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Advice To Beginner Investors In Crypto, Part 3

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Part 1

Part 2

Introduction

In the previous parts I discussed setting up a password manager and wallets. I also discussed the fundamental dynamics of the market, how Bitcoin and its mining reward halving drive it, and how you should time your entry and your exit to the market. In this part, I'll discuss how you can go about increasing your potential rewards by investing in altcoins if you have appetite for higher risk.

The top 10 altcoins

The obvious and the simplest path to higher rewards (coupled with higher risk) is investing in altcoins. Cryptocurrencies other than Bitcoin are called altcoins as in "alternative coins". That term was invented in the very early days of Bitcoin when the first altcoins were created. The very first one of them was Namecoin which was created in April 2011, which was only a little over two years after Bitcoin itself was released. Most readers today are unlikely to ever have heard of Namecoin. That does not mean Namecoin is dead. In the public blockchain space, scarcely anything really dies. That's because public blockchains are not companies or anything like that. They are protocols, which in this case means cryptographically enforced rules of interaction between computers running a compatible version of the protocol software. They're something each node (computer operator) participates in completely voluntarily retaining complete ownership and control over their own node. It's their own business which version of some particular protocol they want to participate in or none at all. But I digress. Namecoin is the native cryptocurrency of a decentralized identity management platform. Go and check it out if you're interested.

The least volatile altcoins are those with the highest market caps. I'd consider the top 10 or so particularly noteworthy. At present they are:

These are the largest market cap coins. Market cap is simply the product of the number of all the coins in circulation and the spot market price of one coin. Bitcoin is at $243 billion, followed by Ethereum at $47 billion all the way down to Cardano at $3.4 billion.

That set has already has an interesting selection of different types of coins. Let's take a look at them. I have already talked about Bitcoin.

Ethereum (ETH)

Ethereum was launched in July 2015. It has a Proof-of-Work consensus mechanism just like Bitcoin. What that means is that transactions that haven't been validated by the network, yet, are upon validation organized into blocks that an Ethereum miner has to sign. In order for a signed block to be valid it has to contain the output of a hash function that is of the correct form (a hash is a kind of one-way encryption computed from an input) that has all the transactions in the block, the hash of the previous block, some header information, and a random parameter that the miner varies and hopes to get right through trial and error. Blocks are set to be found and thus transactions confirmed faster on Ethereum than on Bitcoin, in 10 to 20 seconds instead of Bitcoin's 10 minutes.

Where Ethereum is completely different from Bitcoin is the type of transactions it processes. While Ethereum does allow its native cryptocurrency and a host of other tokens on it to be transferred, Ethereum is also designed to execute instructions that are part of computer programs written in a special programming language designed for Ethereum called Solidity that has the same expressive power as any of the commonly used programming languages of today. Ethereum is thus a giant decentralized computer that runs computer programs on a blockchain like they are normally run in a runtime environment on single computer. Such programs are called smart contracts. When a smart contract is sent to an Ethereum address to be run, Ethereum compiles it into a set simple instructions that it executes in the same way as it executes simple account balance transfers in Ether (ETH) or any of the other tokens that it supports. The reason why these programs are called smart contracts is that their execution as they are written is guaranteed by the entire network. Ethereum relies on no single entity to run the contract. What that means is that the network can run self-executing (=smart) contracts between two or more parties in a way that relies on trusting no one.

Ethereum was the first of its kind, which has secured it a solid first mover advantage among smart contract platforms. Ethereum is the home of hundreds of projects. It has become the blockchain of choice for many projects that need a token. It is used by decentralized exchanges where users can exchange tokens with one another without trusting a centralized single entity without having KYC ( = Know Your Customer, required proof and registration of identity) forced upon the users. It's also used by decentralized lending protocols that allow for collateralized loans to be issued. The possibilities are limitless but decentralized finance is the economically most important application of Ethereum. All the transactions need to be paid for with Ether, the main token, which makes Ether (ETH) a utility token. The plethora of activity on Ethereum creates quite a bit of upward pressure on the price of Ether. One of Ethereum's drawbacks from the user's point of view is its high transaction fees owing to the fact that it uses Proof-of-Work as its consensus algorithm and its popularity.

Ethereum has transition into Proof-of-Stake in its road map. It's been talked about for years. The transition is slated to take place in phases between 2020 and 2022. In Proof-of-Stake (PoS) the right to act as a block signer will be gained by staking Ether (locking it into a contract) in exchange for staking rewards. PoS will make transacting on Ethereum cheaper and for the chain to be able to scale. Since Ether is a utility token that is used to essentially pay for artificially scarce computational power spent by the minders, the immediate impact of the transition into PoS on the price of Ether is not clear. There will be less demand for ETH as a utility coin but no selling pressure from miners, either. Better utility could be expected to increase the value of Ether.

Tether

Tether is a stablecoin pegged to the US dollar and backed by bank deposits. It is not an investment vehicle.

Ripple (XRP)

Ripple is a protocol for exchanging assets on a blockchain. Ripple is a network of payment gateways on a blockchain where IOUs (debt) are exchanged. Ripple is not trustless as transacting on payment gateways on Ripple requires trusting a counterparty to honor their debt obligations. Ripple could be characterized as an improved, highly automated and extremely scalable version of legacy interbank payment networks like SWIFT. The tokenomics of Ripple depends on the Ripple Foundation that controls an extremely large preminted stock of XRP tokens that are slowly burned in transactions on the network. Many consider Ripple not to be a true cryptocurrency because it is not a trustless, permissionless and decentralized network.

Bitcoin Cash (BCH)

Bitcoin Cash is a chain forked from Bitcoin in August 2017. The fork took place because there were two camps in Bitcoin: those who advocated large blocks to improve scalability (fitting much more transactions into each block processed in 10 minutes) at the cost of more network centralization and those who advocated keeping the blocks smaller so that Bitcoin nodes could be run with less resources. Note that while in Bitcoin mining - calculating the hashes - and operating a node which involves holding a copy of the blockchain and validating the blocks have been separated a long time ago, the increase in the block size would still have increased the hardware requirements for running a node (not a miner)). The two camps couldn't come to an agreement, which is why the large block advocates developed their own version of Bitcoin, which they called Bitcoin Cash, and started running it. This didn't sit well with the original Bitcoin advocates many of whom disparagingly called Bitcoin Cash (or BCash in the original Bitcoin people's lingo) just a money grab that made use of Bitcoin's brand recognition. The Bitcoin Cash people extol their chain's better ability to scale and function as a payment system. The Bitcoin forks are a good example of how irreconciliable differences are resolved in the world of crypto. Because all public blockchains use open source code owned by no one, anyone can create their own version of any chain and freely try and find support for it. If a blockchain ran copyrighted code, no one would touch it with a ten foot pole because that would contradict the tenet of permissionlessness.

Interestingly, in early December 2017, there was an attempt at robbing the original Bitcoin of its #1 status by the Bitcoin Cash camp. What they did was dump massive amounts of BTC for BCH to get the market caps to flip and to shake the confidence the market had for BTC's continued dominance. This was possible because the creators of Bitcoin Cash included many large Bitcoin whales. The attempt was futile which became evident in a few days. This failed operation had proved hugely costly to the founders of Bitcoin Cash involved.

Bitcoin Cash is not the only Bitcoin fork out there. Late 2017 saw many Bitcoin forks that had no chance to upset the market dominance hierarchy. Some of them proved to have staying power nonetheless and were no doubt profitable ventures for their founders.

Chainlink (LINK)

Chainlink is an intresting idea. It's a network of oracles that provide a decentralized feed of real world data indended for smart contracts to operate on. The problem with smart contracts is that they cannot trustlessly interact with the external world. The oracles run on individual servers that interact with the Ethereum blockchain to receive the LINK token (a so-called ERC-20 token on Ethereum like hundreds of others) as payment for their services and to read and write data on the chain (Ethereum). To increase trust, the users of Chainlink may require the oracles to stake the LINK token as collateral to keep them honest.

Chainlink is the most successful example of a service filling a gap in the blockchain space. Without oracles connecting blockchain to the analog realm they'd be confined to the digital realm. In the summer of 2020, Chainlink took the crypto space by a storm. Only in 2018 it had traded at 20 cents whereas now it is valued at over $12.

Binance Coin (BNB)

Binance Coin is a utility coin launched by the cryptocurrency exchange Binance. Holding it confers reductions in exchange fees, which gives the coin its utility. It has done well as its high market cap proves. If the crypto boom were a gold rush, Binance would be like a store selling shovels to prospectors and BNB would be a like a coupon issued by the store with which gear could be bought at a reduced price.

Polkadot (DOT)

Polkadot is a cross-chain interoperability protocol. Polkadot's internal architecture and consensus model are more complicated than usual. It involves staking and voting and multiple parallel blockchains with their own consensus and governance models and one central one called the Relay Chain. The external world is connected to via so-called Bridges. The key design goals have been scalability and ability to upgrade the system without forks. The system is used to pass tokens and all kinds of other information between chains. Polkadot basically answers to a need to connect blockchains and move the space beyond the current state where individual chains are islands that do not talk to teach other and between which there is a false sense of competition and not much value-enhancing interoperability, yet.

Litecoin (LTC)

Litecoin is one of the oldest altcoins. It was launched in October 2011. Its code base is based on Bitcoin but it uses a different hashing algorithm. Litecoin processes blocks four times faster than Bitcoin and its hashing algorithm is memory hard (= designed to require a lot of memory as opposed to processing power) the purpose of which is to make it easier to mine on consumer hardware. It has historically served as a test network of Bitcoin. It still has a pretty good brand recognition. It's available on a lot of exchanges and it has some use as a cheaper and faster way to move funds compared to Bitcoin.

Cardano

Cardano is a smart contract platform that uses a Proof-of-Stake (PoS) consensus algorithm. It boasts to have been based on peer-reviewed research. There are many (PoS) smart contract platforms these days. It was released in 2017. Conceptually there is nothing new to Cardano. Its founder is Charles Hoskinson who was also involved in the development of Ethereum and Bitshares.

Conclusion

As you can see, there are many types of coins even among the top 10 alone. I hope you were entertained and informed by this post. Deciding which coins to invest based on fundamentals is a lot of work because you have to study at least the basics to get a clue as to whether a network may or not have some use. This work isn't done by most investors, particularly retail, which is why the valuations of coins can be quite baffling at times. For instance, who would've guessed that a mere joke of a coin based on an Internet meme called Dogecoin (DOGE) (created in 2013) could end up having a market cap of over $300 million dollars and placed 47th on a list of over 8000 coins. This presents a problem because as investors you and I want a return on our investment. But going by fundamentals is by no means a clear pathway to profit as the market is can be quite irrational.

I won't be going through all of the 8000 coins any time soon. But we'll see if I can muster a fourth installment of this series where I will discuss coins and tokens picked out the vast undergrowth of smaller cap coins.

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