What is a Crypto Index Fund and How Does It Work?
What is an Index Fund?
Indexes are a sort of measurement or scale that is used to describe the top-performing shares or financial instruments in the market. Financial experts create indexes as metrics to filter the best shares in a particular discipline such as healthcare or supply chain etc.
An index fund is a type of financial vehicle that invests in the top-performing shares or market instruments in an index.
What is a Crypto Index Fund?
Crypto index funds are fashioned after stock index funds and contain a group of digital assets that are highest performers based on the measurement criteria of the given index fund. In simpler words, crypto index funds track the performance of specified crypto indexes.
Crypto index funds are fashioned after traditional index funds such as S&P 500 and Dow Jones Industrial Average etc.
It is important to note that crypto index funds are different from crypto ETFs. Crypto ETFs share a lot of features with the traditional ETFs. They are also regulated investment instruments and issue shares that are listed on a stock exchange market.
Usually, traditional ETFs track the value of underlying assets while crypto ETFs track the performance of derivatives and futures contracts.
Major Purpose of Crypto Index Fund
During the Covid-19 quarantine economic stability of various nations took a massive hit. A considerable amount of nations are still reeling from the lingering effects of the global financial crisis. At the same time, regardless of the technological advancements and development a huge percentage of the global population continues to remain unbanked.
Furthermore, the common person continues to deal with contentious problems such as lack of wage growth, unaffordable property costs, and government debt.
After the last international financial crisis of 2008, fintech innovations such as blockchain and DLTs have provided people various viable instruments of investments in the form of cryptocurrencies such as Bitcoin, Ethereum, Solana, and others.
However, a lot of regulators around the world have voiced their reservations regarding the significant price volatility in cryptocurrencies. In this pretext, tokenized securities that are backed by real world assets such as commodities or property have gained traction.
Tokenized products require blockchain for record-keeping and representing the value of RWAs in a digitized form. The tokenized assets represent value from the collateral funds.
Some good examples of crypto index funds are Grayscale Large Cap Fund and Bitwise 10 Crypto Index Fund. Both these funds track the performance of top 10 cryptocurrencies by market cap and weigh them in terms of liquidity.
Crypto index funds allow investors with portfolio diversification and security by spreading investment capital into multiple cryptocurrencies. In contrast, spot trading allows investors to invest in just one coin that increases their risk of losses.
How Does a Crypto Index Fund Operate?
A crypto index fund pools a number of cryptocurrencies from the spot market based on a metric or market performance criteria. The fund is usually automated and can add or remove cryptocurrencies based on the variance of their market performance in accordance with set parameters for qualification. The fund issues shares that represent the value of the tracked cryptocurrencies in the proportional value.
In this way, traditional investors may also seek exposure in crypto index fund by purchasing their shares and without buying a cryptocurrency directly. Index funds are viewed as a passive investment strategy and fund managers do not actively purchase or sell the backing assets.
The investors are saved from the hassle of securing or managing, underlying assets of the index fund. However, they are charged a management fee while some index funds also using an expense ratio.
Advantages of Crypto Index Funds
Here are some of the benefits of crypto index funds:
Crypto index funds are a good way of gaining exposure in a wide variety of cryptocurrency at once. In this manner, crypto index funds spread the risk across a multitude of digital assets and various projects.
Crypto Index funds also charge investors a professional management fee. The index funds are managed by qualified managers who are authorized to make the decision about which coins to include or exclude from an index fund in order to keep it in a balanced state.
Crypto Index funds issue shares that are listed on traditional stock exchanges. They can be bought or sold like other financial instruments.
Crypto Index funds are good for qualifying for tax-deductible. They provide investors with a tax advantage since investors are able to gain exposure in multiple backing assets instead of just one product at a time. In order to gain the maximum exposure, it is best to use a taxable account for index funds.
Conclusion
There are numerous benefits of investing in a crypto index fund as visible from the aforementioned examples. However, investors must also beware of various risks associated with crypto index funds such as lack of control, higher management fees, and barrier access in order to incorporate the best risk management strategies.
