How to Buy a Crypto Index Fund
Rather than pick individual stocks, many stock market investors prefer to invest in funds based on broad-based indexes or market sectors. Over the past five to ten years, the number of cryptocurrencies available to investors have grown. New sectors like DeFi (Decentralized Finance) have emerged as well. What options are available to investors who would rather buy a crypto index as an easy way to acquire and manage a cryptocurrency portfolio? This article will explain how to buy a crypto index.
Why Buy a Crypto Index?
- Accurately track the broader crypto market: Don't miss a big move in an alt coin by only owning Bitcoin.
- Reduce volatility and risk: Owning a portfolio of diverse investments has been shown to lower risk.
- Lower effort: Buying one index is easier than buying individual components.
Crypto Index Asset Selection
- Characteristics: Index funds are usually created with a set of shared characteristics. For example, one could create a DeFi index, comprised of cryptocurrency tokens associated with Decentralized Finance, such as UNI, AAVE, and MKR.
- Market cap: Market capitalization, viewable on a site like CoinGecko, gives an indication of the overall value of a particular coin. Most indexes are constructed from the top market cap coins sharing certain characteristics.
Crypto Index Allocation
- Market cap weighted: Most indexes weight the components by market cap, meaning that bigger and higher notional value cryptocurrencies comprise more of the index, while smaller cryptocurrencies are a similarly small part of the index.
- Equal weighted: Some indexes are constructed to give the same weight to every component, meaning an index of 5 cryptocurrencies would contain 20% of each, no matter how large or small each coin's market cap is.
- Square root weighted: Taking the square root of a market cap weight will have the effect of making the weights a bit more equal. Since Bitcoin has such a large market cap, many indexes constructed with Bitcoin as a component could be viewed as overweight an otherwise expensive and mature coin and being underweight smaller coins with potentially higher upside potential.
- Minimum weight: Sometimes an index with either many components or a large variance in weights can lead to some components having very small weights. In an effort to combat that, you might see indexes set a minimum weight for inclusion and either exclude small components or round up their weight for inclusion.
Crypto Index Maintenance
- Additions and removals: If an index is constructed using a variable input like market cap, then the index definitions and weights will change over time. This could mean that some components become too small to remain included and must be removed, while others can increase in value and should be added to the index.
- Rebalancing: The market caps or variable inputs of the components can vary over time, meaning that the index weights may change over time. An existing cryptocurrency index portfolio may require overweight components to be sold and underweight components bought. This process is called rebalancing.
- Buffer zone: If a change in weight is so small as to be de-minimus, it might not be worth changing the index definition or rebalancing. To manage this process, a buffer zone can be established.
- Frequency: Index definitions and rebalancing are typically done on a monthly, quarterly, or annual basis.
What Crypto Indexes Are Available?
- Bitwise 10 (BITW)
- Bloomberg Galaxy Crypto Index (BGCI)
- Nasdaq Crypto Index (NCI)
- S&P Crypto Megacap (SPCMC)
- Cboe and CoinRoutes
Trading a Crypto Index
- Exchange listings: Not all crypto exchanges list the same coins. Therefore, it can make crypto index fund constructions difficult and specific to an exchange.
- Investment products vs. baskets: Some indexes are tradable as structure products, funds, or futures. They typically do not give you ownership over the individual components, but rather indirect financial exposure to the index. The term "basket" is sometimes used to refer to the collection of index components.
- Fair value: Investment products may trade at a discount or premium to the fair value represented by the individual components. Depending on the market dynamics, it might not be possible for professional trading firms to engage in arbitrage in order to keep the values of the index funds in-line with the fair value. Therefore, trading a basket of the individual index components is the best way to trade at the fair value.
- Fees: Index funds that are actively managed as a structured product usually have an expense ratio or ongoing fee. In the nascent crypto market, these fees can be quite high and cut into investment returns.
- Dollar cost averaging: Rather than invest all your money at once and possibly buy at the high, you might consider investing a fixed amount over a period of time in order to avoid poor market timing.
How to Buy a Crypto Index Fund with Cove Markets
Cove Markets will soon be launching an Index Trader with predefined cryptocurrency portfolios. This will allow users to buy a cryptocurrency portfolio of coins with shared characteristics. Customers will own the individual coins and there will be no hidden fees or overhead.
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