With big increases in the value of cryptocurrencies like Bitcoin and Doge, average people are now seeing how possible it is to make money in crypto. However, the market is volatile, and poor timing can result in big losses. Diversification can help lessen the risk, but it takes a lot of effort to buy a diverse array of coins and keep track of the allocation amid a rapidly-changing marketplace. The easiest way to diversify is to invest in a mutual fund, and the easiest type of mutual fund to understand is an index fund.
Stock index funds are a common way for regular investors to participate in the stock market with lower risk because they're betting on the market as a whole rather than a single company. To bet on the future of cryptocurrency rather than a single coin, you need to diversify, and the advent of crypto index funds is one more way traditional financial products are making their way into the world of blockchain.
Let’s take a look at how these funds work and why they might be a smart place to put your money.
What Are Index Funds?
The first thing to understand is the difference between stocks and mutual funds. When you buy stock in, say, Apple, you own a piece of that company. You purchase a share at a certain price, and if that price goes up, your share will be worth more money when you eventually sell it. You can also earn dividends through holding a stock, payouts that come on a regular basis for shareholders.
However, if that stock's value goes down and stays down, you’ll lose money. You have to pay close attention to the companies in which you're invested, and to diversify, you'll need to purchase stock in many different companies in order to mitigate risk.
A mutual fund is where you invest your money with a fund manager, along with a whole lot of other people. That giant pool of money is then taken and invested in a LOT of companies through the purchase of MANY stocks. While you may only be able to afford a share or two of a single company, a mutual fund allows you to own small pieces of hundreds or thousands of companies.
There are two types of mutual funds: active and passive. An active fund is where the fund manager makes choices about what to invest in, and by going with that fund, you’re trusting their judgment. A passive fund is built on a set of rules, and doesn’t deviate from them. Index funds are passive funds meant to mimic the market. Instead of investing in a company that’s listed on the stock exchange, you’re investing in the entire market.
The oldest index fund is VFIAX, the Vanguard 500 Index Fund Admiral Shares, which provides exposure to 500 of the largest companies in America. You can also purchase shares in indexes that mimic the total stock market, international stocks, bond indexes, and real estate investments; these are all made up of hundreds or thousands of individual assets purchased in proportion to their market capitalization. In other words, the largest percentage of assets will be in the largest companies, which for VFIAX would be Apple, Microsoft, and Amazon.
The key thing these funds provide is diversification, which lowers risk. The theory is that you can’t beat the market, so you should instead follow the market. In fact, index funds have been proven to provide better returns on average than actively-managed funds while offering lower fees. Warren Buffett has even called them “the most sensible equity investment for the great majority of investors.” These types of funds are now so popular that they control more assets than actively-managed funds.
Crypto indexes can work in the same way, with an investment in the fund offering exposure to a wide range of currencies in varying percentages. You can't really "mimic the market" with crypto in the same way as the stock market because index funds base how much of each stock they buy on market capitalization. Since Bitcoin is such a huge part of the crypto market, a market cap-based fund would be almost all Bitcoin, defeating the purpose of risk management through diversification. That's why crypto index funds have specific policies about the types of coins they buy and limits on how much of each they will purchase.
When choosing a crypto index fund, the criteria should be largely the same as with traditional indexes:
1) What assets does the fund hold?
2) What is the expense ratio? This is the amount you pay to the fund for managing your money.
3) How well has it performed over time?
This third one is a little tough because these indexes are so new, but the appeal of index funds in other asset classes is that they offer steady growth over time rather than huge ups and downs. With crypto, you should see steady growth in that fund’s recent past, but smaller peaks and valleys than come from a single currency’s swings.
The idea is that if an asset crashes (such as a coin’s value plummeting or a company’s stock becoming worthless), you won’t be as exposed because it’s only a small part of the fund’s portfolio, and they’ll dump it quickly so you don’t have to stay on top of it. The result should be that your money may not jump by huge leaps and bounds, but will continue to grow just as the market does.
Here are a few crypto index funds that are gaining interest, and what makes them attractive to investors.
Bitwise
In 2017, Bitwise created the Bitwise 10 Crypto Index Fund. They have since expanded to offer several other funds, all of which have different assets. BITQ, for example, focuses on companies innovating the blockchain sphere, while the Bitwise DeFi Crypto Index Fund tracks decentralized finance assets such as protocol tokens.
As the first out of the gate, BITW is a leader in this space and has garnered a lot of attention. The amount of time it’s been around also means there’s more data about its success that can be relied upon.
Fund: BITW
Assets Under Management: $763 million
Largest Fund Holdings: Bitcoin, Ethereum, Bitcoin Cash, Litecoin, Chainlink
Expense Ratio: 2.5%
Growth 2021 to Date: 51.3%
Growth Past Year: 349%
Invictus Capital
Invictus offers a user-friendly investment platform that features crypto index funds along with assets like gold, renewable energy markets, and margin lending. It also has its own token, ICAP, which can be earned by staking crypto assets for a predetermined period of time.
Invictus’ first fund was Crypto20, which is invested heavily in Ethereum, Bitcoin, and Cardano, among others. To invest in Crypto20, tokens must be purchased from other users. However, there is another fund, Crypto10 Hedged, which is an open-ended fund that attempts to lower risk through a cash allocation strategy.
Fund: C10
Assets Under Management: $12.6 million
Largest Fund Holdings: Binance, Cardano, Ethereum
Expense Ratio: 1.7%, with a 0.5% subscription/redemption fee
Growth 2021 to Date: 114%
Growth Past Year: 299%
Wave Financial
In addition to an index fund, Wave Financial also has an actively-managed VC fund and a Bitcoin Income Fund based on call options. These are more complicated products, but its Select 5 Index is rather simple. It’s based in only five tokens in sizable allocations. Wave’s SEC form listed the minimum investment at $50,000, so this is an opportunity for those with a lot of cash.
How Do These Funds Compare To Other Investments?
While Wave Financial has not been as forthcoming with its full performance data, we can compare the other two index funds to stock indexes and individual crypto assets. Let’s take a look at the one-year growth of each, as of 5/29/21:
VFIAX: 37.9%
VTSAX (Vanguard Total Stock Market): 41.7%
BITW: 349%
C10: 299%
BTC: 260%
ETH: 976%
DOGE: 11,937%
Now, it’s important to remember two things: 1) these numbers change daily, so by the time you read this, they will be different, and 2) these particular cryptocurrencies have seen huge gains in the past year. It’s tough to know if they will continue to grow like this, but that’s the thing that’s both exciting and risky about crypto investments.
Stock indexes obviously have not seen the one-year growth of crypto, but the difference is that you can look at data for them that goes back decades. That provides peace of mind and confidence in the abilities of the people running these funds to deliver solid returns. As time goes on, the best crypto funds should do the same.
We can also see that crypto index funds aren’t able to provide the instant success of something like Doge. That’s why this isn’t a good choice for day traders and short-term investors, because reallocation won’t be done quickly enough for their liking and is something they can take care of on their own.
But for people new to crypto, long-term investors, and anyone who sees potential in the technology but doesn’t keep up with the day to day, a crypto index fund is a great way to purchase assets that you can hold for a long time without putting all your eggs in one basket.
The more cryptocurrency can offer investment products that match those in traditional markets, the more legitimate it will seem to average investors, which will only push its value higher. If you believe in blockchain and cryptocurrency, but aren’t as inclined to believe in Dogecoin or Bitcoin, this is a way to make a sensible play.