities in a decentralized app, security, or governance ecosystem.
Choosing the Right Type of Cryptocurrency for Investment
Now that you have a basic understanding of cryptocurrencies and their types, the next logical step is to create an investment strategy. There are many templates for success, and the best strategy is the one that is developed with your case in mind.
Investment Strategies for Crypto Coins
The crypto space is a land of opportunity for investors. Understanding what trading strategy suits you depends on your goals, investment capital, and risk appetite. That being said, the following strategies are generally prevalent among traders in this space:
- Dollar-cost averaging (DCA) — DCA is one of the most popular investment strategies that has been tried and tested for years. It refers to investing small amounts into an asset periodically regardless of market conditions instead of investing all at once. This helps reduce risk in investment.
- HODL — Holding on for Dear Life, or HODLing, is a long-term holding strategy. This might be a good option if you have a healthy investment capital.
- Day and swing trading — Day and swing trading are strategies that capitalize on the market’s volatility. Traders look to make small profits on trades made in the short term, ranging from a day to a few weeks.
Risk Management in Crypto Investment
Crypto is a volatile space compared to other financial markets. The opportunity brought by this volatility also comes with its risks. Generally, the currencies with the following attributes involve higher risk:
- Small market cap: Bitcoin’s market cap is nearing a trillion, and other high-cap currencies like Ethereum and XRP also have tens of billions invested in them. This makes them less volatile compared to low market cap coins. Investing in high caps generally means lesser risk.
- Utility: If a coin lacks utility, it has weak fundamentals. A currency with weak fundamentals comes with many associated risks as the value is merely driven by the community’s enthusiasm instead of the business itself.
Newbies in the space should have efficient stop-loss strategies if they’re looking to trade in the short term. For long-term investments, looking into the company fundamentals is highly advised.
Where to Buy All Types of
If you’re interested in buying cryptocurrencies, there are hundreds of exchanges. To get the best trading experience, choose a highly reputable exchange like Binance, Kucoin, OKX, or Kraken. These exchanges are generally reliable and allow users to buy using PayPal, credit cards, and other payment methods, giving the best on-ramp experience. Alternatively, crypto traders can purchase cryptocurrency CFDs with an online brokerage platform.
- What Should Beginners Know About Crypto Coins?Beginners should have an understanding of the following key concepts:
- Types of crypto coins
- Most popular cryptocurrencies
- Blockchain basics
- Is Bitcoin Still the Leading Cryptocurrency Coin?The whole crypto market has a market cap of $1.75 trillion. Bitcoin’s market cap alone accounts for around 48% of the market size, making it the leading crypto by a mile.
- How Do I Start Investing in Cryptocurrency?To start investing in cryptocurrency, find out the currency that you want to invest in by having clear goals and an understanding of your risk appetite. The next step is to register with a reputable exchange. Exchanges generally have a user-friendly flow that can help with buying easily.
- Can Cryptocurrencies Be Used Like Regular Money?Most cryptos are too volatile to be used like regular money. However, fiat-pegged stablecoins mimic the value of sovereign currencies and can be used as a medium of exchange.
- What Are the Risks of Investing in Cryptocurrency?Crypto is a volatile market compared to stocks and forex. The price movements are sudden and sharp. While this volatility brings areas of opportunity, it also comes with a lot of risk. Apart from this, keeping your funds on a centralized exchange is also considered to be risky. However, this risk can be mitigated by managing your funds offline using cold wallets.
- How Can I Use Cryptocurrency in Everyday Transactions?Crypto has yet to see the sort of adoption that makes it easy to transact coins for everyday transactions. However, some businesses have started accepting cryptos as a mode of payment. Moreover, if your region has a Central Bank-issued CBDC, it can also be used as a legal tender.