- Just like the traditional stock market index, crypto index funds are becoming increasingly important, especially to retail investors
- Most crypto index funds keep track of the performance of the top 20 cryptos by market capitalization
- An index fund is a proven way of diversifying risk by investing in multiple assets
Since blockchain and cryptocurrencies gained institutional and mainstream interest, there has been a continuing upward trajectory in terms of adoption. Bitcoin and other cryptocurrencies are fast becoming a household name across many industries and the general public. However, there are two major issues with this model: it is difficult for retail investors to buy, and it is difficult to diversify. Crypto index funds have the ability to solve this problem.
The 2018 bear market that saw the price of Bitcoin plunged below $3500 is currently fading away, Bitcoin is currently sitting comfortably above the $10k mark. Blockchain technology and cryptocurrencies have opened up a lot of opportunities to the public in the world of finance. Cryptocurrencies have served as an alternative investment for most people.
Just like the traditional stock market index, the demand for a crypto index fund is continually growing. With a lot of crypto index funds springing up lately, this is unarguably going to be a very hot topic in the cryptocurrency space in 2020.
Crypto index funds work similarly to other existing traditional index funds e.g. the S&P 500 Index. Understanding how S&P 500 works will give you an idea of what you can expect in a typical crypto index.
Financial Indexes and The S&P 500
An index is an indicator or measure of a quantity. It refers to a statistical measure of the change in the securities market. Usually, Indices are made up of a basket of securities that represents a portion or segment of the entire market. A good example is the S&P 500 and the Dow Jones Industrial Average (DJIA).
The S&P 500 calculates the valuation of the stocks of the top 500 corporations by market capitalization traded on the New York Stock Exchange(NYSE) or NASDAQ Composite.
The S&P (Standard and Poor) measures the performance of the stock market by keeping track of the profits and loss of the largest listed companies in the United States. Investors use it as the overall market benchmark for weighing other investments. Certain criteria govern the listing of a company’s stock in the index.
The S&P is the largest index in the United States with 500 listed companies compared to the Dow Jones Industrial Average (DJIA) that tracks only 30 companies. It is important to note that it is not possible to invest in the index directly, however, you can invest in Exchange-Traded Funds (ETFs) that mirrors the performance of the index.
How Crypto Index Fund Works
Most individuals involved with cryptocurrencies handle their funds directly via multiple exchange platforms, cold storage, hardware wallets, and more. This management could be ambiguous and makes it extremely difficult to keep track of everything going on in the market.
Thanks to crypto index funds there is a solution to this hassle and is a useful reference for anyone who wants to get an idea of the current market picture. Aside from being an investment basket that houses and manages a group of cryptocurrencies in one place, the crypto index helps in diversifying investments across a wide range of currencies. This helps spread the risk associated with a single asset.
Most crypto index funds are made up of top cryptocurrencies by market cap, a typical example is the CIX100 index, Grayscale and Bloomberg’s BGCI Index. Fund managers and investors leverage on this index to stay on top of things around market movements.
The index also assists crypto investors in keeping track of selected assets, such as the top 20 coins by market capitalization. An example is Bloomberg’s BGCI Index that keeps track of the top 12 cryptos listed in Coinmarketcap, as they are considered to be most liquid and less volatile digital assets.
A cryptocurrency index doesn’t work in isolation, it retrieves trading data via streaming exchange APIs from some selected cryptocurrency exchanges. This gives investors the luxury of creating a portfolio that best matches their investment choice.
Investing Strategies That Tracks The Performance Of Crypto Index Fund
As stated before, it is not possible to invest in an index directly. However, portfolios can be built to mirror the performance of an index. Platforms that make it possible for retail investors to invest in an index fund are now rising slowly. A good example is the Coinbase Index Fund, Shrimpy, and AXIACoin.
Investing in an index fund is not a complex task as many would think. In fact, it is a very straightforward activity.
Investing in an index involves buying into an index fund in the form of shares made up of a basket of different cryptocurrencies. In other words, you don’t buy into any single coin directly but rather you buy into a fund that is made up of a bunch of cryptocurrencies. The money invested is spread across the basket of cryptocurrencies you have selected.
A cryptocurrency Exchange-Traded Funds (ETFs) is another brilliant investing instrument that taps into an index. A cryptocurrency ETF works, in theory, just like every other ETF. It would track the performance of an index or a basket of one or more digital assets.
Companies that offer ETFs services usually have a commensurate or equivalents stake of the digital tokens being indexed. The ownership of these digital assets is usually represented in the form of shares. Investing in an ETF will require investors to buy into these shares. ETF investors gain exposure to the performance of the underlying digital asset. An example is the Bitcoin ETF.
As cryptocurrency and blockchain continue to penetrate the mainstream Fintech, many new innovations are poised to further disrupt this space. Even though the crypto indexes are a relatively new concept within the crypto community, it is, however, gaining increased popularity each day.
Investing in cryptocurrencies should involve some mindful research about the market, and so is a crypto index. As more companies hit the crypto airwaves with their innovative products, the ability to index into crypto and maintain diversification could become a game-changer.