What are Crypto Indexes? — Explained for Dummies
First, what’s an Index?
In Traditional finance, an index is a method used to track the performance of a group of assets in a standardized way. A good example of this is the S&P500. It’s the most popular index by far and includes 80% of the total stocks traded in the US.
In simpler terms, an index acts like a basket of selected stocks in the market. These stocks are bundled together so investors deal with a single instrument rather than having to manually trade through multiple assets consecutively.
Crypto indexes (or indices) work the same way but track the performance of a basket of cryptocurrencies instead. These indexes are usually created following certain themes and are typically weighted by market capitalization. For example, an index can track the top 25 crypto projects per market cap, or track the top decentralized finance (DeFi) projects per market cap.
As such, the price performances of the cryptocurrencies within an index determine the price of that index.
How is a Crypto Index Structured?
A Crypto Index is compiled according to various criteria. Often, Crypto Indexes are constructed according to market capitalization and price development, because of this, certain cryptocurrencies such as stable coins are excluded.
This is especially true for a crypto index that focuses on the largest cryptocurrencies. Here, for example, cryptocurrencies are included in the top 20 in terms of market capitalization.
As soon as a cryptocurrency slips out of the top 20, it is replaced with another one.
The situation is similar to a crypto index based on the price performance of individual cryptocurrencies. Not all cryptocurrencies will be listed here, only those above a certain market capitalization and trading volume.
Other crypto indices, for example, only represent a certain area of application with the largest cryptocurrencies. The most common areas of application include Oracles, NFTs, or DeFi Bluechips. Accordingly, there are no limits to the structure of the various crypto indices. Therefore, investors enjoy a wide choice and decide on a Crypto Index that meets their requirements.
Advantages of Crypto indexes
Ok, so why bother investing in indexes like the Defipulse index for example, when you could just buy some of the top DeFi coins on the market? Well, there are a couple of reasons actually;
1. Risk diversification
Crypto indexes allow investors to diversify risk across a range of assets simultaneously, thus mitigating the chances of being overly exposed to a single token at any given time.
2. Targeted Portfolio exposure
Crypto indexes are excellent avenues for granting all types of investors easy, targeted portfolio exposure to popular or emerging cryptocurrency trends e.g. NFT projects in the case of an NFT-centric index
3. Cost-Effectiveness
Cryptocurrency indexes offer efficient and cost-effective experiences when it comes to trading crypto, as they allow investors to deal with a single instrument rather than having to manually trade through multiple assets consecutively.
Which Crypto Index is the best?
There is no right or wrong with a Crypto Index. The decision is subjective and reflects the needs of potential investors. Each investor decides on his investment strategy and chooses a suitable Crypto Index for himself accordingly.
I’ll give an overview of some popular crypto indexes just to get you started.
DeFi Pulse Index (DPI)
This is a Crypto Index of the DeFi analysis site: DeFi Pulse. Via the issuer IndexCoop, the DeFi Crypto Index is composed according to various criteria. It is a capitalization-weighted index that tracks Decentralised Finance (DeFi) performance across the entire market.
Among other things, weighting for tokens added to the index is based on the following criteria:
- Descriptive characteristics of the token
- Characteristics of the token’s supply
- Characteristics of the traction of the project
- Characteristics of the user security of the token
These criteria are reviewed every month after the definition phase, and individual cryptocurrencies are excluded, added, or weighted differently. Currently, a total of 14 cryptocurrencies are included in the DeFi Pulse Index.
Crypto20 (C20)
Invictus Capital set a new standard in November 2017 with the Crypto20 Fund. This is an index that allows investors to invest in a token representing the 20 largest cryptocurrencies by market capitalization. This simplified method is not only cost-effective, but it reduces research and rebalancing requirements for investors.
This allows investors to track overall market performance and take advantage of diversification benefits within the crypto market. The token can be traded directly through the Invictus investor platform or obtained through a 3rd party exchange like ours.
Metaverse Index (MVI)
The Metaverse Index is designed to capture the trend of entertainment, sports, and business shifting to a virtual environment, with economic activity in this environment taking place on the Ethereum blockchain.
The Metaverse index was created by Index Coop and it consists of the most popular DeFi tokens that fall under the Coingecko category of Non Fungible Tokens, Entertainment, Virtual Reality, Augmented Reality, or Music.
Weighting criteria for tokens added to the index are based on market capitalization and liquidity. Also, the index is community-managed and is rebalanced monthly. Investing in the Metaverse index serves as an easy passive strategy for anyone who’s bullish on NFT and entertainment protocols like Axie, Rarible, and Audius.
Conclusion
Many newcomers to cryptocurrency trading may find it difficult to invest in highly-volatile crypto assets and with over 7500 cryptocurrencies in the world, It is not unheard of for new and relatively experienced investors to occasionally make unforced errors.
Trading with a crypto index can help solve this problem for both curious investors who wish to test the waters in crypto more broadly and experienced investors who want exposure to specific sectors in the market.
At Fluidcoins we are on a mission to develop an open financial system for Africa. We strongly believe simplifying crypto and minimizing risk for our users is key to achieving this goal. Hence, our new wallet will be offering crypto indices!!!
