A Beginner's Guide To Investing In Crypto Index Funds

Cryptocurrency index funds are a way to build a diverse crypto portfolio through a single investment. They are a type of mutual fund, which pools investor funds that a fund manager invests in securities. Index funds, however, do not have a fund manager; instead, they invest in a specific stock market index. While crypto index funds are mostly theoretical at the moment, with very few successful attempts to build traditional investment vehicles that track multiple types of cryptocurrency, there are a few options available for investors.

The benefits of index funds

Index funds are a great way to invest in cryptocurrencies. They are affordable, easy to invest in, and typically generate solid returns. Here are some of the benefits of investing in cryptocurrency index funds:

Diversification

Index funds provide investors with a diversified portfolio of cryptocurrencies, which can help to spread risk across different coins and projects. By investing in a basket of cryptocurrencies, rather than just one coin, investors can reduce the high volatility that is commonly associated with individual cryptocurrencies. This means that if one cryptocurrency performs poorly, the other cryptocurrencies in the fund may perform well, helping to balance out the overall performance of the fund.

Professional Management

Index funds are typically managed by experienced professionals who make decisions about what coins to include in the fund and when to rebalance it. This can help to reduce the time and effort required for individual investors to research and select individual coins to invest in. Financial experts select the coins that make up the index and rebalance the cryptocurrency portfolio as needed, so participants don't have to worry about which crypto assets are included, saving them a lot of time.

Liquidity

Since index funds are traded on exchanges, they can be bought and sold like any other asset, providing institutional investors with a streamlined approach to gain exposure to digital assets.

Tax Efficiency

Index funds are tax-efficient and may even offer a tax advantage since only one index fund is kept rather than numerous individual equities, especially if they are kept in a taxable account.

Reduced Risk

Participation in a cryptocurrency index fund may help to mitigate risk. This is based on the principle of diversification: the more diversified a portfolio is, the less risk it carries. If one cryptocurrency within the index behaves negatively, a well-diversified index fund can help offset those losses.

Passive Investment

Cryptocurrency index funds are a passive investment strategy, as they are designed to track the performance of a particular market or index, rather than trying to beat it. After the initial investment is made, the provider will automatically rebalance and reweight the crypto index fund based on its own systems and objectives.

What is a cryptocurrency index fund?

A cryptocurrency index fund is an investment vehicle that allows investors to gain exposure to a broad range of crypto assets in a single investment. It is designed to provide a simple and familiar way for investors to access the crypto market, without having to pick individual cryptocurrencies or tokens.

Index funds are well-known in traditional finance and are considered a good investment for retirement, as they offer diversification and track a specific market or asset class. Similarly, a cryptocurrency index fund allows investors to track the crypto market by investing in a basket of cryptocurrencies, which are selected and managed by crypto experts.

These funds are typically weighted by market capitalisation, with the largest and most established cryptocurrencies making up a significant portion of the fund. For example, the Coinbase Index Fund includes all assets listed on the Coinbase exchange, weighted by market capitalisation. Other funds may include a specific number of cryptocurrencies, such as 7, 20, or 50 in each index.

Cryptocurrency index funds are generally restricted to accredited investors and have high minimum investment requirements, making them more accessible to institutional investors or high-net-worth individuals. However, some providers are working to launch funds that are accessible to a wider range of investors, including retail investors.

How to invest in cryptocurrency index funds

Investing in a cryptocurrency index fund is a way to gain exposure to a diverse range of cryptocurrencies without having to manually select and manage individual assets. Here are the steps to invest in cryptocurrency index funds:

Research and Choose a Fund:

Begin by researching the different crypto index funds available. Look for funds with a good track record that are managed by reputable companies. Check the fund's historical performance and read reviews from other investors. Some examples of crypto index funds include:

• Bitwise 10 Crypto Index Fund (BITW)
• Bloomberg Galaxy Crypto Index Fund (BGCI)
• Nasdaq Crypto Index Fund (NCI)
• Fidelity Crypto Industry and Digital Payments Index (FDIG)
• Bitwise DeFi Crypto Index Fund (BDEFI)

Open an Account:

Once you have identified a fund that you are interested in, you will need to open an account with the fund manager. This can typically be done online and may require you to provide personal information and proof of identity.

Fund Your Account:

After opening an account, you will need to fund it with cash or cryptocurrency. The minimum investment amount may vary depending on the fund.

Buy Shares in the Crypto Index Fund:

Once your account is funded, you can buy shares in the crypto index fund. The price of the shares will be determined by the fund's net asset value (NAV), which is calculated based on the value of the underlying assets in the fund.

Monitor Your Investment:

After buying shares in the fund, it is important to monitor its performance and ensure it meets your expectations. Some funds may allow users to trade shares on a secondary market, while others may require them to hold their shares for a certain period.

Track Your Gains and Losses:

Finally, track your gains and losses in the crypto index fund by comparing the NAV of the fund to the price you paid for your shares.

Benefits of Crypto Index Funds:

• Diversification: Crypto index funds spread risk across different coins and projects.
• Professional Management: Experienced professionals make decisions about coin selection and fund rebalancing.
• Liquidity: Index funds are traded on exchanges and can be bought and sold like any other asset.
• Tax Efficiency: Index funds may offer tax advantages, especially if held in a taxable account.

Disadvantages of Crypto Index Funds:

• Lack of Control: Investors have less control over their investments as fund managers make decisions.
• Higher Fees: Index funds often have higher fees than buying individual coins due to management costs.
• Barrier to Access: Crypto index funds may not be available in countries without cryptocurrency exchanges or underbanked populations.
• Lack of Knowledge: Novice investors may miss out on opportunities by investing in a fund instead of individual coins.

The DIY option

If you want to build your own crypto index fund, you can follow these steps:

• Sign up for an account with a cryptocurrency exchange: You can choose from a variety of exchanges, such as Coinbase, Gemini, Kraken, or Binance. These platforms offer different features and fees, so it's important to compare them before selecting one that suits your needs.
• Select the cryptocurrencies for your index fund: Research and carefully evaluate the unique characteristics of each cryptocurrency before deciding which ones to include in your index fund. Remember to consider the risks and volatility associated with each coin.
• Decide on the investment allocation: Determine how much you want to invest in each cryptocurrency you've chosen. Consider your budget, risk tolerance, and investment strategy when deciding on the allocation.
• Be mindful of trading fees: While you won't pay an expense ratio by building your own crypto index fund, exchanges typically charge trading fees. Compare the fees across different exchanges to find the most affordable option.

Keep in mind that this method can be time-consuming, especially if you plan to rebalance your portfolio frequently based on price movements. Additionally, it may be challenging to manage a large number of cryptocurrencies in your index fund.

The future of cryptocurrency index funds

As of 2024, there are already more than a dozen crypto index funds in the market, with assets under management ranging from $1 million to several hundred million dollars. The Bitwise 10 Crypto Index Fund (BITW) is one of the most notable, tracking the 10 largest cryptocurrencies by market capitalization. Other popular options include the Bloomberg Galaxy Crypto Index Fund (BGCI) and the Nasdaq Crypto Index Fund (NCI), which also offer diversified exposure to leading cryptocurrencies.

The benefits of cryptocurrency index funds include instant diversification, passive management, and streamlined access to digital assets for institutional investors. However, one of the key challenges is the high fees associated with these funds, with some charging an expense ratio of up to 2.5%. Additionally, the majority of these funds give preference to Bitcoin and Ethereum, which may limit the level of diversification.

Looking ahead, the growing institutional acceptance and maturity of digital assets, coupled with the entry of reputable TradFi firms into the crypto space, are positive indicators for the future of cryptocurrency index funds. As the market continues to evolve and regulatory approvals come through, we can expect to see more investors turning to cryptocurrency index funds as a foundational building block for their portfolios.

Frequently asked questions