The Compounding Risk of Alt-Coins and the Impending Alt-Coin crash.

I’ve been having a lot of discussions of late regarding the bitcoin landscape and what we’re in for in the near to medium term. I’ve been with bitcoin for a long time now and I’ve been watching the sentiment change over time, it’s truly exciting. I’ve also been well in tune with public sentiment on bitcoin and I’ve recently noticed a worrying trend.

People new to Bitcoin always initially gravitate towards the idea of bitcoin mining and really that’s to be expected. “What? I can make money with my computer?” of course people are going to look into that. I think we need to accept this is going to happen, and people soon enough realise mining bitcoin isn’t a simple proposition nor profitable.

The thing that worries me most right now is that people new to cryptocurrency are instead looking into mining alt-coins as a way to “get in”.

Historically when times are good for bitcoin, the alt-coins all get a boost, with people looking for an investment that can appreciate at a faster rate and in effect compound their profits. But conversely when times are bad for bitcoin, the alt-coins take a tumble.

At the root of the issues are a few major points

  1. The alt-coins don’t provide a major innovation to give them value as an alternative crypto-coin
  2. Alt-Coins can’t be used to make purchases and can almost exclusively only be traded or donated (and then traded to realise any value anyway).
  3. Alt-Coins can’t be directly traded for any of the major fiat currencies and must first be traded for bitcoin to realise any value.
  4. The liquidity of alt-coins is miniscule.
  5. Alt-Coin values are explicitly linked to bitcoin values.

In comparison bitcoin is accepted by many thousands of shops, it can be directly traded for any of the major fiat currencies, it is the original major innovation and has earned the associated network effect, it has quite substantial liquidity although still small in relative terms to the broader forex sectors and finally it is valued independently against fiat currencies.

The lifecycle of bitcoin is necessarily unstable and experiences rapid growth, and rapid contractions. We can accept that, and we understand the risk. What many don’t understand is the domino effect on alt-coins.

When times are bad people rush to dump their crypto-coins no matter which crypto-coin. Generally they are looking for an exit into a fiat currency. When times are bad the resistance and liquidity falls, accelerating market movements. Consider a situation where your crypto-coin is falling and you first need to sell your crypto-coin for bitcoin, before selling it for fiat. The first part of the cycle is that your crypto-coin will be dumped by many for bitcoin, with extremely limited liquidity and with very little buy interest for your crypto-coin. The exchange value of your crypto-coin for bitcoin will plummet as not only do people panic sell to exit bitcoin because the price is falling, the crypto-coin price relative to bitcoin is also diving because people are also exiting the alt-coin for bitcoin compounding the USD value declines.

We are watching new crypto-coins being released with absolutely no innovation, pre-mined (one person already mined all the coins, ie. corrupt), and with absolutely no infrastructure, but yet they are gaining market caps in the millions within days of release. Every man and his dog is trying to create their own cryptocurrency with little to no barriers to entry, and the list of alt-coins will inevitably explode in the coming months to hundreds if not thousands of minor variants. This is a disaster waiting to happen.

In truth most of the alt-coins are simply used as an alternative means for buying bitcoin, which is an absurdity in itself, since bitcoin is the easiest of all the cryptocurrencies to buy. Vendors who accept the one alt-coin that has achieved any traction (litecoin) are really only looking to convert it back to bitcoin anyway, so they actually have no incentive to accept anything other than bitcoin in the long run (other than to capitalise on the wealth effect of “litecoin millionaires” wanting to spend their worthless hoards).

Bitcoin could conceivably lose 90% of its market cap in the coming months, this is just a natural growing pain, but the trickle down effect on the alt-coins will be catastrophic. Bitcoin has the liquidity and interest of new investment to resist an out of control freefall, whereas alt-coins simply don’t. A 90% decline in bitcoin immediately results in a 90% decline in alt-coins value, the panic selling of alt-coins necessarily means their sale for bitcoins, which compounds the alt-coin losses again as their bitcoin relative values also freefall. The result could be a 90% loss compounded by a 90% loss, for a 99% loss in value.

So what’s the rub? Sure you can make some quick money on alt-coins, but don’t delude yourself. When shit inevitably hits the fan, the vast majority of alt-coins will trip, fall, tumble and ultimately die. A novel alt-coin might have a fighting chance but in the end the world only needs one crypto-coin and for the benefit of all, only actually wants one crypto-coin, so far none of the competitors are novel enough to become the dominant player.

One currency to rule them all, one currency to find them
One currency to bring them all, and in the darkness bind them.

Mark my words, the cryptocurrency space is in for a rocky ride and an alt-coin crash. When? I’ve got no idea, possibly in a year or two, but it will happen.

As a caveat, personally I don’t count namecoin as an alt-coin because its purpose isn’t as a currency. As such although I wouldn’t invest in namecoin, it should persist beyond the alt-coin crash cycle.

5 thoughts on “The Compounding Risk of Alt-Coins and the Impending Alt-Coin crash.

  1. paulrg on

    Couldn’t agree more. It will be alt coins that create the crypto currency bubble with gains in value akin to all those companies that gained multi million dollar valuations during the dot-com bubble just because they put an “e” in front of their name.

    It will be a necessary growing pain and, when the tide does go out, the strongest will initially suffer in tandem but will then also eventually rise again – but that may take some significant time.

  2. simonvrouwe on

    “A 90% decline in bitcoin immediately results in a 90% decline in alt-coins value, the panic selling of alt-coins necessarily means their sale for bitcoins”

    Sale for bitcoins … thus countering further decline of bitcoin price. So perhaps the alt-coins can bring some stability in the bitcoin exchange rate, dampening the sharpest fluctuations. The alt-coins bring liquidity in the bitcoin market as they can be converted into bitcoins relatively fast. That being sayd: alt-coins are a riskier gamble, unless it’s the one that brings some significant improvement over bitcoin.

  3. Jeremy Gan on

    That’s just not true. I’m an investor in Quark and the currency has the real potential to change the nature of the game because it is founded upon CPU mining rather than GPU or ASIC mining – hence restricting the creation of a “super-computer super-class.”

    The trouble with you Bitcoiners and Litecoiners, is that you think the crypto-world revolves around you just because you are financially and emotionally linked with the two strongest currencies. Well I have news for you, Bitcoin won’t be around in ten years time. It may have fired the first shot, but it won’t be the currency that claims the crown.

  4. @simonvrouwe

    The altcoin to bitcoin market is entirely separate from the fiat market, so unfortunately it doesn’t provide stability for bitcoin.

    @Jeremy Gan

    “I’m an investor in Quark” – I’m not sure I can be bothered reading the rest of your comment because I’ve lost respect for you, but let me try anyway.

    scrypt is not immune to ASIC’s, in fact a scrypt ASIC is being produced as we speak. And the problem you describe exists already in Quark in the MASSIVE early mining rewards (borderline pre-mined). There are many other inherent problems with Quark, such as stupidly rapid blocks, which causes major blockchain bloat, which is further compounded by the illusion of extra security through additional hashing rounds. If Quark is used to any degree the blockchain will be unmanageably large, and sooner rather than later no CPU will be able to check transactions because it requires far too much hashing to catch up on the blockchain.

    One thing I’m certain of is Quarkcoin has absolutely NO future. None.

    You need to understand the protocol behind each cryptocurrency before you suggest one is worthwhile, because Quarkcoin is NOT sustainable.

  5. Philippe on

    Even if I agree on most of your points, there is something strange in saying “Bitcoin has the liquidity and interest of new investment to resist an out of control freefall” tahen just afterwards you talk about an hypothetic “90% decline in bitcoin” I think if you’re invested in BTC or any ALT, 90% or 99% don’t matter much… it’d mean that the whole crypto world had taken a serious blow…

    You got to sort the alts, many are long run P&D schemes, others seems to have some future. I think you shouldn’t invest more than 50% of your BTC in alts, and no more than 10% of your whole portfolio in a specific alt.

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