A Primer on Crypto Index Funds

What are crypto index funds and which portfolios are available for average investors?

Cryptoassets are a new and ever-evolving asset class. As such, many investors actively speculate on the price of bitcoin, ether, and other cryptocurrencies. Speculation isn’t all bad, it’s a necessary component of free markets. The nascent nature of cryptoassets and lack of concrete valuation models has resulted in volatility and hype. For those who are looking to invest in cryptoassets, index funds present a unique opportunity to gain exposure to the crypto market.

First and foremost, this is not investment advice. Do your own research. Make your own decisions. This article is merely meant to examine and provide insight into a popular asset speculation vehicle in crypto.

What’s an Index Fund?

An index fund is a type of mutual fund with a portfolio constructed to match or track the components of a market index. For example, the S&P 500 index is comprised of the largest companies publicly traded on the stock market. Other index funds focus on financial services, real estate, or consumer goods.

Furthermore, index funds are usually passively managed, meaning they don’t have managers who are picking stocks or making decisions about how to allocate the firm’s capital. The S&P 500 index fund picks the top assets by market capitalization(total value of a company) and purchases shares of those companies in proportion to their total value percentage of the market. Some index funds also add a price weight to the index fund, so a stock worth $100 will have more influence than a stock worth $20.

Some of the most popular index examples are the S&P500, NASDAQ 100, and Dow Jones Industrial Average.

What Are The Benefits of Index Funds?

Diversification and Simplicity.

As an investment strategy, diversification prompts investors to put their money into not only various stocks, but various types of securities and assets. Diversification enables investors to avoid risk while increasing returns on their capital. It’s a fundamental principle when examining personal finance 101 or basic investment strategy.

To quote Barry Ritholtz, “The beauty of diversification is it’s about as close as you can get to a free lunch in investing.”

Diversification allows an investor to take no additional risk while simultaneously increasing their return on investment. Other than compound interest, there’s nothing more beautiful than diversification in investing.

The other main advantage of index funds for investors is the ease of managing the investment. Investors don’t have to spend time analyzing stocks, portfolios, or numerous asset classes. It’s easy to invest in an index fund and wait while a firm manages the rebalancing of the fund at the cost of a small fee(often less than a half a percent). Additionally, most investors will not beat the performance of the S&P 500 Index due to their lack of experience or skill in investing. Stock picking is obviously difficult, but even allocating one’s assets to real estate, individual stocks, or a sector-specific stock category requires significant research.

What Are Crypto Index funds?

Crypto index funds — similar to the Nasdaq 100 or Dow Jones Industrial Average — are a representation of a market index, specifically the cryptoasset market. While this new asset class is only a decade old, it’s rapidly maturing and integrating into the current financial system. Most crypto index funds use a weighted portfolio for the top ten cryptoassets according to total network/market value.

What Are Some of The Best Crypto Index Funds?

Unfortunately, many crypto index funds are limited to accredited investors, meaning the average individual is not able to participate or buy shares of these index funds. The most common criteria for accredited investors are 1) if you made over $200,000 in the last two calendar years, or 2) if you have greater than $1,000,000 in net worth, excluding your primary residence.

Some of the top Crypto Index Funds for accredited investors or non-U.S residents include

• Bitwise 10 Private Index Fund — 62% Bitcoin
• Grayscale Digital Large Cap Fund — 68.4% Bitcoin
• Morgan Creek Digital Asset Index Fund -71.8% Bitcoin
• Bloomberg Galaxy Crypto Index (BGCI) — 30% Bitcoin

Will These Index Funds Outperform The Stock Market?

It’s impossible to say how cryptoassets as a whole, let alone individual index funds will perform against the stock market. However, some investors believe it’s a no-brainer. In 2018, Anthony Pompliano, Co-Founder and Partner of Morgan Creek Digital issued the following bet on Twitter.

Anthony Pompliano, or “Pomp” as he’s affectionately known, believes that his firms crypto index fund will outperform the S&P 500 index fund over the next decade. While undoubtedly a bold bet, there hasn’t been a single individual or firm to take Morgan Creek Digital up on their proposal.

Morgan Creek Digital’s index fund is only available to accredited investors. However, there are a few index-esque funds in the space that have low minimums and are available for non-accredited investors.

Index Fund for Retail Investors

Abra

Abra offers the Bitwise 10 Crypto Index (BIT10) for investors seeking exposure to 80% of the crypto market. The partnership with Bitwise Asset Management provides retail investors access to BIT 10 tokens which are pegged to the Bitwise 10 Crypto Index. The Abra BIT10 index is rebalanced monthly, has no fees, and a low $5 minimum. The current composition of the index fund is mostly comprised of BTC, ETH, and XRP.

Index Bundles for Retail Investors

U.S regulations often prohibit or limit U.S citizens from investing in index funds or similar securities. The following firms offer index-esque packages where investors can purchase multiple cryptoassets according to market cap. However, unlike an index fund, the portfolio of assets is not rebalanced monthly. Additionally, the weight or proportioned amount of each cryptoasset is assigned based on the price at the time of purchase. Therefore, the portfolio of assets will reflect a snapshot of the market as opposed to a monthly average. Combined with the volatility of cryptoassets, an investor’s portfolio may not be the most accurate representation of the crypto market. Below are two of the easiest places to purchase crypto portfolios.

Coinbase

The Coinbase Bundle offers a one-click purchase for the first 5 cryptocurrencies that were listed on Coinbase which are weighted by market cap at the time of purchase.

Coinbase Bundle

• Bitcoin — 76.59%
• Ethereum — 15.84%
• Litecoin — 3.94%
• Bitcoin Cash — 3.11%
• Ethereum Classic — 0.52%

The retail-aimed product allows users to invest as little as $25 in the basket of cryptoassets.

Circle Invest

The team at Circle launched Circle Invest, which allows an investor to buy 12 different cryptoassets in a single investment. Cicles’s Apple and Android mobile app enables an easy way to purchase crypto right from your phone. The app even lets you set up recurring buys so that you can dollar cost average into your cryptoasset portfolio. Lastly, Circle Invest offers minimum invests as low as one dollar.

Are Crypto Index Funds and Bundles a Worthwhile Investment?

As with any investment, benchmarking is essential in order to determine the effectiveness of a strategy. When investors are evaluating their stock choices, they use an index fund, such as the Dow Jones Industrial Average to represent the overall market. If their individual stock or fund beats the market the investment strategy is considered worthwhile. If the stock or fund does not beat market returns, the investor would have made a better decision by investing in a market index fund.

This concept becomes somewhat more difficult when applying it to cryptoassets and the cryptomarket. For example, Bitcoin currently represents 56% of the crypto market. In comparison, Apple, the company with consistently one of the largest stock market capitalizations, constitutes a 4.7% weighting in the Dow Jones Industrial Average and 11.1% in the Nasdaq 100, according to FactSet. Factor ether into the total crypto market cap(~8.5%) and now 65% of the total crypto market is represented by two assets. In fact, nearly every crypto index fund is comprised upwards of 70% of bitcoin and ether. The overall market essentially moves with bitcoin and ether regardless of other assets. So, should you invest in other cryptoassets?

Howard Lutnick, billionaire and CEO of Cantor FitzGerald and BGC Partners has stated, “95% of all returns are by asset allocation and 5% is which asset you pick. It’s just binary.”

According to Lutnick, it’s not about which stock you purchased, but did you choose to invest in stocks. Similarly, this strategy may apply to cryptoassets. It may not matter if you invest in a specific cryptocurrency or token, as long as you invest in cryptoassets as a whole. However, cryptoassets are far less stable, and some of the cryptoassets outside the top 10 are highly volatile. Obviously, it’s impossible to predict the future or know which cryptoassets will outperform the market. Therefore, an index fund or portfolio of cryptoassets that is predominantly bitcoin and ether may be the best option for investors seeking to allocate capital to this new asset class.

Disclaimer: The views expressed by the author above do not necessarily represent the views of Consensys AG. ConsenSys is a decentralized community with ConsenSys Media being a platform for members to freely express their diverse ideas and perspectives. To learn more about ConsenSys and Ethereum, please visit our website.