The term cryptocurrency has come to encompass much more than just Bitcoin (quotation BTC). Therefore, knowing where to start can be confusing. To help you, we can divide cryptocurrencies into different categories based on their properties. This categorization helps distinguish one type of cryptocurrency from another.
While there are many more than three types of cryptocurrencies, the ones we'll cover here are a good place to start. The first are pure cryptocurrencies, such as Bitcoin. The second are stablecoins, which are backed or linked to fiat currency. The last is tokens, which are very similar to stocks, but for cryptocurrency companies.
1. Cryptocurrencies as well
A pure cryptocurrency is built to be a form of money on the Internet. Although Bitcoin was the first cryptocurrency set to become the internet's native currency, it has many competitors.
Shortly after the birth of Bitcoin, other projects were born that sought to improve the Bitcoin model. Other coins such as Ethereum (ETH) have copied aspects of the Bitcoin model, such as node counting and block rewards.
As new projects emerged, they experimented with the number of computers running the network (number of nodes) and the issuance of new coins (rewards in chunks). The number of nodes is a rough measure of how decentralized and robust a cryptocurrency is. In large part, block rewards determine the monetary policy of a particular cryptocurrency. That is, how many coins exist and when new coins come into circulation.
The fundamental aspect of pure cryptocurrencies is that they are independent financial assets, preferably considered as money on the internet.
2. Stable coins (stablecoins)
Stable currencies are priced pegged to a fiat currency, such as the dollar. They are interesting for the stability and familiarity of the digital currency or the dollar. In most cases, stablecoins can benefit from the benefits of cryptocurrencies, such as near-instant transfer times and low-cost transaction fees.
The stable coin design is such that it avoids price volatility, which is the main drawback of pure cryptocurrencies. For this reason, Stablecoins are the preferred asset for trading over pure cryptocurrencies. They allow traders to take and hold profits in a stable asset instead of worrying about price volatility.
Although the intention of stablecoins is to keep the price anchored to the corresponding asset, some stablecoins have lost the anchor. This is because not all stablecoins are backed by fiat currency deposits. When this happens, holders of a stablecoin may find it impossible to redeem it for the original asset or something of equivalent value. Some stablecoins are priced by algorithms, which have proven not to be as reliable as a stablecoin with physical media.
Also known as crypto token, this cryptocurrency category is quite broad. Tokens comprise more than 99% of digital currencies, in part because they are so easy to create and launch. In most cases, tokens represent a participation in a cryptocurrency project, platform or network.
Many tokens are launched through a process called initial coin offering (ICO). This is a similar process to listing a company through an initial public offering (IPO). At this time, investors can purchase tokens from project administrators if they believe in the use case or the direction of the company. In general, the more possibilities a token can be used within an application or product, the greater the value the token can acquire.
Examples of use cases are paying commissions on a platform, joining company special offers, and participating in the governance of a project. Once launched, the token is subject to price fluctuations as the project progresses and the market develops.
A good portion of crypto tokens are governance tokens. These types of tokens function like a company's stock. They are used to vote on the direction of the project, how the treasury is spent and what new features need to be developed next. This new type of company has been given the name of DAO, for decentralized autonomous organization. Tokens play an important role in the governance of these organizations and represent a step in a new direction in administrative decision making.
There are many other sub-categories
While pure cryptocurrencies, stablecoins and tokens are a good place to start, there are many other sub-categories that can give you a broader understanding. The interplay between these types of top-tier cryptocurrencies is what makes up the entire cryptocurrency industry. Most of them fall into one of these three categories. One notable exception is non-fungible tokens (NFTs), but it is a type of cryptocurrency that needs its own item to be fully covered.