What Are Altcoins and ICOs? How Do They Work?
You’re probably familiar with Bitcoin by now. But that’s only the tip of the iceberg.
Altcoins and ICOs can provide significantly higher returns than Bitcoin. However, they are also less mainstream. As a result, people are far more skeptical - and quite rightly so.
With the surge in popularity of cryptocurrencies, we have also witnessed a surge in scammers and hackers who are trying to steal money from people with little experience.
In this article, you’ll learn more about altcoins and ICOs, how they work, and what you need to know before making investments.
What is an “Altcoin”?
The term “altcoin” stands for “alternative to Bitcoin”. It is used to describe any cryptocurrency that is not Bitcoin. Fundamentally, most altcoins are very similar to Bitcoin. In fact, many altcoins are essentially just Bitcoin clones, with only minor changes. Most of them don’t survive very long.
For example, some of these changes might include:
- A different transaction speed
- A different distribution method
- A different hashing algorithm
However, a small proportion of altcoins are different enough to have significant potential and have shown early investors high returns.
What Are Some of the Most Popular Altcoins?
Some popular altcoins that you might have heard of include:
- Litecoin - This was one of the first altcoins. It has a different hashing algorithm to Bitcoin and also has a much higher number of currency units.
- Ripple - Serves as a protocol that users can employ to make inter-currency payments simple.
- Namecoin - This was the first altcoin. It was created in April 2011. Its primary purpose was to decentralize domain name registration.
- Monero - An open-source cryptocurrency that focuses on privacy, decentralization, and scalability.
Should I Invest in Altcoins?
Investing in any cryptocurrency comes with a great deal of risk, so you should never invest anything you can’t afford to lose.
It’s also important to note that altcoin markets are significantly more volatile than the likes of Bitcoin. This is mainly because they have much lower market caps, which makes them much more prone to price manipulation.
“Pump and dump” schemes are especially common in altcoin markets. This is when wealthy traders - also known as ‘whales’ - inject large amounts of capital into low-valued coins. This creates hype and drives up the price.
Once the price has risen enough, they will sell these coins on exchanges, driving the prices back down and causing gullible investors to lose significant amounts of money.
In order to avoid this, it is important that you don’t just look for whichever coin has made the most gains over the past few weeks. Instead, you should thoroughly research whichever coins you’re interested in investing in and evaluate their long-term health.
If a coin is a good investment, it will generally be backed by a strong community, have high liquidity, and have a team of developers who are proactively improving its source code.
Where Can I Buy Altcoins?
Mainstream exchanges like Coinbase don’t sell altcoins. However, most exchanges use Bitcoin as an intermediary, so you’ll first need to buy Bitcoin in order to purchase altcoins.
Now that we’ve covered the basics of altcoins, let’s take a look at initial coin offerings in more detail.
What is an Initial Coin Offering (ICO)?
An ICO is a method of crowdfunding that is centered specifically around cryptocurrencies. It is mainly used as a way for startups to raise capital.
ICOs are unregulated, and they are often used as a way to bypass the rigorous capital-raising process that is required by both banks and venture capitalists.
In return for investing money into a startup, the investors receive virtual “tokens”. These tokens can be exchanged for legal tender, or for other cryptocurrencies. They can be thought of as being similar to shares of a company that are sold to investors in an Initial Public Offering (IPO) transaction.
Token sales have been around for a few years now. However, it didn’t become a mainstream method of raising capital until as recently as September 2017, when Kik messenger launched their ICO. It managed to raise $100M and was the highest-profit ICO of its time.
Since then, the ICOs have seen an explosion in growth. However, their growth has been so phenomenal that many countries have been struggling with how to regulate them. In some countries, such as China and South Korea, ICOs have been banned altogether.
ICOs are also sometimes referred to as Initial Public Coin Offerings (IPCOs).
How does an ICO work?
Once a firm has decided they want to raise money via an ICO, they are required to create a whitepaper. This is designed to answer common questions, such as:
- What is the project about?
- What is the purpose of the project, and what needs does it fulfill?
- How much money is required to complete the project?
- What proportion of the tokens will the project founders keep for themselves?
- What are the forms of currency accepted?
- What are the start and end dates of the ICO?
If the funds raised do not reach the minimum amount required by the firm, the money will be returned to the backers and the ICO is deemed unsuccessful.
If the funding goal is met and the project officially launches, these tokens held by investors will become functional units of currency. Investors often purchase them in the hope that they will appreciate in value.
One example of a wildly successful ICO is the smart contract platform, Ethereum. Back in 2014, it raised $18 million in Bitcoins. One Ether was worth only $0.40. The project went live in 2015. Right now, as of December 2017, one Ether is valued over $700.
Should I invest in ICOs?
As we’ve witnessed with the likes of Ethereum, some ICOs have the potential to be wildly successful. However, stories of ICO scams are becoming ever-more frequent.
In November 2017, the founders of Confido, the ‘smart contract startup’ disappeared with over $375,000 of investors’ money.
Before investing in an ICO, it is imperative that you carry out extensive research on the team backing the project to minimize your risk of losing money.