Investing In Cryptocurrency Funds: What Are Index Funds?
Cryptocurrency price indices are created primarily to assess the investment attractiveness of crypto trading instruments. In other words, this is another method of investing in cryptocurrency. In the previous article, we talked about indices used for market analysis. This is what CoinMarketCap index and similar platforms are made for. They create a broad picture of the cryptocurrency market and see the price movements of various crypto assets.
In fact, a good choice of crypto assets for investing is a difficult task. Over the last ten years, more than 2500 coins and tokens appeared on the market, and many of them have already fallen into oblivion. So the question is how to compile an investment portfolio correctly. The answer lies in using cryptocurrency indices. You can do it yourself or by investing money in a cryptocurrency index fund. This option is good for passive traders focused on long-term investments.
Cryptocurrency index funds and how they are built
In cryptocurrency index funds, an investment is formed in proportion to shares of digital assets included in a particular index. Investors can choose a cryptocurrency list themselves or entrust this task to the fund.
All cryptocurrency indices are based on the same principles as any stock exchange index, such as the S&P 500, Dow Jones, etc. They represent an average price or capitalization of a certain amount of crypto assets. For example, an index can contain the 10 most expensive cryptocurrencies, or top 50 assets by the cryptocurrency market capitalization — there are many options.
Investing in an index is equivalent to putting money in cryptocurrencies the index is composed of. Thus, everything looks simple from the perspective of investors, as they shouldn't choose how to distribute funds among crypto assets.
Index value is constantly changing. As a rule, in order to get the value of an index, an average price of a cryptocurrency for a 24-hour period is calculated. The list of cryptocurrencies and their shares in the index (and therefore in the portfolio) can also change. It depends on the cryptocurrency market capitalization and price movement — and of course, on the way the index is built.
Two methods to construct an index
This type of indices contains crypto assets in proportion to their current prices. Let’s take the example of the XYZ index that consists of three cryptocurrencies: X — $3, Y — $9, Z — $18.
The current index value is (3+9+18) / 3 = 30/3 = $10.
- The share of X is 3/30 = 1/10 of 10;
- The share of Y is 9/30 = 3/10;
- The share of Z is 18/30 = 6/10.
As you can see, the calculation is very simple. Prices are taken from cryptocurrency exchanges that provide data through open APIs. The average price volume is taken from several platforms to determine the relevance. Thus, in order to compose an index, it makes sense to take popular cryptocurrencies traded on many exchanges.
This index contains crypto assets in proportion to their market capitalization. The greater the capitalization of cryptocurrencies is, the more money an investor puts in it.
For example, if bitcoin capitalization is 52% and ether capitalization is 11% (as of January 2019), they will be distributed accordingly in the index. At the same time, the remaining 37% will also be proportionally formed from other selected cryptocurrencies.
Many cryptocurrency indices available on the market today are capitalization-weighted. For example, CCI30, TaiFu 30, Coinbase Index. However, this way to compose an index has disadvantages — so does investing in cryptocurrency funds in general. A profitable fund doesn't follow the market, it goes ahead. After all, all funds are created for the sole purpose of making a profit. It is always worth remembering that this way of investing is risky — but that's a topic for another article.