As bitcoin, the largest cryptocurrency by market value, became more mainstream this year, the number of altcoins, or alternative digital coins, such as XRP and polkadot, in the market began to increase rapidly as well.
Some have garnered more attention than others. Dogecoin, for example, is a meme-inspired altcoin that began as a joke in 2013, but recently surged in popularity. To even its co-founder's surprise, it's now one of the top 10 cryptocurrencies by market value and hit an all-time high of nearly 74 cents in May.
This is the result of a number of factors, including social media buzz by big names like billionaire Elon Musk. The SpaceX and Tesla CEO has been a frequent supporter of dogecoin on Twitter, but has also tweeted about other altcoins, like baby dogecoin and shiba inu.
Though it's not clear whether Musk's support is serious, his tweets mentioning these altcoins have seemed to impact their price and value.
Seeing this may tempt investors to take part in the action, but experts warn to be especially careful when investing in altcoins. Although cryptocurrency can be a very volatile and speculative investment in general, experts say altcoins can be even more so.
"Risk can be measured in a variety of different ways," Meltem Demirors, CoinShares chief strategy officer, tells CNBC Make It. But "many of these assets are much more risky than bitcoin and ethereum."
Here's what you should know, according to experts.
What is an altcoin?
Altcoins, which are sometimes called "s--- coins," typically refer to the multitude of cryptocurrencies aside from bitcoin. Although bitcoin and ether account for nearly 70% of the cryptocurrency market, as Demirors points out, there are thousands of other cryptocurrencies that exist.
There are many differences between altcoins and bitcoin. For one, most altcoins, like dogecoin, are created quickly with copied source code from other digital coins, including that of bitcoin. Often, altcoins are underdeveloped by design, whereas bitcoin was carefully created with a well thought out ecosystem, white paper and built-in scarcity. Bitcoin was made to be completely decentralized, whereas altcoins can often be controlled by a small group or entity.
Additionally, many developers behind altcoins put money into marketing their coins, while bitcoin does not, Demirors says.
Demirors also explains that for lesser known cryptocurrencies, there is typically less information available to the public, as well as less funding backing up these projects. That makes investing in altcoins riskier than bitcoin or ether — while there's potential for high reward in taking a risk, there's also a major chance of losing everything.
"As more and more cryptocurrencies proliferate the marketplace, lower market cap coins tend to be further out on the risk [vs.] reward spectrum," Demirors says.
Why altcoins are considered more risky
Though experts warn that all cryptocurrency can be a risky and volatile investment, altcoins may require additional caution.
There are many risks to consider, Demirors says, including reputation risk, which is the threat that an altcoin project may not be in good standing. Before investing, it's critical to determine if the founders of the project are credible.
Potential investors should assess market access risk as well, which refers to the accessibility of each digital coin, including where it's available for purchase. If the altcoin is only available via an obscure backchannel, rather than a regulated exchange, for example, it may be worth thinking through the investment a bit more. If the method of purchasing a coin seems sketchy, it's possible the altcoin project is unsecure or a scam.
However, one of the biggest risks of altcoins is technical risk, since the quality of code behind each digital coin can vary. Many of the dog-themed altcoins, for example, were created by developers who copied and pasted the source code of other coins to create their own. Dogecoin, in particular, is a fork, or code copy, of luckycoin, which is a fork of litecoin, which is a fork of bitcoin.
"In crypto, code is open source. This means anyone can copy the source code of a protocol or a smart contract, make minor changes and deploy that code," Demirors says. This can leave room for weaknesses within a code, making the altcoin potentially less safe and susceptible to bad actors.
Some altcoins, like shiba inu, run on the ethereum blockchain. Though its native currency is ether, ethereum has the ability to power different cryptocurrencies and applications due to the way it was built. This can allow for underdeveloped currencies to be launched into circulation at a low cost to a developer.
It's smart to make sure that a reputable third party has audited and reviewed the code of any altcoin you're interested in buying. An audit will uncover if there are issues in a digital coin's development, including if it's possible for a central party to control the network or its funds, Demirors says. That could be potentially harmful because a single entity could cause volatility in an altcoin's value. In an extreme case, it could even tank the value of the coin by withdrawing its investment.
However, even if a coin is audited, it's still possible for a sketchy project to slip through the cracks, so experts are clear: You should only invest as much as you can afford to lose.
Plus, there is typically no insurance for cryptocurrency investments, so it's possible to lose your entire investment regardless of how careful you are.
Investing on social media buzz can be dangerous
In addition to Musk, many social media influencers, including Kim Kardashian West, have been hyping different altcoins, sometimes through paid ads.
"It's no secret that crypto Twitter is the most active and passionate community on Twitter today, and smart marketers and fin-fluencers have recognized that engaging with Crypto Twitter will boost their own engagement numbers," Demirors says.
But, remember that just because an influencer or executive tweets about a cryptocurrency does not mean it is valuable or a good investment. Feeding into social media hype will often result in money lost, experts warn.
That's in part why investors should always do their own research before deciding where to put their money. As the SEC warned in 2017, "it is never a good idea to make an investment decision just because someone famous says a product or service is a good investment."
Sign up now: Get smarter about your money and career with our weekly newsletter
- 3 important differences between bitcoin and dogecoin, according to experts
- Here's what to know about cryptocurrency-based DeFi
- Younger investors are calling bitcoin 'boomer coin'–here's why they prefer dogecoin and other altcoins