Altcoins – where volatility lives

Two years after the bitcoin protocol first appeared, it was followed by its first offshoot—Namecoin, a cryptocurrency aiming to build a censorship-free web. This was the first of thousands of alternative cryptocurrencies spawned by bitcoin, that today includes more than 800 with market capitalizations of over a million dollars.

While bitcoin is still by far the largest—representing around half the market cap of all cryptocurrencies—it is now just the backbone of what has become a diverse ecosystem of alternatives, otherwise known as altcoins. This is a blanket term for alternative cryptocurrencies, most of which are based on bitcoin’s codebase, but have mutated into a range of different offerings—each with its own story to tell, and its own claim to uniqueness.

Some have introduced new functionality to the blockchain, like Ethereum with smart contracts, while others have technical advantages, like Monero’s anonymous transactions. Some, like Dogecoin, started life as a meme and eventually became a valuable commodity. To the uneducated investor, these altcoins are a minefield: Questionable projects flourish alongside legitimate ventures, and distinguishing between them requires careful consideration.

High highs and lower lows

Since the first altcoin in 2010, many have risen through the ranks to sit alongside bitcoin, but many more have sunk into obscurity. Historic market cap data from 2010-2017 reveals a range of coins that would be unfamiliar to the investor of 2018. Witness Novacoin and Terracoin, for example, both of which were once top 10 assets but now don’t make it into the top 300.

Those that have succeeded, however, have done so in style, offering investors skyrocketing returns that dwarf even bitcoin. NEM, for example, an altcoin that is popular in Japan, offered nearly 30,000% returns in 2017. NEO, which some call the ‘Chinese ethereum’, even in today’s bear market has yielded 60799% to early investors.

To their critics, these altcoins are just worthless spin-offs of bitcoin. But to their believers, they offer hundreds of different ways to improve on bitcoin’s original codebase.

Bitcoin price drives the market

Regardless of their diversity of technology and use cases, however, the financial status of these altcoins is largely attributable to the price of bitcoin. As money surged into bitcoin in late 2017, some investors sought even greater returns by investing in altcoins, causing prices to continue surging through early January, long after the bitcoin price had peaked.

Periods like this are known as an ‘alt season’ by crypto traders—a time when the price of bitcoin has steadied, and those seeking greater returns shift to investing in alternatives. At their peak in January, these alternative coins made up 70 percent of all cryptocurrency trading volume and bitcoin’s share of crypto’s overall market capitalization had fallen to 32 percent.

Since January 31st, however, the price of bitcoin has fallen 36 percent, but it is the altcoins that have suffered the most in the downturn. XRP, for example, which posted 36,000 percent gains in 2017, is down over 85 percent from its all-time high. Cardano is down 93 percent and Dash is down 88 percent – making bitcoin’s drop seem pedestrian in comparison.

At the same time bitcoin has reaffirmed its status as a cryptocurrency safe haven, returning to over 50 percent market share as investors flee the altcoins in favor of a less volatile asset.

The regulation and liquidity challenge

From the perspective of institutional investors, such market instability creates an uncertain environment, and many are waiting for clarity from regulators in the hope that it will contribute to a reduction in volatility. In the meantime, those wanting to test the water without holding the asset are restricted to futures contracts, and the promise of ETFs.

To date the SEC has rejected every bitcoin ETF proposal, with its primary concerns being the potential for market manipulation and a lack of traditional means of detecting and deterring fraud. And what goes for bitcoin goes double for altcoins. With very low liquidity, altcoins remain vulnerable to market manipulation and low market cap coins in particular can suffer from slippage with large orders—or witness large price movements on so much as a single tweet.

Aside from traditional financial instruments, there is another route under construction for institutional investors wanting to enter the space. Stablecoins are a particular type of altcoin that combine the core values of cryptocurrencies like decentralization and security, with stability in price.

By doing so, these altcoins aim to overcome the volatility that is such a hurdle to mass adoption, and also boost the level of trust needed for institutional investors to participate in the market. Two of the biggest stablecoin projects—EURS and TrueUSD—have launched coins that are pegged to the movement of their fiat equivalents, and backed by partnerships with governments and institutions.

With price stability, fully-audited reserves and trusted partnerships, these projects may assist institutional money to enter the cryptocurrency marketplace. They won’t themselves produce the returns of the more speculative alts — given their pegged nature — and instead will more likely find their utility in easing crypto on-ramping and off-ramping, and moving assets between exchanges.