Crypto Index Funds: Everything You Need to Know

UTC by Ibukun Ogundare · 7 min read
Crypto Index Funds: Everything You Need to Know
Photo: Depositphotos

The below guide describes crypto index funds – the upgraded version of traditional index funds. They present investors with‌ an investment plan that simultaneously gives a high ROI and mitigates the risk of investing in a particular crypto.

The progressive development of cryptocurrency has lately been posing a competitive threat to the traditional financial system. The technological setup sidelines the function of a centralized body, firm, or individual replacing them with smart contracts. With this in place, the beauty of distributed ledger technology (DLT) is gradually replacing many traditional methods of banking and investing. Despite this, stocks and bonds investors are resentful about the development of the cryptocurrency space. This is because cryptocurrency does not have all the financial tools the financial market has.

Before this time, crypto market behaviours have always countered many financial laws, theses, and tools. For this reason, many financial investors have refused to recognize cryptocurrencies as a legit investment. Some of these financial laws and tools are becoming dominant in the crypto market. This guide will address one of the most powerful traditional financial tools dominating the crypto sector: the crypto index funds. Will their use bring calamity to the crypto sector? Or good tidings to the space? Will it restructure the goal of blockchain technology?

Crypto Index Fund Defined

A crypto index fund is a financial investment tool that allows a particular investor to put funds into a wide range of cryptocurrencies. Investors get a diversified portfolio by putting their funds into an index pool of funds.

The crypto index fund is the upgraded version of the traditional index fund, which is a mutual fund. A traditional index fund is designed to track the composition and performance of a particular financial market index. Mutual funds allow people to pool their money together into a managed fund, while a market index tracks the performance of a specified number of stocks.

Contrary to the traditional index fund, the crypto index fund does not have a manager. These market indexes symbolize a portion of the general market, either stocks, bonds, or crypto. For instance, the S&P 500, an example of a traditional index fund, tracks the market index of 500 large US companies.

How Crypto Index Funds Work

The functional mechanism of the crypto index fund is not different from the conventional market index. It presents investors with‌ an investment plan that simultaneously gives a high ROI and mitigates the risk of investing in a particular crypto. A crypto index fund tracks the performance, price, and capitalization of a group of cryptocurrencies. As earlier stated, it uses an automated indexing process to provide cryptocurrency behaviours. With this provided data, fund managers can then calculate the performance of any group of cryptocurrencies. Using an automated indexing process gives no room for any display of human incompetence.

Crypto enthusiasts can invest in three different cryptos so that when one of these assets fails, the other two can cover up the loss. Tokens of a cryptocurrency index fund represent an investor’s share of the total funds. Keeping to the originality of cryptocurrency, blockchain-based smart contract servers control index funds.

Impact on the Industry

Introducing the crypto index funds has changed the perspective of investors on cryptocurrency. Initially, many investors are afraid to lose their assets to the cryptocurrency market’s volatility. In most cases, investors have to analyze deeply before investing in a single cryptocurrency. Crypto index funds mitigate the fear and stress associated with investing by offering diversification.

Another worthwhile impact of crypto index funds is the attraction of sceptical and newbie investors. Investors can now skip the thorough pre-investment research by investing in crypto index funds. The attraction of investors to this financial tool has indirectly increased the popularity of the crypto space. Since the crypto index debuted in the space, there has been a spike in the number of institutions providing such services.

Types of Crypto Index Funds

There are two major types of crypto index funds, namely the on-chain and off-chain. They both give investors access to crypto indices and exchange-traded funds (ETFs). On-chain crypto index funds (also known as decentralized crypto index funds) offer investors access to a basket of crypto tokens. It literally tracks a group of cryptocurrencies transacted on the chain. In this method, investors can trade and lend out their funds as tokens. On-chain crypto index fund gives investors the advantage of buying a wide range of tokens for a lesser fee. This method has dominated the DeFi because it is affordable and controlled by smart contracts. Potential investors can purchase these funds via DAOs like Index Coop, Enzyme Finance, Indexed Finance, PieDAO, PowerPool, and Bankless DAO.

On the other hand, the off-chain crypto index fund follows the precept of traditional index funds that need a centralized intermediary. This central body provides custody and manages the portfolio of assets in the pool. Investors can monitor their funds through online brokerage accounts or management firms. These centralized crypto management firms include Fidelity, Vanguard, etc.

Examples of Crypto Index Funds

Investors are free to choose their preferred crypto index fund. There are several examples of crypto index funds, and here are a few of them:

  • Bitwise 10 Crypto Index Fund. This crypto index fund offers investment in the top ten cryptocurrencies according to market cap. A larger percentage of the investment goes to Bitcoin (BTC) and Ethereum (ETH). The other cryptocurrencies include Solana (SOL), Cardano (ADA), Polygon (MATIC), Litecoin (LTC), Chainlink (LINK), Polkadot (DOT), Uniswap (UNI), and Avalanche (AVAX). Bitwise focuses only on crypto tokens, excluding stablecoins.
  • Grayscale Digital Large Cap Fund (GDLC). Grayscale offers several options for investing in cryptocurrency. However, the GDLC is the only diversified method of crypto investment, with a large chunk of pool funds invested in BTC and ETH.
  • Morgan Creek Digital Asset Index Fund. The token covers ten cryptocurrencies, including BTC, ETH, ADA, DOT, LTC, UNI, AVAX, ATOM, BCH, and FIL. BTC and ETH take about 64.8% and 28.8% of the total investment. Notably, this index fund is in collaboration with Bitwise.
  • Bloomberg Galaxy Crypto Index (BGCI). It tracks the trade of large digital assets like BTC and ETH in USD. BGCI covers a different category, including stores of value, medium of exchange, smart contract protocols, and privacy assets.
  • CRYPTO20. This index primarily tracks the prices of the top 20 cryptocurrencies by market capitalization.
  • DeFi Pulse Index (DPI). Unlike other indexes, developers restrict DPI to tokens in the DeFi industry only.
  • NFT Index. The use of the market index does not exempt non-fungible tokens (NFTs). The designation of NFTI helps track some digital assets in the NFT industry.

Pros and Cons of Investing in Crypto Index Funds

An overall evaluation of crypto index funds highlights the advantages alongside their dark sides. The benefits of crypto index funds include:

  • Mitigation of expenses. Crypto index fund reduces commissions and transaction fees. Investors escape high fees associated with several single tokens.
  • Crypto index funds spread investors’ risk across different cryptocurrencies. Diversification reduces the stress encountered in researching the best crypto to buy. However, it is pertinent for investors to choose the most credible investment fund for greater yield.
  • It also makes investment easier for newbie investors. They can invest without being bothered about any crypto. The investment primarily provides users with an array of crypto assets.
  • Despite the volatility of the crypto space, the crypto index fund guarantees investors of earning long-term returns. These consistent drops in income shield investors against enormous losses.

On the other hand, crypto index funds have a few weak sides:

  • Meager return. The combination of cryptocurrencies sometimes affects the returns on investment. Several poor-performing cryptos can minimize investors’ ROI.
  • Rigidity. In cases of poor performance, investors cannot change the cryptocurrency combination. Only asset managers can change the combination, reducing the control of investors on their funds.
  • Peaky minimum investment. The minimum investment of many asset management firms is expensive for investors. Invariably, it encourages potential investors to invest in a single asset.

Final Thoughts

The crypto sector is gradually replacing the traditional finance system with an improved banking method. Crypto index funds will go a long way in reducing the fears associated with crypto investment and attracting more investors. It is unarguably a secure way of practising not putting your eggs in one basket. Investors can invest and relax with little research while assured of earning great ROI.

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FAQ

What is a crypto index fund?

A crypto index fund is a financial tool that allows an investor to invest in a wide range of cryptocurrencies simultaneously. In a single investment, an investor can invest in BTC, ETH, and MATIC without purchasing them one after the other.

How does a crypto index fund work?

In simple terms, a crypto index fund tracks underlying crypto assets’ price, performance, and capitalization. This mechanism is just like conventional index funds. 

What is the role of crypto index funds?

Crypto index funds have helped attract many potential investors by mitigating risk, reducing research, and guaranteeing earnings. It has helped increase the interest of traditional firms in the crypto sector.

What are the benefits of investing in crypto index funds?

Investing in crypto index funds reduces the impact of volatility, a major red flag for potential investors. Individuals can freely invest without thorough research, diversify their investment and lower investment fees.

What are the crypto index funds available in the market today?

There are a lot of examples of crypto indexes today. Some of them are: DeFi Pulse Index (DPI), CRYPTO20, Grayscale Digital Large Cap Fund, Bitwise 10 Crypto Index Fund, etc. 

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