How (not) to invest in crypto index funds
Exploring the benefits — and risks.
DISCLAIMER: This article is not financial advice.
Spotlight: Crypto20
Crypto20 has had a phenomenal run — despite recent market conditions, it is still up almost 200% since its launch at the end of October.
The idea behind Crypto20 is simple: the company manages a portfolio consisting of the top 20 coins by market cap, and a somewhat scientific algorithm automatically rebalances the portfolio once a week.
These assets are tokenized, and token holders are entitled to draw down the equivalent net asset value of their tokens in Ethereum at any time. The tokens can be traded on exchanges and are currently attracting a premium of 36% over the net asset value. Meanwhile, the management fee is just 0.5% per year.
This represents significantly better returns than HODLing long-term major coins without the extreme time commitment required to day trade.
It sounds like the perfect option for passive traders to maximise their profits — but there’s a problem.
Counterparty Risk
Even though Crypto20 has had their underlying asset holdings audited by KPMG, and by all accounts appear to be a legitimate company, Crypto20 maintains direct ownership over all of the underlying assets — creating a single point of failure.
If Crypto20 is hacked and the funds stolen, the tokens owned by investors will be worth nothing.
The more time that elapses, the higher the risk that these funds will be stolen by someone inside or outside of the company. Because the underlying funds are cryptocurrencies, it is much easier for a thief to keep what they have stolen — making these funds a big target.
To get an idea of the likelihood of such an attack happening, one needs only look at statistics for exchanges: over the 8 years to August 2016, a third of all exchanges were hacked.
Risk Management
If similar risk was assumed for index funds (and there is no reason why it would be any different than exchanges), over an 8 year period there is a 1/3 chance of an index fund being completely wiped out.
It would be prudent to limit exposure to this asset class and to reinvest any significant profits (rather than adopt a “let your winners run” approach).
DISCLOSURE: The author of this article owns Crypto20 tokens.
