Cryptocurrency investing has proven itself more than a fleeting trend. While many options exist to buy, sell, trade, or invest in crypto directly through exchanges, wallets, and other platforms, other investment vehicles provide distinct advantages while offering a different risk profile.
The sheer variety of cryptocurrencies can overwhelm many investors. With tens of thousands of cryptocurrencies and tokens out there, many beginners find themselves overwhelmed by the array as well as the varied levels of volatility of each coin.
However, like in the case of stock trade indices, crypto index funds offer a structured, professionally managed, and diversified way to invest in digital assets. Crypto index funds offer investors an alternative that often reduces the risk associated with picking individual cryptos yourself.
What are cryptocurrency index funds, and why do they matter?
A crypto index fund is a new financial product and investment vehicle that invests in a basket of cryptocurrencies, much like any traditional index fund. It seeks to mimic, track, or replicate the performance of a specific crypto index or market benchmark. An example of a performance benchmark would be the top 20 or 20 cryptocurrencies or tokens by market cap.
Traditional index funds like the S&P 500 tracks the performance of specific stock market indexes. The S&P 500, a well-known investment product, tracks the performance of five hundred of the largest publicly traded US companies on the NYSE or NASDAQ. Regarding industry weighting, the S&P 500 skews the highest towards information technology (IT) at 28.1%, followed by healthcare at 13.3%, consumer discretionary stocks at 11.8%, and financials at 11.5%.
Similarly, crypto index funds are designed to provide investors with exposure to a broad selection of cryptocurrencies. They may be weighted to spread risk and reduce the impact of the volatility of individual assets. They simplify crypto investing for retail investors and institutions by reducing complexity and providing risk mitigation advantages.
Advantages of Investing in Crypto Index Funds
Crypto index funds are a passive investment option for novice and experienced investors. Here are some reasons to consider crypto index funds versus buying crypto directly:
Experienced finance professionals handle the management and decision-making in index funds, including crypto index funds. Outsourcing your investment decisions to these professionals might make sense if you do not have the time or expertise to actively trade and manage a crypto portfolio.
For newcomers to the crypto market, crypto index funds make the investment process more accessible. They eliminate the need for an investor to research, screen, and select the crypto investment themselves. Moreover, they allow access to a broad range of digital assets with a single investment.
Compared to investing in individual cryptos, which may experience lower trading volumes and sudden liquidity constraints, crypto index funds offer a higher level of liquidity. This way, investors can trade, buy, or sell their shares within market hours.
Holding a basket of cryptocurrencies spreads the risk across diverse assets, thus reducing the impact of the volatility of any single coin. In this way, you are protected against extreme market fluctuations. Diversification prevents or reduces the risk of catastrophic losses.
Crypto index funds typically charge reasonable management fees. Depending on your choice, some of the better index funds’ fees can be lower than the trading fees you incur when buying and selling individual coins on crypto exchanges. The best index funds would have low fees, and it is recommended that you select those that don’t charge over 1%.
However, you still need to weigh expense ratios with other vital elements, such as the number of cryptocurrencies they follow. For example, the advantage might compensate for a higher expense ratio if a fund follows the most significant ten cryptocurrencies—not including stablecoins.
How To Invest in Cryptocurrency Index Funds
Given their advantages, why aren’t crypto index funds more widely available? It all boils down to regulation. There have been numerous attempts to launch crypto funds over the years. However, the US SEC hasn’t approved the majority of applicants.
The S&P Dow Jones Indices have developed their cryptocurrency trade indices. The S&P Cryptocurrency Index Series is comprised of several different indexes that track the performance of the most prominent digital assets. Retail investors, unfortunately, can’t invest in such indexes. However, if approved, it is possible to see index funds that follow them in the future.
While retail investors have limited options, there are still ways to tap alternatives. Anyone with a brokerage account may consider instruments like the Bitwise 10 Crypto Index Fund. As the name suggests, this non-OTC trust helps you gain diversified exposure to cryptocurrencies by tracking the top 10 most valued cryptos, periodically rebalanced and screened for risk, and weighted by their current market capitalization.
Those wanting to remain on the traditional route can explore index fund tokens. However, these instruments are best for experienced crypto traders. Index fund tokens work similarly to index funds by tracking a group of cryptocurrencies: some track NFTs, primary DeFi tokens, and top cryptocurrencies by market cap. Accessing and investing in such tokens uses decentralized exchanges or DEXs and some trading expertise.
Some experienced crypto investors recommend creating a DIY crypto index fund. While unconventional, this might work for some investors determined to apply their investing strategy to crypto coins and tokens. It simply involves signing up for an account in a reputable crypto exchange, evaluating the coins or tokens available and their properties, picking out the types of cryptocurrencies that make up your index fund, deciding on the allocation for each, and purchasing them as part of your basket.
This strategy lets you control your DIY “crypto index fund” without paying expense ratios or management fees. However, you are not spared from exchange trading fees. Disadvantages of the DIY crypto index fund strategy include lack of or insufficient information—as retail traders may receive less information than institutions—and the time and effort required to monitor, manage, and rebalance your fund regularly.
It may help to do dollar-cost averaging (DCA) as you invest in crypto, which means you allocate a fixed amount at regular intervals, regardless of market conditions, thus reducing the impact of market fluctuations.
Another strategy you can use is long-term “HODLing,” which in crypto parlance means holding your index fund investment for an extended period. You can also combine active and passive strategies, which means you can keep a core position in an index fund and still actively trade cryptos you believe have strong growth potential. Your index fund constitutes your passive strategy.
Navigate Volatile Markets With Crypto Index Funds
Crypto index funds offer an alternative avenue to participate in the dynamic digital asset market while providing the diversification, management, and simplicity of traditional index fund investing. While scarce and in their infancy, crypto index funds could become more popular in the future as the regulation of digital assets becomes clearer. Moreover, the increased financialization of crypto markets could lead to more interest in crypto index funds or similar instruments as sophisticated and institutional investors pour in.
As an individual or retail investor, you should be wary of their drawbacks, such as limited investment control, management fees, and strategies not aligned with your investment goals. As with any investment instrument, remember that your investment goals, risk tolerance, time horizon, and the amount of money you invest are all critical factors in whether to get into crypto fund investing. Also, remember that while others are managing your investments, it still helps to keep abreast of market trends to empower your decisions.