Beyond Bitcoin: A Guide to the Most Promising Cryptocurrencies

Just as the success of Facebook helped spawn endless clones, Bitcoin’s arrival on the big stage comes with an assortment of digital currencies, known as “altcoins,” riding on Satoshi’s coattails. As the saying goes, a rising tide raises all ships. With Bitcoin up over 5000 percent since the beginning of the year, the altcoin market is booming. The price of Litecoin, what some consider silver to bitcoin’s gold, has traded as high as $20, up nearly 1000 percent in the last six months.

Is there room for more than one sheriff in town? In the case of Facebook, competitors with similar functionality never made it, regardless of apparently advantageous tweaks to the original formula. ConnectU, a direct copy founded by the Winklevii, was short-lived. Diaspora’s focus on privacy failed because people simply didn’t care. Google+ only survives in spite of itself because of, well, Google.

Successful competitors found a way to relevantly differentiate themselves. LinkedIn was for work. Twitter focused on short status updates you could broadcast publicly. Eventually, once Facebook matured, other entrants incrementally improved the social network’s fundamental features. Instagram filtered the photo while Snapchat perfected the selfie. Given bitcoin’s dominance, what will it take for an altcoin to succeed?

Litecoin: the little brother

Price at time of writing: $28.35

Market Cap: $503,102,328

Consistent with its name, Litecoin is essentially Bitcoin-lite and is the second most valuable altcoin. It shares nearly all the same features except it has a shorter block rate (every 2.5 minutes versus 10) and a different proof-of-work (scrypt versus SHA2). Shorter block rates mean faster transaction times, which is advantageous, but it’s not a huge change. The use of a separate proof-of-work is. Scrypt was chosen because it theoretically prevents the use of ASICs, those specialized chips that greatly increase mining power and efficiency (though there is debate over the validity of this claim). This is supposed to maintain a sense of egalitarian participation since the arrival of ASIC chips has significantly raised the barriers of entry for mining. If you aren’t already a Bitcoin miner, forget about it. That boat has sailed.

Unlike social networks, Litecoin benefits from its similarities to Bitcoin because of familiarity. All digital currencies have a learning curve, which meant Litecoin’s creators had little explaining to do. They also lucked out with timing. Litecoin popped up right around Bitcoin’s bubble earlier in the year, just as the first ASIC systems started shipping. This made it especially attractive to miners suddenly squeezed out by these powerful entrants. Rather than scrap their now unprofitable mining rigs, all they had to do was download some software to start mining litecoins, which had risen in value from about 50 cents in the fall of 2012 to a few dollars by early 2013. Because why not? They had nothing to lose.

Today, Litecoin maintains its status as a destination for Bitcoin castaways. For those who feel like they missed the boat, with Bitcoin hovering around $900, litecoins are a way to hedge their FOMO at a cost of only $20 each. Of course, you could always just buy a fraction of a bitcoin, but there’s something psychologically satisfying about owning a couple of something rather than 0.05.

All of which keeps Litecoin alive in a Google+ sort of way. It’s Bitcoin, but cheaper and not as popular, with a more accessible mining system. It’s there and people use it, but you aren’t really sure it has a purpose. It’s also not nearly as functional. If only a few vendors accept Bitcoin, nobody accepts Litecoin. That could change, and the shift could be an easy one, especially for those who already accept any digital currency. This makes its future much harder to predict, since it has no real identity of its own. But Litecoin may continue to exist simply because Bitcoin does.

Peercoin: Actually green

Price: $3.51

Market Cap: $73,096,656

Peercoin, the third largest cryptocurrency, is another Bitcoin clone with only a couple of distinguishing features. The first is that there’s no hard limit on the total number of peercoins mined and it's designed to eventually attain an inflation rate of one percent. This feature could theoretically boost Peercoin’s longevity.

And while Peercoin initially employs the same mining template as Bitcoin, the plan is eventually to transition from a proof-of-work mining setup to proof-of-stake. Rather than requiring processing power, the Peercoin algorithm is calculated based on the size of your holdings. So if you own one percent of peercoins, you’ll generate one percent of all proof-of-stake coin blocks. It also introduces the concept of coin “age,” which is the amount of time your coins have stayed static.

To mine, you “spend” the combined ages of your coins, which determines the probability of mining success. Attempting to mine and sending coins will reset their age. The benefit of this system is that it reduces energy waste, a criticism of Bitcoin mining, and addresses the “51 percent attack” vulnerability by making it much more expensive, relatively speaking, to take over the system. It also has a more consistent fee structure, which could incidentally lead to lower comparable transaction fees in the future.

Peercoin has yet to transition to this system so mining currently mirrors that of Bitcoin, which means it’s dominated by ASICs. Once that transition happens, Peercoin could be an easy choice for environmentally conscious cryptocurrency fans, you know, as a way to express themselves. And like Litecoin, Peercoin’s survival hinges largely on Bitcoin’s continued success. Its price, about $3.50, got a nice boost after being mentioned in The New York Times.

Namecoin: More than money

Price: $6.91

Market Cap: $51,210,571

As the fourth most popular crytocurrency, Namecoin is the first prominent iteration of the Bitcoin model that provides functionality beyond payments. While Namecoin can also be used as a currency, its purpose is to manage information access rather than money. In its current iteration, it utilizes all of the same Bitcoin principles to serve as a distributed Domain Name System (DNS) for the top level .bit domain. In other words, it’s a peer-to-peer version of ICANN.

Domain names are registered for a fee of 0.01 namecoins and recorded and maintained on the blockchain. New transactions occur when users transfer their domain name rights. Everything else works just like Bitcoin. The benefits of this DNS system versus a centralized one, like ICANN, is that it prevents internet censorship and theoretically reduces downtimes. But since domains are cheap and cannot be seized, cybersquatting is rampant by early adopters.

Namecoin is compelling because it proves just how versatile the decentralized Bitcoin model is. Beyond DNS, a similar system could be employed to manage logins, torrent trackers, or even decentralized email—all while maintaining the functionality of a currency. As such, it’s one of the only clones that may survive even if Bitcoin fails. Moreover, expect to see further variations of the system. As it turns out, Bitcoin is about more than just money.

Primecoin: For science!

Price: $5.45

Market Cap: 17,511,483

As mentioned earlier, one of the primary drawbacks of Bitcoin is that the mining system is a complete and utter waste of energy. And as Bitcoin expands, so does the waste, which is obviously a net loss for the environment. Those unfamiliar with the intricacies of the mining model will often suggest incorporating mining with useful systems of distributed computing like SETI@home and folding@home, where people can contribute their spare processing power to help find aliens or simulate protein folding.

The reasons those models don’t fit is because the solutions need to be efficiently verifiable. Once a profit motive exists, there’s nothing to stop bad apples from submitting fake results. But in Primecoin, we have the first execution of the Bitcoin model where mining actually contributes to society by implementing scientific proof-of-work. Rather than solving an arbitrary hash, Primecoin miners search for chains of prime numbers, which happens to be a rich and historic mathematics tradition for a variety of reasons covered by the University of Tennessee at Martin. The Electronic Frontier Foundation even offers $550,000 worth of prizes for anyone who discovers a prime number more than 1 million, 10 million, 100 million and 1 billion digits long, of which the first two have already been claimed.

The result is a digital currency that resembles Bitcoin but also serves a scientific purpose. With Primecoin, new blocks are generated every minute resulting in smoother difficulty adjustments and faster transaction times. And unlike Bitcoin, where block rewards are determined by a fixed schedule, Primecoin uses a self-adjusting formula. The number of primecoins released per block is equal to 999 divided by the square of the difficulty. Since Moore’s law predicts that computer power increases exponentially and the computing power required to discover prime chains is exponential in its length, this formula should converge at some maximum as long as the system’s overall difficulty increases linearly.

It’s a clever idea but not without flaws. The goal of the self-adjusting algorithm is to mimic gold. Unfortunately in practice, this causes issues. When interest in Primecoin increases, the rise in price attracts more miners and thus a higher difficulty level, which in turn means that the number of primecoins being created is reduced. The end result is that the supply of primecoins grows at a slower rate as demand increases, the exact opposite of the optimal desired outcome. This exacerbates price volatility, which, as we’ve seen with Bitcoin, is already problematic, given the currency’s wild price swings. A currency’s usefulness is defined by its price stability.

It’s a critical flaw that hasn’t stopped Primecoin from becoming the fourth largest cryptocurrency. Given the currency’s novel implementation of the Bitcoin concept, Primecoin could stand the test of time, just as SETI@home and folding@home have sustained that priceless feeling of doing good, even if its upside isn't as pronounced. If the benefits of ever-longer prime number chains is more abstract than finding aliens or curing Alzheimer’s as a benefit to society, there’s always the profit motive.

Ripple: Everyone's a bank

Price: $0.023

Market Cap: $2,311,810,087

Ripple is perhaps the most intriguing contender among the most popular altcoins, if only because it’s the only one that doesn’t resemble Bitcoin, and one that’s already attracted millions in venture capital from prominent firms like Google Ventures, Andreessen Horowitz, Lightspeed Venture, The Bitcoin Opportunity Fund. It’s uniqueness, of course, poses its own problems, in that most people aren’t sure what it exactly is. Rather than competing with Bitcoin directly, Ripple is meant to complement other currencies, both virtual and fiat, by acting as a decentralized payment system and exchange.

Ripple is technically an internet protocol, like HTTP and TCP/IP, which are used to relay websites and data, respectively, in a standardized fashion. Ripple is designed to send and receive payments. A good way to wrap your head around it is to think of email. Using your Gmail account, you can send email to your mom’s Yahoo account or even to that dude still using AOL. Ripple functions in a similar manner. No matter what provider or financial institution you use, you’ll be able to send money using the Ripple protocol.

Here’s where things can get a little confusing. Ripple isn’t just a currency or a payment process. It’s actually a whole slew of things. Ripple is composed of three main parts: a payment network, a distributed exchange, and its own Bitcoin-like currency. The payment network is basically a Facebook for finance, a web of approved friends you can transact with. The distributed exchange is an automated system for currency trades, giving Ripple cross-currency compatibility. That means you can send or receive money using any currency you choose, whether its dollars or bitcoins. Finally, the currency, known as ripples, plays a key role in the system's overall functionality and security.

So how does it work? At its core, Ripple is built around a distributed public ledger, similar to Bitcoin’s block chain, that records transactions and account balances, but also offers to buy or sell currencies or assets, thus creating the first distributed financial exchange. To achieve this, participants in the network agree to changes in the ledger via a consensus algorithm rather than proof-of-work. (It’s a bit technical, but there’s a video explaining the process.) Consensus is achieved every two to five seconds, eliminating the need for a centralized clearing house. The Ripple currency is then used as a means of preventing network spam and also serves as a bridge currency. Each transaction requires a small fee paid in ripples, which are destroyed once the transaction is made.

Still with me? Because it’s about to get a bit wonkier. Just like the financial system at large, Ripple is built on a system of trust. For instance, if you have $500 in your Chase account, you trust that the bank will have that money available for you when you withdraw it. This is the fundamental concept of the Ripple system and also where the social network comes into play. Except with Ripple, everyone is their own bank and you get to decide which friends to trust and how much money they’re good for. In other words, the ledger is a record of everyone’s debts rather than a balance of money they actually have in the system, just as your bank account balance is actually a record of the amount the bank is indebted to you. So with Ripple, you’re exchanging IOUs instead of cold hard cash, a revolving line of credit between you, your friends, and your friends of friends. Debts are then cleared outside the system. Here’s how it works:

It starts with a social network, in which the relationships between people are defined by lines of credit. For example, I know Stefan and Andreas. I am willing to let them get up to $1000 and $2000 in debt to me, respectively. In turn, they both know Elli. Stefan only recently met her and is only willing to give her $300 of credit. Andreas knows her better, knows she has a stable job etc - he is willing to give her $500 of credit. I have Bitcoins to sell.

Elli would like to purchase some Bitcoins for dollars. She does not know me, but that doesn't matter. She can instruct her exchange software to purchase coins and receive them from me immediately. By doing so, she becomes in debt to Stefan and Andreas by whatever amounts were necessary to make her desired purchase, and they both become transitively in debt to me. The fact that this debt exists may be a matter of public record for some implementations. For others, only the two actors in each line of credit know the balances. At some later date I will settle up with Stefan and Andreas. We can settle with cash, PayPal, wire transfers, whatever makes the most sense. We can use even quite reversible forms of payment like PayPal because of the pre-existing trust relationships. And of course, Elli will pay both Stefan and Andreas in the same manner.

Hence the name: debt “ripples” through your social graph.

Such a system obviously presents a host of potential problems. For one, every participant is exposed to a certain degree of counterparty risk, and measuring that risk isn’t something most people are good at or have practice doing, which is why they generally leave the practice of lending money to professional bankers. It’s impossible to be sure if or when someone will pay you back, even if they’re a close friend. It should be noted that the Ripple currency itself is not subject to counterparty risk.

Moreover, because transactions ripple through the system, your balances can be affected even if you haven’t personally made a transaction. In other words, you could wake up one day to suddenly find that you owe a friend (or a few friends) a bunch of money. In that sense, everyone is a passive liquidity provider, which inherently puts you at risk even when you have nothing to gain.

The currency itself has also been the target of criticism. Without a self-regulating system of mining, the creators of Ripple conjured up an arbitrary amount to start, exactly 100 billion ripples. They then proceeded to “gift” 80 billion of them to Ripple Labs, a for profit company, which intends to give away 55 billion of them to users of the system. Thus far, only a small fraction of those ripples have been distributed and there’s little transparency or standardization on how that process might work. In early November, the New York Times reported that 7.5 billion ripples had been released into the wild. As a protocol, Ripple itself is owned by no one.

The process of consensus also poses its issues, since the process of validation is distributed but not decentralized. In theory, users can pick and choose their own network of validators to ensure transaction integrity. But Ripple readily admits that “in practice, most people will use the default UNL supplied by their client.” Similar to the state of Ripple currency, this list of validators will be maintained by Ripple Labs, which promises to maintain a diverse selection of validators they can "trust to not collude to defraud us." Of course, poor management of the validator pool will undermine the entire system, prompting users to flee, but again, it ultimately amounts to a centralized system and power in the hands of a few.

Not only must users trust their selected network of peers, they also have to trust Ripple Labs. Predictably, these revelations have drawn the ire of Bitcoin supporters, who believe the company is trying to “cash in on Bitcoin’s popularity.” As such, the top Google result for a search of “Ripple currency” is the site RippleScam.org. Likewise, Ripple’s centralization and profit potential has made it particularly attractive to Silicon Valley investors.

Still, Ripple’s unique concept as a system of p2p credit is intriguing in and of itself and also has clear benefits. Transaction fees are lower or non-existent, similar to Bitcoin. But transactions are faster, confirmed in seconds rather than a minimum of minutes. It’s also more accessible in that users can use whatever currency they choose. It’s for this reason that Ripple’s creators claim it to be a complement rather than competition.

Indeed, as a decentralized exchange, Ripple might end up being the easiest way to purchase bitcoins or any altcoin for that matter, a process that remains daunting for cryptocurrency newbies. It also provides a practical way to spend your stash of coins, no matter what currency the merchant receives. Consequently, if Ripple ever gains traction, it will be a huge boon for digital currency innovation since new market entrants can join an existing platform. Ripple makes all currencies easy to use.

Which is perhaps what makes Ripple the smartest long term bet, beyond being not-just-another-Bitcoin. Even if the Great Crash happens, as many predict, and Bitcoin goes the way of MySpace, it’s only a matter of time before Facebook eventually arrives. In that sense, it’s protected against a potentially fickle public. It’s not just a bet on Bitcoin or any particular clone, it’s a bet on virtual currencies as a whole. Because if Bitcoin is Facebook, then Ripple is the iPhone. Who’s going to bet against that?

@sfnuop