Why Should I Invest in Crypto Indices?
Recently, a new way of raising money in crypto has emerged. It allows you to earn without buying digital assets themselves while reducing the risk to a minimal level. Meet crypto indices — indicators that reflect performance of a certain group of crypto assets.
What are indices? Imagine a class of 30 students passing a test. Each of the students will get their own score, and their average grade reflecting the overall result is an index. The class takes the test weekly, so the index will constantly change, showing shifts in students’ general performance over time.
Indices have been popular in traditional finance since the 19th century when they were first introduced by Charles Dow (we will review the Dow theory, a robust theoretical framework for analysing cryptocurrency prices, in our future posts). Crypto indices represent a new promising investment opportunity that allows earning a good healthy income. Let’s see what they are and how you can profit from them.
Indices in traditional economy
In finance, a market index depicts how a certain number of stocks have performed over time. Instead of considering asset prices one by one, you can use the index to grasp an overall picture of what was happening in the market in a given period.
In the late 19th century, an American journalist and the founder of the Wall Street Journal Charles Henry Dow was trying to find a way to describe general market movements. He introduced the first indices in history — DJIA, Dow Jones Industrial Average, and DJTA, Dow Jones Transportation Average. The former represented the largest American manufacturing companies, while the latter brought together the biggest railroads, airlines, and delivery businesses.
In any index, each company that is a part of it has its share, or weight. The more the company’s stock price and its market capitalization, the more weight in the index it has. A business with a share of 20% will impact the index’s price more than a company with a weight of 10%.
Dow Jones’ indices are still around today, but the most popular market index now is S&P 500 (The Standard and Poor’s 500). It represents the largest 500 public companies in the USA. S&P 500 doesn’t include all America’s businesses, but it comprises companies from different sectors of industry and serves as a good representation of the whole market.
Another renowned index is Nasdaq — an average value of 3,000 high-tech companies such as Amazon, Apple, Google, and Microsoft that are listed on Nasdaq, one of the stock exchanges based in New York City.
The changes in indices are measured in points, where 1 point equals 1 US Dollar. Say, you can hear on the news that the S&P 500 is down 10 points, which means the index has lost $10 of its value.
The performance of the mentioned market indices varies from day to day and even from year to year, reflecting the state of the American and the world’s economy. But although it can show different results, historically, it appears to be growing in the long-term. In other countries, national market indices represent the economic prosperity level of those states.
How do I invest in indices?
An index is just an indicator, so you can’t invest in it directly. However, there are funds that copy indices’ prices and allow you to allocate money in them. For instance, there is the S&P 500 index fund that reflects the S&P 500 index price. You can invest in this index fund and gain wealth in case the index grows.
Market indices work well for investors who don’t have knowledge or time to evaluate the performance of single companies. The key perk of indices is that they mitigate risk from picking wrong assets — even if a certain company depreciates while the overall market rises, you will anyway win. An index is a diversified portfolio in one place — the proverbial eggs are put in separate baskets (companies that are involved in tech, health care, etc.) but are brought together.
What are crypto indices?
Crypto indices allow for investing without purchasing any specific coins. An index in crypto is an aggregation of several digital assets picked by their market capitalization. Like crypto portfolios, indices have different levels of diversification: some contain more assets while the others comprise fewer. Coins may have different weights in indices, ranging from 5% to 40% and higher. The price of an index is composed of prices of underlying digital assets multiplied by their weight and derives from their market behavior.
Watching a crypto index is like watching the performance of someone’s crypto portfolio. Here are the main advantages of such indices:
- You will have a broader look on crypto and will be able to detect trends that you didn’t spot before,
- You reduce your volatility risks — if one coin in the index dumps, the growth of other coins will balance it out,
- Indices are assembled by professional investors so you can learn from their profound expertise.
Crypto index funds
Just like in fiat, crypto index funds watch the price of a respective index and allow you to invest in it. By allocating money in such a fund, consider you’re buying a whole crypto portfolio at once that is spread and balanced across several digital assets.
But even more importantly, indices protect you if some of the assets start performing poorly — they literally exclude those coins from the “index portfolio” and replace them by the tokens that show a better dynamic. Say, if you’ve invested in a “Top 10 Cryptos Index Fund” and a certain coin drops from the Top 10 list, it gets replaced by another, and you don’t lose your funds. This wouldn’t be possible if you invested in those assets on your own, would it?
Let’s bring an example of how this can work. If you look at the snapshot of the Top 10 coins from August 2013, you can see there were Bitcoin, Ripple (XRP), Litecoin, Namecoin, PPCoin, Feathercoin, Novacoin, Primecoin, Terracoin, and Devcoin.
Consider you bought these assets back then hoping they will further increase their value. But let’s move 5 years ahead and see the Top 10 list in August 2018: there were Bitcoin, Ethereum, XRP, Bitcoin Cash, EOS, Stellar, Litecoin, Cardano, Tether, and IOTA. Only 3 coins from the original list are present!
And here’s what we have on the list in January 2022, 8.5 years from the original investment: Bitcoin, Ethereum, Binance Coin, Tether, Cardano, USD Coin, Solana, XRP, Terra, and Polkadot. Only Bitcoin and Ripple (XRP) are holding their positions. Most of the coins from 2013 have been abandoned, and Litecoin that was still on the list by 2018 couldn’t compete with newer coins further.
Crypto market is unpredictable — even today’s largest assets can drop out of the race at some point. Crypto indices protect you from this by constantly picking the best assets in the market.
Crypto index funds to invest in
Let’s take a look at the three most popular platforms where you can invest in an index:
- CMC Markets
The Nasdaq crypto index (NCI) was launched in February 2021 and comprises 8 assets of which Bitcoin and Ethereum make up 95%. The rest is spread between Litecoin, Chainlink, Uniswap, Bitcoin Cash, Stellar, and Filecoin. The fund is managed by a panel of investment experts, the Nasdaq Crypto Index Oversight Committee.
CMC Markets, a financial services company based in the UK, offers 3 indices. It’s quite flexible about their contents: the company adds new coins and rebalances their shares if it’s considered profitable.
- The All Crypto Index includes 14 currencies where BTC, ETH, SOL, ADA, and DOGE have a 12% weighting, and the remaining coins are represented by 4.44% shares.
- The Emerging Crypto Index comprises 9 altcoins such as Polygon, Litecoin, Chainlink, TRON, Bitcoin Cash, and others. Currently, the biggest share of 21.71% belongs to Polygon.
- The Major Crypto Index has 40% of both Bitcoin and Ethereum, 8.55% of Solana, 6.45% of Cardano, and 5% of Dogecoin.
S&P introduced its indices in May 2021. Currently, there are 8 of them, and some consist only of Bitcoin and Ethereum in different proportions, and the others are made up of 30 different crypto coins.
The future of crypto indices
You may have thought while reading this article that investing in funds made by traditional financial institutions goes against the philosophy of crypto. If you did, know that you’re not alone! Enthusiasts have already created tokenized crypto indices in which you can invest in a DEX and store in an Ethereum wallet.
One example is the DeFi Pulse Index. It focuses on performance of the largest DeFi tokens and currently includes 18 assets, of which Uniswap, Aave, and Maker make up about 60%. This index works well for those who are excited by DeFi but don’t have enough expertise to make weighted investment decisions.
NFTs weren’t left behind by the new trend, too — among others, there is the Metaverse Index (MVI) that puts together 15 key assets from gaming and entertainment such as Axie Infinity, Decentraland, Enjin, and Rarible.
Crypto indices were one of the most exciting innovations in crypto investments last year. We expect many more indices to emerge and suggest you do a research not to miss out on some great opportunities.