Derivatives and Alt Coins

In rather basic terms, the value of a derivative is based on the value of something else, yet has no intrinsic value by itself. Given the buzz with banks and their “derivative” problems in the news today, are derivatives necessarily a bad thing? Well it depends on who you ask, but if we apply that same definition of derivatives to cryptocurrencies, we can see that nearly all alt-coins are simply a derivative of bitcoin to varying degrees. A simple (and popular) derivative example would be litecoin. For example, if bitcoin is priced at $150 and litecoin (being a derivative of bitcoin) is valued at 0.017 of bitcoin, then we can conclude that litecoin would be valued at 0.017 of $150 or ~$2.55 each.

But wait, there’s more. Generally speaking, the more derivative dependencies involved, the greater the derivative risk… And rewards. For example, if you check out Cryptsy, you might see that doubloons (DBL) are traded in litecoin only. Using the previous example above and the speculative value of DBL currently at 0.0025 of litecoin, we know that each DBL is currently valued at $0.006375. Since DBL value is based on litecoin, which is based on bitcoin, this can make for wider market swings in any given time frame due to increased number of dependencies. If, for example, DBL increased to 0.003 of LTC, which in turn increased to 0.02 of BTC which increased to $167, then DBL value has increased to just over $0.01, which is a hefty gain of over 50%. Of course the market could have turned out just as worse or some combination in between.

It gets even more complicated when you delve deeper. On one exchange, mcxnow, you’ll find you can trade mcxFEE’s which are essentially a futures derivative that pays dividends in multiple coins based on exchange volume. A recent analysis based on various metrics has indicated the mcxFEE’s are severely overpriced, even though their value has actually increased since the time of their review. This is not to say it was a bad analysis, but moreso that the market is still finding itself with regards to cryptocurrencies. Metrics and analysis aside, the market will always be at the right price at any given time.

Now that we know how derivatives relate to cryptocurrencies, the question remains… Which alt-coins are good investments? Only time knows the answer to that question, but if you’re a seasoned trader of alt-coins, then you know it’s important to do your homework before trading away your precious bitcoins for an alt-coin investment. If not, here are 3 questions you may want to ask yourself before you jump on the latest troll-box fad.

1. Developer competence and communication. IMO, this is the single most important factor. Many traders and miners rely on the “Magic” of developers that breathe life into these various alt-coins. Does the developer have a solid programming knowledge of cryptocurrencies? Do they communicate necessary updates in a clear and timely manner?

2. Is the coin sustainable? Some coins were created with the intent of severe deflationary effects in as little as 2 months. Once all coins are minted, this provides little incentive for miners to mine and support this coin through transaction fees only. Without miners to process transactions, trading may eventually grind to a halt leaving you holding the bag.

3. Does the coin have global appeal? A key to any successful cryptocurrency is global adaption. The more people that mine the coin, the more balanced the coin distribution is which ultimately makes a healthier market. Since cryptocurrencies are currently not limited by national borders, I would recommend avoiding coins that appeal only to a specific country only (CHN, AMC).

Of course, these are not the only questions to ask before investing. Sound off in the comments below and let us know what YOU look for when adopting an alt-coin.

Disclaimer: The views in this article are solely the author’s opinion and do not necessarily represent the views of CryptoLife.net nor its owners and/or affiliates. Any prices or forward looking statements in this article are for exemplary purposes only and are not intended to define what prices *should* be. As always, invest only what you can afford to lose and at your own risk.