Types of cryptocurrencies
Updated: Jun 21, 2021
When faced with the question “Which is better? Bitcoin or Ether”, I freeze because callously naming one would be doing a huge disservice to the person asking the question. I think those of us familiar with the cryptocurrency space should take the time to explain the cryptocurrency ecosystem and that is exactly what I attempt to do here.
Choosing between bitcoin and ether is like choosing between Unilever stock and oil. The 2 belong to completely different categories. In today’s article, I list out the different categories of cryptocurrencies. This is not an exhaustive list. I’m sure I’ve missed whole categories but I hope I’m able to provide a framework to serious investors. When you hear of a new cryptocurrency, your first step should be to determine which category the cryptocurrency falls in and then compare it to others in the same category.
Take a minute to study the chart above. The cryptocurrency universe can be divided in 2 - DeFi and Non-DeFi. DeFi is further divided into 5 categories and Non-DeFi into 2 categories.
Cryptocurrencies that serve only as money and nothing else. This might seem trivial because in history just about anything has been used as money. However, there are properties that make something a better candidate to be used as money than others. And a good candidate for money does a better job of transferring value across space (say transfer money to someone in the other side of the planet) and safeguarding value across time (say store purchasing power for your grandkids). Gold is a better candidate to be used as money than say seashells. Bitcoin is a better candidate to be used as money than U.S. dollars.
Within the currencies category, there are 2 types:
A. Public coins - All transactions are published in a public ledger and one can see the provenance of every coin. When it was created, which wallets it passed through and which wallet it is currently sitting in. The real-world identity of the person or organization that controls the wallets may or may not be known though. => Cryptocurrencies that fall in this category include Bitcoin, Litecoin, Bitcoin cash, Bitcoin SV, Dogecoin, etc
B. Privacy coins - These are a class of coins that enable anonymous transactions. They obscure the origin and destination addresses of the coins as well as the amount being transferred. They protect the identity of users and are not appreciated by law enforcement agencies that view it as a tool for criminals.
Privacy coins are further of 2 types.
=> Those that offer anonymity by default like Monero (XMR) and
=> Those that let the user decide if they want anonymity like Zcash (ZEC) and DASH.
An Apple iPhone or any Android phone is a platform on which different apps run. Similarly, there are blockchains that serve as platforms for running dapps (decentralized apps). These blockchains support smart contracts i.e. contracts that self execute when certain conditions are met thanks to a built-in if/then logic
3. Dapps (Decentralized Apps)
We all have apps on our smartphones. These might include Uber, Deliveroo, Coinbase, WhatsApp, Gmail, Zoom, etc. The dapps (decentralized apps) that run on blockchain platforms have their own cryptocurrencies.
The dapps running on platforms require data from outside the dapps. For example, if CRV is being borrowed by depositing ETH on Aave then Aave needs to pull data on the correct price of CRV and ETH. This data can come from decentralized exchanges like Uniswap and Sushiswap as well as centralized exchanges like Coinbase, Kraken, and Binance. There is a danger that the data from outside sources could be corrupted. Depending on a single data source is not advisable for a smart contract as incorrect pricing will lead to incorrect transactions that cannot be reversed given the immutability of the blockchain. There are cryptocurrencies that specialize in collecting data from outside the blockchain environment in a decentralized manner.
=> These include Chainlink (LINK) and Band protocol.
Given the volatility of cryptocurrencies, it helps to have blockchain native cryptocurrencies that track the value of the more stable fiat currencies like the U.S. dollar. What is the point of having a cryptocurrency that tracks the U.S. dollar? Why not keep money in the original U.S. dollar form? Let’s say you want to convert your bitcoin to U.S. dollar, then converting to USDT is much easier than converting to U.S. dollar as value remains on the blockchain and does not need to be off-ramped.
There are 3 main types of stablecoins
A. Fiat-backed stablecoins - are backed 1:1 with fiat currencies i.e. there is an audited bank account somewhere holding cash and cash equivalents that back every unit of the stablecoin. These stablecoins are centralized and non-transparent.
=> Examples include USDC, USDT, GUSD, BUSD.
B. Crypto-backed stablecoins - are backed by cryptocurrencies. Given the volatility of cryptocurrencies, 1:1 backing is not sufficient. These are over-collateralised. For every unit of stablecoin issued, say 1.5 cryptocurrencies are locked through smart contracts to the platform. These stablecoins exist on the blockchain and the cryptocurrencies backing these stablecoins are available for anyone to see and verify. However, given the high collateralization ratio, they’re not that capital efficient.
=> An example is Dai of MakerDao.
C. Algorithmic stablecoins - are stablecoins that maintain their value through price stabilizing algorithms. There are no currencies necessarily backing them.
=> Examples include Terra, Fei protocol,
1. Data storage and transmission
Cryptocurrencies that use blockchain to provide data storage or content caching and streaming services.
These are of 2 types:
A. Static data - Decentralized data storage services that challenge centralized cloud storage provided by the likes of Amazon Web Services.
=> These include Filecoin (FIL), Storj, and Sia.
B. Dynamic data - These use a network of distributed computing devices with spare processing capacity to cache and stream video content.
=> The best example of this is Theta and TFuel.
2. Non Fungible Tokens (NFTs)
Most cryptocurrencies are fungible i.e. one unit of a particular cryptocurrency is the same value as another unit of the same cryptocurrency. 1 BTC coin is equal to any other BTC coin. If I borrow $100 from you, you want me to return $100 to you. You don’t care if I return the exact same $100 note. However, 1 Picasso painting is not the same value as the crayon drawing I made in kindergarten. Similarly, Non-Fungible Tokens follow a different token standard such that each token is different. In the case of Ethereum, NFTs use the token standard ERC721 or ERC1155. Fungible tokens on Ethereum use the token standard ERC20. Other blockchains have similar standards for fungible and non-fungible tokens.
=> NFTs can represent art like the “Everydays: The first 5000 days” created by artist Beeple that sold recently for $69 million, collectibles like NBA Top Shots, digital plots of land in virtual worlds like Decentraland (MANA) or video game skins and weapons.
There are many other ways to categorize cryptocurrencies as well.
** Security tokens vs Utility tokens
** Coins vs tokens - Do they native tokens of a blockchain or built on another blockchain?
** Consensus mechanism- Do they use proof of work, proof of stake, proof of authority, proof of space-time?
** Distribution - Were coins pre-mined or did they have a fair distribution?