Cryptocurrency is on the minds of many investors these days, and it’s easy to understand why. The value of various cryptocurrencies has increased dramatically, making cryptocurrency one of the greatest forms of investment of the recent decade. Furthermore, the blockchain technology that underpins cryptocurrency can disrupt a wide range of industries, resulting in the creation of profitable new firms in the process.
There is a problem with bitcoin, however. You can’t actually “invest in cryptocurrency” itself, as you can in the stock market, which allows you to do so through overall market index funds. As an alternative, you must invest in a specific cryptocurrency such as Bitcoin, Solana or Ethereum.
Furthermore, it is difficult to maintain a diverse portfolio of crypto assets in a traditional brokerage account, let alone a retirement account. To be sure, all of this generates some friction, especially for those who are new to the world of Bitcoin. There isn’t a crypto index fund that allows you to make a single investment into the whole cryptocurrency ecosystem. Is there a difference?
This detailed guide will cover the issue of crypto index funds, including the currently available options and those that may become accessible in the future. We’ll also talk about the possibility of manually constructing your own “index fund.”
What Is Meant By Crypto Index Fund?
It is a financial product that allows investors to gain exposure to a broadly diversified portfolio of digital currency assets through purchasing shares in the fund. However, as of early 2022, there is no such thing as a genuine crypto index fund in the USA.
Consider what an index fund is first to gain a complete understanding of the concept.
It is possible to invest in an index fund through an ETF (exchange-traded fund) or a mutual fund, depending on the structure of the investment instrument. In essence, it is a financial asset that holds a diverse range of assets in a single “package.”
It is the goal of index funds to replicate the performance of a particular financial index. For example, the S&P 500 index measures 500 of the top publicly traded firms in the United States — and there are numerous mutual funds indexes and exchange-traded funds (ETFs) designed to mimic this index.
The fund managers purchase each stock included in the index in the same proportion as it is featured in the index. Having an investment product that individuals may purchase directly to get the same performance as the index without needing to buy hundreds of individual equities is its rationale.
The majority of index funds make investments in bonds or stocks. For instance, the following are some prominent index funds:
The FXNAX (Fidelity U.S. Bond Index Fund) invests in a diverse mix of United States government bonds, mortgage-backed security bonds, and corporate bonds in its portfolio. The FXNAX tracks the Bloomberg Barclays U.S. Aggregate Bond Index.
The Vanguard S&P 500 Index Fund (VOO) invests in each of the United States’ 500 largest corporations. It’s made to follow the S&P 500 stock market index.
The Vanguard Developed Markets Index Fund (VTMGX) invests in more than 4,000 equities worldwide, with a focus on developed markets. Its goal is to replicate the FTSE Developed All Cap ex U.S. Index.
According to theory, a crypto index fund would track the performance of a specific “index” of cryptocurrencies assets. It may, for example, follow the values of the 10 leading cryptocurrencies, the top 100 cryptocurrencies, or even the “whole market” for digital assets.
Unfortunately, there are no pure cryptocurrency index funds available (as of early 2022). In the case of the top-ten index fund BITW, which will be examined in greater detail below, this is far from the “whole market” index fund that so many investors are searching for.
Is There An “Index” For Cryptocurrencies?
When it comes to stocks, we have countless indexes to examine to measure the market’s overall performance. But what about cryptocurrencies? The alternatives are limited, but cryptocurrency indexing is currently significantly less reliable than stock indexing at this time.
Indexes Of Cryptocurrencies Maintained By S&P Dow Jones.
The S&P Dow Jones Indices is the most formal indexing attempt for the cryptocurrency industry, and it was launched in 2015 (this company has also launched S&P 500 index).
Currently, the business maintains eight separate indices that track the cryptocurrency industry. Perhaps the most relevant index is the S&P Cryptocurrency Broad Digital Market Index, which monitors over 250 most popular cryptocurrencies.
Please remember that there are no alternative investment index funds that monitor these indexes; the S&P indexes are only provided for informational purposes.
The S&P crypto indexes track a max of a few hundred cryptocurrencies, even though more than 15,000 unique cryptocurrencies exist. CoinMarketCap is a website that maintains an international cryptocurrency market capitalization index based on the total market capitalization of all currently recognized cryptocurrencies. Their website also includes some history charts that depict several cryptocurrency coins’ performance (long term).
Unfortunately, there is no way to actively invest in this “index” other than to purchase each token one at a time, as has been the case previously.
Some Crypto Index Funds Where You Can Invest In 2022
So yet, it appears that crypto index funds are only a theoretical possibility. Are there any that are now available that you really can invest in right now?
Bitwise 10 Crypto Index Fund (BITW)
The Bitwise 10 Cryptocurrency Index Fund is the only “index fund” in the cryptocurrency sector traded on a public exchange. In its initial offering, this fund was sold as a private placement, which meant that it was only available to hedge funds and other approved investors.
Although it is no longer private, it is now openly traded; anyone with a brokerage account can purchase it on the open market. The fund is now traded under the trade name “BITW” on the stock exchange. Please remember that Bitwise Asset Management offers more cryptocurrency index funds exclusively to accredited investors. It seems to be the only publicly listed option accessible to the general public.
The Bitwise 10 Index Fund, as the name implies, makes investments in the ten most valuable cryptocurrencies in the world (calculated by market cap).
Since the shares are rebalanced each month, this composition is changed. In an unusual move, Bitwise excludes stable currencies from consideration and concentrates entirely on crypto tokens. Due to the fact that stable coins are designed to maintain parity with the value of the United States dollar, this is a benefit for investors who seek long-term price appreciation.
While BITW appears to be a decent idea on paper, there is one significant flaw: The expense ratio is 2.5 percent, according to the company (charged annually). It is a very expensive price that will significantly impact long-term performance.
Due to the high cost, BITW trades at such a price that differs from its NAV (net asset value) or the aggregate price of its real holdings, partly because of the fee. At the moment, it is trading at a discount.
BITW does not closely track its fundamental holdings, in part because investors are assessing the long-term consequences of the company’s high expense ratio when deciding whether to invest.
So while BITW is anything but perfect, it is an excellent starting point. The primary advantage is that it may be purchased through a traditional investment account or maybe even a retirement plan. You also didn’t have to worry about keeping track of your cash or cryptocurrency wallets. However, what if you desire more personalization, greater diversification, or cheaper expenses in your investment?
How To Build Your Own Crypto Index Fund?
Building your own “index fund” is an option to investing in established funds such as BITW. It entails purchasing cryptocurrencies straight from a cryptocurrency exchange.
There are advantages and disadvantages to using this approach:
- You are the sole owner of cryptocurrencies.
- You save money by not paying continuing management costs.
- It is impossible to detect “tracking faults” in the index fund’s performance compared to the underlying assets.
- You have the option to personalize depending on your investment choices.
- It requires more effort, especially when rebalancing.
- You may need to use various exchanges to obtain all of your desired coins.
- You must handle your investments and keep them safe.
- It is possible that tax reporting will be more complicated.
- There are still fees associated with purchasing and selling your crypto assets.
How To Establish Your Cryptocurrency Portfolio?
What is the best way to create your own cryptocurrency “index fund” out of cryptocurrencies? Here are the fundamentals.
- Create an account with a cryptocurrency exchange of your choice.
- Identify the number of crypto assets in which you wish to invest. A coin index of the top ten coins is an excellent place to start.
- Please make a list of your coin allocations and total them up. Market cap weighting is the greatest way to emulate an “index” strategy.
- Make use of the statistics on CoinMarketCap to determine the market domination of each cryptocurrency you are considering investing in
- The proper amount of each cryptocurrency asset should be purchased from the exchange.
- Rebalance as needed, but keep in mind that selling assets may have tax ramifications.
How Do You Calculate Market Cap Weighting For Your Cryptocurrency Index Fund?
You can manually calculate it by dividing the market capitalization of each cryptocurrency token by the market capitalization of the entire cryptocurrency market. Alternatively, you can refer to the charts supplied by CoinMarketCap, that calculate the “market dominance” of each of the 10 leading cryptocurrencies in terms of dollar value.
As a result, after calculating market dominance, you would distribute approximately 41 percent of your investment to Bitcoin, 21 percent to Ethereum, and so on.
If you decide to exclude stable coins such as Tether and USD Coin from your calculations, you’ll need to figure out what percentages to use instead. Additionally, if you decide to invest in coins that aren’t in the top ten, you’ll have to do all of the calculations manually, which will take longer.
When investing in Chainlink (LINK) that is not among the top 10, you will calculate the percentage of your portfolio to allocate in the following way:
CoinMarketCap provides the most up-to-date information on cryptocurrency market prices.
Find out how much money LINK is worth ($8 billion, for example).
Divide the result by the total market capitalization of all cryptocurrencies ($2.1 trillion, for example).
To calculate the percentage, multiply that number by 100.
In this instance, you would allocate 0.38 percent of your total investment to LINK to correspond to the appropriate market capitalization weighting.
You Can Go For A Half And Half Approach
If you had the option to merge direct crypto ownership with ETF-style investments, would you take advantage of the best of both worlds? It’s becoming increasingly simple to purchase Bitcoin in exchange-traded fund (ETF) form, and Ethereum ETFs are expected to launch in the not-too-distant future. It offers an interesting investment opportunity for those who are interested.
According to the Financial Times, cryptocurrency investors could choose to invest in Bitcoin ETFs in their retirement funds or taxable brokerage accounts while also purchasing other cryptocurrencies directly from exchanges. While using this approach, investors can take advantage of the tax benefits associated with holding cryptocurrency in their tax-advantaged investment accounts even while having the ability to invest directly in a greater variety of coins.
For example, if you chose to invest $10,000 in the cryptocurrency market, you could do the following:
You should put $4,100 into your Roth IRA to invest in the ProShares Bitcoin Strategy ETF (BITO) (41 percent of investment).
Purchase $2,100 in Ethereum and deposit it into your exchange account (21 percent of investment).
Purchase the remaining $3,800 in value of various other cryptocurrencies in your exchange account (38 percent of your investment), with distributions based on the market capitalization of each coin you select.
As you can see, you can make this personalized indexing approach as complicated or as straightforward as you want, depending on your needs.
This customized approach may be the best option for knowledgeable crypto-investors until better alternatives for true crypto index funds become available.
Don’t want to make things too complicated? In terms of total market capitalization, Bitcoin and Ethereum account for more than 60 percent of the total — and that figure rises even greater when you exclude stable coins from the calculation.
As a result, investing solely in Bitcoin and Ethereum still provides you with a significant level of publicity to the general crypto market. At the same time, smaller allocations to the rest of the top 10–15 coins can help round out your portfolio if you’re inclined to put in the time and energy.
Other Options For Investing In Cryptocurrency
Are you dissatisfied with the current offering of cryptocurrency index funds? There are a plethora of options available for purchasing crypto assets these days. Here’s a high-level overview.
Directly Buying Cryptocurrency On An Exchange
Purchasing coins directly from a reputable cryptocurrency exchange provides you with access to a large number of tokens as well as the advantage of direct ownership of the coins.
At the moment, cryptocurrency exchanges offer the most diversification potential, as they enable you to invest in a greater variety of tokens and build your cryptocurrency portfolio in the manner of an index fund, for example. Exchanges like these allow you to purchase, sell, and exchange cryptocurrencies with other cryptocurrency owners, with the exchange acting as a middleman between the two parties. It also has the capability of storing your coins on your behalf, or it can move them to a crypto wallet on your behalf.
Exchanges charge transaction costs for buying and selling, but they do not charge operational expenditures for management or custodial services, which is unusual.
Buying Crypto ETFs & Mutual Funds
Investors also have access to crypto exchange-traded funds (ETFs) and cryptocurrency mutual funds. At this stage of 2022, these ETFs are nearly entirely focused on Bitcoin, and as a result, they do not provide a balanced index-style investing opportunity.
As more funds receive regulatory clearance from the SEC (Securities and Exchange Commission) in the coming years, we are expected to witness an increase in the number of funds launched.
Investors do not yet have access to a true cryptocurrency index fund, which is a step forward. It may alter in the next months or years as cryptocurrency becomes more popular and investor demand increases. For the time being, the best approach is to invest in cryptocurrency ETFs and mutual funds or to create your own diversified cryptocurrency portfolio.