Cryptocurrencies: A Beginner’s Guide to Altcoins

Cryptocurrencies have become an increasingly popular asset class, with thousands of them available in the market and new ones being launched regularly. However, due to the unique characteristics of each cryptocurrency, it can be challenging to compare them. One approach to ranking them is by their market capitalization, which is calculated by multiplying the number of assets available by their market price. Not surprisingly, the two most valuable cryptocurrencies are Bitcoin and Ether, which is the token for the Ethereum network. In this way, market capitalization can serve as a useful proxy for assessing the value of different cryptocurrencies.

Source: CoinMarketCap

Bitcoin and Ether are the two most valuable cryptocurrencies with the largest market capitalizations, which surpass those of the other top eleven cryptocurrencies by a significant margin. Moreover, they have been in the market for a long time and have an established track record in the history of cryptocurrency. As a result, they are often considered separately from other cryptocurrencies. In contrast, all other cryptocurrencies are usually referred to as “altcoins.”

The sheer number of altcoins available in the market can be overwhelming and confusing. It can be challenging to understand the various types of altcoins. To simplify things, let’s categorize altcoins into four groups, which can help you make sense of this complex universe of digital assets:

• Payment cryptocurrencies
• Utility tokens
• Stablecoins
• Central Bank Digital Currencies (CBDCs)

It’s important to note that there is a fifth group called non-fungible tokens (NFTs), but we will look at this group in the last section of this article. This is because NFTs have fundamental differences from other digital assets, and it’s important to address them separately.

1. Payment Cryptocurrency

The first group we will look at is payment cryptocurrencies, with Bitcoin being a prime example. The main function of payment cryptocurrencies is to facilitate digital transactions as peer-to-peer electronic cash. These cryptocurrencies typically have their own blockchain network dedicated to their use as a medium of exchange. The blockchain infrastructure is generally not designed to support smart contracts as low transaction costs and speed are prioritized. Another important aspect of payment cryptocurrencies is that they should have a finite supply to maintain their value.

1.1. Ripple (XRP)

Let’s now focus on the payment cryptocurrency that is ranked number six in our table, Ripple, and its native token XRP. Ripple was launched in 2012 by Ripple Labs, even before the Ethereum network. Ripple uses a distributed ledger called the XRP Ledger (XPRL) to track transactions. The network was designed to be faster, cheaper, and more scalable than Bitcoin, and XRP is intended to be used as a bridge currency for global payments. What’s interesting about Ripple is that it uses a quorum-based consensus mechanism to put transactions in order using a predefined set of rules to prevent double-spending. Transactions are arranged in a first-come, first-served basis, and validators in the XRP Ledger have a voting system to determine whether or not to include transactions in any given round, which is equivalent to a block in Bitcoin.

Unlike Bitcoin, where it takes up to 10 minutes for a block to be solved and up to 60 minutes for probabilistic finality, Ripple aims for transactions to take only 3 to 6 seconds, even for international payments. It is also more scalable, currently capable of processing 1,500 transactions per second compared to Bitcoin’s 7 to 10 transactions per second. The ultimate goal is to match Visa’s scale of 65,000 transactions per second.

So, how does it do that?

In Ripple, there is no mining process like in Bitcoin. Instead, validators, which are any nodes that run the network software, group transactions by their order of arrival. For example, if Maria tries to send $10 to both Alex and Peter, and the payment to Alex arrives first, then everyone can agree that Maria has enough funds to pay Alex. If the payment to Peter comes second, then it’s clear that Maria cannot send the funds to Peter because they have already been sent to Alex. To group transactions, Ripple uses a proprietary protocol consensus algorithm that groups new transactions or transactions that are awaiting processing every few seconds by each validator. Each validator groups them in a candidate set and compares the candidate sets with other validators on the network, sorted by time. The transactions are then executed according to a set of rules. If over 80% of validators agree on a transaction in a candidate set, the transaction is added to the distributed ledger, and that ledger entry is finalized and closed. If any transaction doesn’t receive enough votes, it will either be discarded or added to the next candidate set. Each transaction can only appear on the candidate set twice before being rejected permanently.

Validators play an important role in maintaining the security of the Ripple network. Anyone can become a validator, but Ripple has a list of preferred validators. Unlike other cryptocurrency networks that require mining, Ripple’s consensus algorithm doesn’t require mining, which means that it has a lower environmental impact. Additionally, the cost of making transactions on the Ripple network is very low, with the minimum transaction cost being 0.0001 XRP or 10 drops, the smallest unit of XRP.

1.2. Issues with Ripple (XRP)

The Ripple network, while having several advantages such as low transaction costs and energy efficiency due to no mining being involved, is not free from issues. One of the main concerns is the supply dynamics of its finite supply of 100 billion XRPs. The Ripple Labs Foundation, which oversees the network, was allocated 80 billion XRPs to sell periodically to fund the ecosystem. The remaining 20 billion XRPs were kept by the three co-founders of the network. Although each transaction on the XRPL burns a little bit of XRP, there are concerns about the supply dynamics, both from regular sales by the foundation as well as unscheduled and unannounced sales from the co-founders.

Moreover, Ripple has been sued by the US Securities and Exchange Commission in December 2020 for allegedly selling XRP as an unregistered securities offering. The proceeds of the sale were used by the company and founders to fund operations, which resembled a stock sale. The lawsuit is still ongoing, and the outcome is currently uncertain.

Despite these issues, Ripple has a strong use case, with many banks and legacy financial institutions backing it. Tokens other than XRP, called IOUs, can be created on the XRPL, allowing other digital assets such as stablecoins and NFTs to use the XRP ledger.

2. Utility Token

Moving beyond payment cryptocurrencies, now let’s explore utility tokens. As the term “utility” refers to the economic concept of something having value due to its usefulness, these are digital tokens that offer some type of benefit to the holder. This is different from the meaning of “utilities” in equity markets, which refers to companies that provide essential services like electricity and gas. It’s important to note that there are many different types of utility tokens, each with their own unique purpose.

Utility tokens can be broadly categorized into five types: financial tokens, infrastructure tokens, governance tokens, service tokens, and media and entertainment tokens.

2.1. Financial Tokens

We will begin with financial tokens. This category can be further divided into two sub-categories: exchange tokens and security tokens.

2.1.1. Exchange Tokens

The financial utility token we should explore is Binance Coin, which is an exchange token. Binance Coin, or BNB for short, is an acronym for Build and Build.

Binance Coin (BNB) is a digital token specifically designed for use on the Binance cryptocurrency exchange, which is renowned for its high trading volume and widespread popularity in the cryptocurrency industry. The founder of Binance and creator of BNB is Changpeng Zhao, a highly accomplished Chinese-Canadian programmer who has made a name for himself in the world of fintech. CZ, as he is commonly referred to, began his career as a developer of futures trading software and quickly progressed to designing high frequency trading systems. Today, as the CEO of Binance, CZ is one of the wealthiest individuals in the world, having invested his liquid net worth entirely in cryptocurrencies.

In 2017, Binance Coin (BNB) was launched via an initial coin offering (ICO) as a utility token for the Binance cryptocurrency exchange. Users of the platform are able to use BNB to pay for fees and also receive discounts. As such, BNB falls under the category of financial tokens, specifically exchange tokens, as it is used on both centralized and decentralized exchanges on the Binance network. Moreover, BNB is also used to pay for smart contracts and decentralized applications that operate on Binance’s latest blockchain.

Binance Coin was initially created with a limited supply of 200 million during its initial coin offering. However, Binance has been utilizing a feature called BNB Auto Burn, where they buy back 20% of their profits every quarter and destroy BNB tokens until only 100 million remain. As a result of this limited supply, BNB has taken on a more speculative nature.

BNB, which was initially built on the Ethereum network as an ERC-20 token standard, has now transitioned to its own blockchain using the BEP-2 standard. In 2020, Binance launched a third version of BNB on another chain using a newer standard called BEP-20. As a result, BNB currently exists in three different versions, each with the same purpose. Binance users can move their BNB between these different versions using the platform’s digital wallet, but it’s essential to specify which specific token they want to transfer. The implementation of multiple token standards can create confusion among users, but Binance has provided a solution for seamless transfers across its different chains.

For network consensus, BNB uses the Proof-of-Staked-Authority (PoSA) algorithm. Under this system, validators must stake collateral in the form of the token to be able to verify new blocks and add them to the blockchain, and earn transaction fees associated with the block. However, unlike Proof-of-Stake systems like Ethereum 2.0, only validators who stake the most BNB have the power to make decisions. The idea is that those with a significant amount of BNB have a vested interest in ensuring the blockchain remains accurate and free from bad actors. The top 21 validators, based on the amount of BNB they stake, are selected as validators for the day, and take turns validating blocks. The following day, the same process is repeated. This approach is much faster than Ethereum’s system, which has around 70,000 validators.

2.1.2. Security Tokens

Another type of financial token is known as a security token. These tokens represent fractional ownership in a security or asset. In essence, investing in a project through a security token is similar to crowdfunding, but the investment is represented by the token. However, security tokens exist in a regulatory gray area, as financial regulators often classify them as a traditional security offering subject to the same regulations as stock or bond offerings. Therefore, although security tokens are not commonly seen, they do fall under the broader definition of financial tokens.

2.2. Infrastructure Tokens

The second category of utility tokens is infrastructure tokens. These tokens serve a specific purpose within a blockchain network’s infrastructure. For example, Ether is used to pay for transaction fees for processing smart contracts, transfers, and decentralized applications (Dapps) on the Ethereum network. Other examples of infrastructure tokens include Cardano and Solana.

2.2.1. Cardano

Cardano is a popular cryptocurrency that ranks seventh in terms of market capitalization. Its ticket symbol is ADA, which is named after Ada Lovelace, a renowned 19th century mathematician. Cardano is known as a third-generation cryptocurrency that aims to improve scalability by increasing the efficiency and speed of transactions. To achieve this, it uses a Proof-of-Stake network consensus that allows for staking pools, offering an alternative to Ethereum. Cardano also has the ability to incorporate smart contracts and decentralized applications (Dapps).

Cardano was one of the first cryptocurrencies to promote its green credentials by using the PoS consensus method. It has also partnered with various organizations, including corporations for supply chain management, universities for tamper-resistant accreditations, and clothing and shoe markets for proof-of-authenticity. Like Ethereum, Cardano has a high cap of 45 billion ADA, with the currency released into circulation as staking rewards from reserves. ADA is also consumed as gas for transactions, smart contracts, and Dapps, contributing to deflationary factors.

2.2.2. Solana

SOL is an infrastructure token and its blockchain Solana boasts being the world’s fastest blockchain. It has a transaction processing speed of over 3000 per second, which is more than twice as fast as Ripple and 300 times faster than Bitcoin. The cryptocurrency’s designers aim to eventually achieve a speed of over 700,000 transactions per second, surpassing Visa’s current speed of 65,000 TPS.

Solana achieves its high processing speed through its approach to securely recording the timestamp with each transaction, which they call Proof-of-History or PoH. PoH uses logic to stamp a sequence of orders for all incoming transactions, rather than relying on a traditional clock timestamp. Using the PoH timestamp logic makes it much faster for the various nodes that form the Solana network to agree on which transaction came first, reducing the time needed for nodes to communicate back and forth. It also allows nodes to process smaller pieces called entries, rather than waiting for an entire block to fill up.

Once the blocks or entries are validated, they use a delegated Proof-of-Stake consensus protocol. Holders of SOL may choose to delegate their tokens to one or more validators who process transactions and then share the reward with the SOL owner. The more coins that you have delegated to a manager, the more likely that manager will get chosen to process a transaction and receive a transaction fee shared with you. Fees on the Solana network are currently very low, at around a fraction of a penny.

However, in order to be profitable, managers need to have a very large stake, which creates a problem since the majority of stake in the Solana network is concentrated among a very small group of validators. This concentration poses a risk for the entire network in case the validator is offline or not functioning, making it impossible for stakers to earn any rewards.

2.3. Other Utility Tokens

The final three types of utility tokens are governance tokens, service tokens, and media and entertainment tokens. These tokens are less common because they serve a specific purpose and are not typically used for speculative investments.

2.3.1. Governance Tokens

Governance tokens provide their holders with the ability to vote on important decisions and changes within a cryptocurrency network. These decisions are typically significant and essential to maintain the decentralized nature of the network. By allowing the community to vote on proposals, governance tokens ensure that decision-making power is not concentrated in the hands of a small group. For instance, Decentralized Autonomous Organization (DAO), which operates as a type of virtual cooperative. The famous Genesis DAO is an example of this. Another example is MakerDAO, which has a separate governance token called the MKR. Holders of MKR can vote on decisions related to MakerDAO’s stablecoin, Dai.

2.3.2. Service Tokens

Certain cryptocurrency projects offer service tokens that provide access or enable specific actions on a network. Storj is an example of such a service token, offering an alternative to popular cloud storage providers such as Google Drive, Dropbox, and Microsoft OneDrive. The Storj platform rents out unused drive space to individuals seeking cloud storage, and users pay for the service using Storj’s native utility token. To earn these tokens, users who are storing data must pass hourly cryptographic file verification checks to confirm they still possess the data.

2.3.3. Media and Entertainment Tokens

Media and entertainment tokens are primarily used in content creation, gaming, and online gambling. Basic Attention Token (BAT) is an example of such a token, rewarding users with tokens for voluntarily viewing advertisements. These tokens can then be given to the top content creators, providing a means for monetizing their efforts.

3. Other Types of Altcoins — Memecoins

If you look at the table in the beginning of this article, you can also notice Dogecoin. Dogecoin, the famous meme coin, was originally created as a joke for crypto enthusiasts, but quickly gained popularity and became one of the leading cryptocurrencies in use today. Its logo is based on a popular meme featuring a Shiba Inu dog, and it was introduced in December 2013 using the same technology as Bitcoin and Litecoin. However, Dogecoin included improvements such as faster access feeds and more affordable transactions. Its success can be attributed to a robust community, popularly known as the Doge Army, which includes influential figures like Elon Musk, Mark Cuban, and Snoop Dogg.

Created by two software engineers, Bill Markus and Jackson Palmer, the purpose of Dogecoin was to raise public awareness of blockchain technology capabilities. In 2021, during the crypto boom, Dogecoin’s value rose as high as 74 cents per token. However, as it does not have a hard cap on its total supply, the value of the coin dropped just as quickly as it had risen. Nowadays, the current price hovers around seven cents per coin.

Crypto Buyers Beware of Risks!

This brings us to the next point — as the world of cryptocurrency and digital assets continues to expand, it’s essential for investors to exercise caution and be aware of what they’re buying. Investing in these assets should be approached with the same level of scrutiny and diligence as any other financial instrument. It’s vital to conduct thorough research and analysis before making any investment decisions. Relying on hearsay or purchasing assets solely based on FOMO (Fear of Missing Out) can lead to potentially disastrous outcomes. So, to navigate the often unpredictable waters of crypto investing, it’s essential to stay informed and disciplined.

Here are some of the fundamentals to consider as your conduct your own due diligence:

• For any crypto asset investment, it would be wise to first start by reading the white paper. This provides valuable insights into the cryptocurrency’s technology, purpose, and potential use cases.
• Another important factor to consider is the team behind the crypto asset. Examining the track record and experience of the team can give investors a sense of the potential risks involved in investing in the asset. Given the lack of regulation and oversight in the digital assets space, it is important to avoid investing in a crypto asset that could potentially collapse due to fraudulent activity.

While there are still no widely accepted ratios or metrics for evaluating cryptocurrencies, there are several measures that are gaining popularity.

• One such measure is the Network Value-to-Transaction ratio (NVT), which calculates a network’s value based on the value of transactions it processes. Cryptocurrencies with lower NVT ratios are considered undervalued, while those with higher ratios may be overvalued.
• Another useful metric is the Price-to-Mining-Breakeven ratio, which compares the cost of producing a digital coin in a Proof-of-Work protocol to the price of the coin itself. A digital coin with a lower break-even ratio is generally more profitable.
• Finally, on-chain metrics provide insights into blockchain activity, including transaction counts, the total value of transactions, active accounts, and hash rate. By analyzing these metrics, investors can gain a clearer understanding of the activity and potential of a particular blockchain.

! It is important to remember that the cryptocurrency market is largely unregulated, which means there are a lot of scams and fraudulent activities taking place.

According to Statista, crypto scams between 2017 and 2022 totaled over $20 billion, with rug pull scams accounting for roughly a third of the losses in 2021. Rug pull scams are perpetrated by bad actors who lure in investors with promises of quick riches. They hype up a new cryptocurrency, attract investors, and then disappear with all the funds. Unfortunately, many investors fall prey to these scams due to the gamification of traditional investments and the prevalence of social media.

One of the recent rug pull scams occurred in 2021, capitalizing on the popularity of the Netflix series Squid Game. The creators of a new cryptocurrency called Squid (SQUID) planned to release 800 million tokens for sale in exchange for Binance Coin (BNB). Holders of SQUID would then use their tokens to compete in a series of games inspired by the show, with winners receiving NFTs and the final winner taking the pool prize. As word of mouth spread, the token’s price skyrocketed, reaching over $2,800 per token. However, on November 1st, 2021, the creators pulled the rug out, swapping their Squid Game coins for BNB and stealing roughly $3.4 million before vanishing.

Therefore, investors need to be vigilant when investing in cryptocurrencies and be aware of the warning flags that could indicate a rug pull scam. These warning flags include a lack of value outside the supposed exchange, an inability to cash out or off-ramp freely, and a lack of a blockchain. By doing their due diligence, investors can protect their investments.

4. Stablecoins

The high level of volatility and risk associated with cryptocurrencies has made it difficult for everyday individuals to use and even more challenging for professional investors to participate in the market. To mitigate these challenges, the marketplace has introduced a cryptocurrency asset known as stablecoin, which aims to address price fluctuations and maintain a more stable value.

So, what is the stablecoin? A stablecoin is a type of cryptocurrency that is designed to maintain a stable price by linking its value to an external reference. This means that the value of the stablecoin is tied to another asset, which is typically less volatile. If the value of the external reference remains stable, then the price of the stablecoin should also remain stable.

In the table of cryptocurrencies at the beginning of the article, you may notice stablecoins such as Tether, USD Coin, and Binance USD. To maintain a stable price, some stablecoins are backed 100% by reserves held by the issuer of the cryptocurrency. This concept is similar to money market funds in traditional finance, which invest in short-term, high-quality securities to maintain a stable value and provide a secure place for investors to temporarily hold their excess cash.

In addition to stablecoins that are backed by collateral or traditional fiat currency and high-quality securities like money market funds, there are also some stablecoins that hold commodities or loan money to crypto-related borrowers. Some types of stablecoins even use computer programs to maintain price stability without being backed by anything. Regardless of the type of stablecoin, buyers must trust the issuers to properly manage the reserves, or token supply to maintain their value. That’s why the three stablecoins on our table are centralized, meaning that the issuers hold the digital ledger that records ownership and are the only ones allowed to write to the blockchain. Unlike Bitcoin, Ether, and other altcoins, there is no mining or network consensus protocol required for stablecoins. This makes them very different from other tokens and cryptocurrencies we’ve looked at so far.

4.1. E-Gold

Stablecoins are a type of cryptocurrency that some may find ironic because they are centralized and, in some cases, backed by the same fiat currencies that cryptocurrencies were intended to disrupt. However, the concept of a pegged coin has been around since the early days of digital currency. In fact, one of the earliest digital coin projects, “E-Gold,” was introduced in 1996 by lawyer Barry Downey and oncologist Douglas Jackson.

E-Gold used physical gold coins that were stored in a safety deposit box, which were then divided into portions that could be bought and sold digitally. It quickly became popular and was used by over one million people globally, with some measure of commercial adoption. However, the cryptocurrency was not able to keep up with cybersecurity, and the network was eventually compromised.

4.2. Why Stablecoins?

Stablecoins are a type of cryptocurrency that aim to provide price stability, which is achieved by being pegged to a specific asset or basket of assets, such as fiat currencies, commodities or cryptocurrencies. Despite being centralized, and in some cases requiring holders to put their trust in an unknown central entity, stablecoins are designed to provide more predictable pricing than traditional cryptocurrencies, which can experience significant volatility.

Stablecoins are valuable to crypto traders who may wish to park their investments while awaiting better market opportunities. Additionally, stablecoins can be used by anyone looking to use cryptocurrencies for everyday transactions without worrying about price fluctuations affecting their purchasing power. Due to their price stability, stablecoins can offer savers better returns than savings accounts in traditional financial systems.

Furthermore, stablecoins can be used as collateral in cryptocurrency-backed loans. Unlike traditional banks, lenders in the cryptocurrency space are not bound by banking regulations, which has led to the emergence of shadow banking. Although shadow banking may offer higher yields than traditional savings products, it lacks government regulator oversight and does not provide government-backed insurance like most financial institutions.

Finally, stablecoins have been issued on various blockchain networks that support smart contracts like Ethereum and Solana, which has made them widely used throughout the DeFi space.

4.3. Types of Stablecoins

Stablecoins come in four main types that are commonly found in the market: fiat-collateralized, commodity-backed, crypto-collateralized, and algorithmic stablecoins.

4.3.1. Fiat-collateralized Stablecoins (off-chain)

The first is fiat-collateralized stablecoins, where the stablecoin is backed by fiat currency as collateral. These stablecoins are not only backed by USD but also by other currencies such as EUR, GBP, MXP, CNY, and more. Regardless of the currency, this group of stablecoins offers a one-to-one ratio with reserves, and the reserves are generally invested in safe and liquid securities like government bonds.

Examples of fiat-collateralized stablecoins include Tether, which has a ticker USDT, USD Coin with a ticker USDC, and Binance USD with a ticker of BUSD. Other notable coins include Pax Dollar, which has a ticker of USDP, and TrueUSD, which goes by TUSD for short. As these stablecoins are usually backed by cash or cash equivalents, these type is known as off-chain stablecoins.

4.3.2. Commodity-backed Stablecoins (off-chain)

Another type of off-chain stablecoin is the commodity-backed stablecoin. PAX Gold and Tether Gold (XAUT) are examples of such stablecoins, which are pegged to commodities, particularly precious metals like physical gold. This concept is similar to the digital currency project called E-Gold, which was introduced in the 1990s. It is important to note that commodity-backed stablecoins are centralized tokens that link their price to the value of the underlying commodity. In the case of Tether Gold, each token is pegged to one troy ounce of gold held in a secured location in Switzerland by a custodian. The holder of XAUT tokens can redeem them for one ounce of gold, which can be delivered in Switzerland or liquidated by Tether.

4.3.3. Crypto-collateralized Stablecoins

The third type of stablecoin are tokens which are backed by one or more cryptocurrencies. These stablecoins are also called on-chain stablecoins since their collateral is stored on a blockchain. The value of this type of stablecoin is pegged to one or a group of cryptocurrencies, but it also has a soft peg to one unit of fiat currency.

One of the most popular examples of a cryptocurrency-backed stablecoin is DAI. The cryptocurrencies used as collateral for DAI are determined by the holders of the governance token in the MakerDAO, which manages the stablecoin. However, since cryptocurrencies are highly volatile, crypto-backed stablecoins usually have an over-collateralization feature. This means that for every USD worth of token, there may be up to two times the amount of crypto used as collateral.

To generate $1 worth of DAI, a holder must pledge $1.50 worth of Ether or eligible crypto collateral into a vault. If the DAI is redeemed, the collaterals are returned to the redeemer, minus an interest charge, making DAI similar to a collateralized loan. The interest rate fluctuates to maintain the soft peg, and if the price of DAI deviates too much from the value of the collateral and hits a minimum ratio, anyone on the protocol can initiate the liquidation of the collateral in an auction.

Auction keepers, usually automated bots, ensure that the vaults are properly collateralized. The auction proceeds are first used to meet the vault’s obligations and assess a fee to the original vault holder. The auction keepers also earn a fee for spotting under-collateralized vaults, and any leftovers are returned to the original vault holder. If the liquidation is not enough to cover the vault’s obligations, it becomes protocol debt and is paid from a buffer of revenues of the MakerDAO.

4.3.4. Algorithmic Stablecoins

Algorithmic stablecoins are a type of stablecoin that use complex computer programs known as algorithms to keep their prices stable. These algorithms balance the funds held on the blockchain, using smart contracts to control supply and demand to maintain price stability.

An algorithmic stablecoin protocol achieves price stability through a process called rebasing. This process reduces the number of coins circulating when the market price goes down and increases the number of coins circulating when it goes up. This is similar to how a central bank may act to defend the peg of their domestic currency in foreign exchange markets by buying or selling foreign assets.

Ampleforth (AMPL) is an example of a pure algorithmic stablecoin that targets maintaining a price close to $1 based on 2019 consumer price index levels. In times of excess demand, the stablecoin’s price might be expected to increase above the $1 peg, and the protocol releases more tokens to existing holders proportionately to bring prices down. In times of excess supply, the protocol will contract the number of coins that holders have to bring up the price of each remaining token.

However, the challenge with algorithmic stablecoins arises when there are significant price moves. It is uncertain whether the computer program that runs the algorithm can cope with these unexpected events, often called black swan events.

4.4. Deep Dive — Tether

Let’s explore Tether in more detail. Tether is the largest and possibly most well-known stablecoin. Tether is widely used by crypto investors and has a market capitalization of $70.9bn, but like most cryptocurrencies, it has faced controversy.

Tether was founded in 2014 by Reeve Collins, Craig Sellars, and Brock Pierce, a former child actor in a few Disney movies. At first, their stablecoin token didn’t gain much traction. However, in 2015, Tether was acquired by new owners based in Hong Kong who also own the Bitfinex crypto centralized exchange. The integration of the token into the Bitfinex ecosystem led to an increase in its popularity.

As Tether grew, it ran into issues with its banking partners. These partners were concerned about the lack of KYC and other checks in the token once the stablecoin passed from the first holder into circulation, sometimes even on numerous blockchains. However, Tether managed to find a new banking partner. During the ensuing crypto bull run, Tether (USDT), which is pegged to the US dollar, became the most popular among the top tokens by traded volume.

Source: Tether Holdings Limited. Consolidated Reserves Report as of 31 December 2022.

Now, USDT has been described as a fiat-based stablecoin, but let’s actually look at what secures this stablecoin. Tether provides financial statements on its website that reveal the assets backing USDT, and let’s do some simple assessment (asset breakdown of Tether provided above). The first category consists of money market securities, which are low risk. Category two includes around $3.5 billion in corporate bonds, funds, and precious metals that are more volatile than cash equivalents but acceptable as they account for no more than 5% of total assets.

However, categories three and four are where things get interesting. They comprise other investments and secured loans, accounting for over 10% of the assets backing USDT. The financial statements provide no clarity on these investments and loans, which could be risky crypto projects, loans to the company’s owners, or money siphoned off to related companies. If the cryptocurrency weakens, how liquid or redeemable are these assets should Tether need to cash out to honor its liabilities? These are essential questions that investors should weigh.

Some may think that this thinking is very negative. However, investors should always do their research and think of any potential missteps that has been made by the company.

5. Central Bank Digital Currencies (CBDC)

Despite the increasing interest of central banks in cryptocurrencies, a full-scale Central Bank Digital Currency (CBDC) has not been introduced anywhere yet. The key characteristic of a CBDC is that it is a virtual digital currency issued by a central bank, making it a centralized currency. It can be issued in the form of a token or an electronic record, and it is pegged to the domestic currency of the issuing country or region.

As CBDCs are issued by central banks, this gives them legitimacy and allows the central bank to maintain full authority and regulation over the currency. While the implementation of CBDCs into the financial system is still in its early stages for many countries, it has the potential to become more widely adopted over time and may have an impact on monetary policy.

However, CBDCs should not be confused with instances such as El Salvador’s decision to adopt a cryptocurrency in September 2021. Although CBDCs share similarities with payment cryptocurrencies like Bitcoin, they have a centralized and permissioned blockchain, with supply controlled solely by the central bank. CBDCs are intended to offer an alternative for low-cost value transfer digitally, rather than replace the current fiat currency of a country or region.

Central banks have not only conducted research on CBDCs but have also begun testing them. The Bank of Canada, the Monetary Authority of Singapore, the Riskbank in Sweden, and the People’s Bank of China are among the central banks that are the furthest along in this regard. While there are critics who claim that central banks are not the right place to implement a cryptocurrency, it’s apparent that the current situation of fraud and risk with private cryptocurrencies is not effective.

5.1. Wholesale CBDC vs. Retail CBDC

Let’s now distinguish CBDCs into two types — wholesale CBDCs and retail CBDCs.

Wholesale CBDCs, as the name suggests, are digital currencies designed primarily for financial institutions to use when dealing with each other rather than individuals. This is beneficial because it allows for faster and more reliable automated clearing and settlement of interbank payments and securities. Wholesale CBDCs may also facilitate smoother cross-border transactions, as they are ledger-based and do not require physical wire transfers like current transactions. This could potentially reduce economic rents for both end-users and banks. Canada’s Project Jasper in 2018 and Singapore’s Project Ubin in CBDCs have focused on this type of wholesale cryptocurrency token.

The second type of CBDC is a retail-oriented digital asset that acts as digital cash backed by the central bank of a country or region. This would eliminate the volatility associated with cryptocurrencies and local currencies as the CBDC would be pegged to the domestic currency. The long-term goal of retail CBDC is to eventually replace physical cash with a digital wallet accessible on a smartphone or other electronic device. This would simplify transactions, reduce economic rents, and improve financial access for underbanked populations.

China has been exploring a retail-focused digital asset, known as e-CNY, since 2014, and has piloted its use in select cities through lotteries to its citizens as of 2021. Despite this progress, the e-CNY still requires third-party services like WeChat Pay or Alipay, and users must set up an account on an e-CNY app, making it not yet fully independent. Similarly, as paper-based krona usage declines in Sweden, the Riskbank has begun a retail CBDC project called e-krona.

5.2. Advantages of CBDCs

Regardless of whether it is a retail or wholesale CBDC, these digital assets share similar advantages and disadvantages. Let us begin with the benefits.

Firstly, CBDCs offer stability. They would have little to no volatility, which would reduce the risk of fraud and failure often associated with other cryptocurrencies.

Secondly, CBDCs could increase accessibility. Traditional banking systems are limited to business hours and do not operate during weekends or holidays. CBDCs, on the other hand, could be available 24/7, improving international payment options and reducing economic barriers for the underbanked.

Lastly, CBDCs could improve the reputation of cryptocurrencies. By broadening the use of permission blockchains for money and payment systems, it would provide legitimacy to the entire cryptocurrency ecosystem. This move would discourage the use of cryptocurrencies by criminals and other malicious users while giving governments the means to track and tax cash transactions. Also, a legitimate government-provided cryptocurrency alternative could crowd out private stablecoins, potentially eliminating bad actors in that space.

5.3. Disadvantages of CBDCs

The drawbacks of CBDC also deserve careful consideration.

The first concern is the return to a centralized entity that controls the recording of all transactions on the blockchain, posing operational risks with a single point of failure. The loss of anonymity, which other cryptocurrencies presently offer, and the risk of potential censorship further exacerbate the issue.

Another significant disadvantage is the potential difficulty for central banks to enact monetary policy changes as needed when dealing with another de facto currency. A central bank’s ability to control the money supply is crucial in fulfilling their mandate, be it price stability, economic growth or full employment.

Lastly, the risk of cyber security issues looms large with CBDC, as with any other cryptocurrency. If hackers gain control of the centralized ledger of a widely adopted CBDC, the consequences could be catastrophic, jeopardizing both wholesale and retail operations for banks and the entire financial system.

Central banks and regulators are currently exploring these and other related issues to ensure that potential CBDC adoption is approached with caution and careful consideration.

6. NFTs

NFTs, or non-fungible tokens, represent a unique type of digital asset that stands out from other categories like payment cryptocurrency, utility tokens, stablecoins, and Central Bank Digital Currencies. The key differentiator lies in the concept of “fungibility,” which refers to the ability of an asset to be exchanged or replaced with another of equal value.

Economically speaking, an asset is deemed to be fungible if it can be readily substituted with another asset of equivalent value. A prime example of this would be a $100 bill, which can be exchanged for either one hundred $1 bills or two $50 bills, without affecting its value. Similar principles apply to stocks and bonds, where one share of a company’s stock is interchangeable with another share of the exact same company. Likewise, one bond can be replaced with another bond of the same issuer, without impacting its worth.

Regarding the previously mentioned types of cryptocurrencies such as payment cryptocurrencies, utility tokens, stablecoins, and CBDCs, each crypto asset within those categories is completely interchangeable with another of the same type. For instance, if one were to exchange an Ether token for another Ether token, or a unit of USDT for another unit of USDT, the exchange would be of no consequence to the owner, since the utility and therefore the value of the tokens are identical. This same principle applies to other cryptocurrencies such as BTC or BAT, where one unit of the cryptocurrency is interchangeable with another of the same type.

However, NFTs are distinguished from other digital assets by their non-fungible nature, meaning that no two NFTs are exactly alike. They are unique and non-interchangeable units of data that are stored on a distributed digital ledger, serving as a form of digital signature that publicly verifies ownership of a digital or physical asset. An NFT can be linked to a digital certificate of authenticity that confers license to use, copy, share, or display the underlying asset, with the added security that ownership records cannot be modified or duplicated.

NFTs can be traded on various specialized online marketplaces, such as OpenSea, Rarible, SuperRare, and Foundation. These tokens are commonly associated with digital files like videos, photos, and audio files. NFTs can also serve as proof of ownership and authenticity for online digital collectibles, such as a weapon in a video game or an asset in a metaverse where only your avatar has exclusive use of that object. Furthermore, NFTs can also be used to authenticate and prove ownership of physical collectible items known as “offline collectibles.” These items include valuable art, watches, jewelry, sneakers, and even fine wine.

NFTs can also serve as “negative value” assets, representing obligations such as loans or responsibilities, or as tickets to events and credentials, including degrees. In other cases, NFTs might represent fractional ownership of real estate.

6.1. Characteristic of NFTs

It is important to note that purchasing an NFT does not grant the new owner any copyrights or intellectual property rights to the underlying asset, unless explicitly stated. Typically, those rights remain with the asset’s original creator. Additionally, creators can set up NFTs so that they receive a portion of any future resales of the NFT in perpetuity.

While an NFT proves ownership of a digital asset, the asset itself is not stored on the blockchain. Instead, the private key to a blockchain address confirming ownership of the NFT resides in a digital wallet, and the NFT represents proof of ownership and authenticity of the asset. Once the network consensus protocol verifies the transfer of ownership, the public record becomes indisputable proof of ownership, and anyone can verify the record.

Various blockchains now support NFTs, but Ethereum was the first blockchain to host them. One of the earliest online collectible NFTs was CryptoKitties, a digital trading game in which users could collect, breed, and trade unique virtual cats stored on the Ethereum blockchain network. The popularity of CryptoKitties in the early days of the Ethereum network caused the entire platform to slow down.

6.2. Why Buy NFTs?

The question of why someone would buy an NFT is a complex one, with many factors at play. Critics of NFTs argue that the value of owning an NFT, particularly for digital assets like images, is limited. They point out that digital images can be easily copied and transferred without the NFT owner’s consent, potentially depriving them of royalties. However, owning a one-of-a-kind asset, whether it is a physical or digital item, holds a certain value for many art collectors. For such collectors, the value of an asset is not necessarily determined by its practical utility or functionality, but rather by its uniqueness, rarity, and cultural significance. Limited supply, uniqueness, and nuance are all factors that drive collectors, as demonstrated, for example, by the sale of baseball cards, stamps, and other collectibles for millions of dollars. Therefore, it is reasonable to assume that NFTs, which offer the same appeal as trading cards but in a digital format, would hold similar appeal to collectors.

6.3. Commercial Use Cases & Risks

NFTs offer real-world applications in the commercial world, notably by providing an unchangeable confirmation of both ownership and authenticity for digital and offline assets. Verification of the public address of the NFT can easily be conducted by a collector to ensure authenticity, while a prospective seller can prove ownership by presenting the private key to the address of the blockchain platform on which the NFT resides. This process becomes even more straightforward if the asset itself is digital.

However, the primary risk associated with NFTs is the blockchain technology itself. In case the blockchain where the NFT is stored fails or goes under, the NFT’s seal of authenticity and ownership may be lost, which can never be verified again. Even though the digital asset may be secure since it is kept off the blockchain, proving ownership of the unique original might be impossible.