Understanding Cryptocurrency Indexes
Loading a crypto screener page after learning about cryptocurrencies is like stepping into a grand, fancy candy store as a child. With so many options to explore, one can almost salivate at the very possibilities laid before their eyes. While one can dream of an everlasting bull market which upon throwing money at, would throw more at you in return, the harsh reality is that unless you’re treating the market as a casino, you’re in for some tedious work.
Indeed, investing is, for the most part, a tasking and monotonous process consisting of reading, research, and data processing. Not only does one have to read thoroughly about a project, its founders, the community, the backers… etc, but also about the external factors that influence it, and the industry the project aims to target. Needless to say, it’s less of a child in a candy shop and more of a health-conscious adult in a grocery store looking for organic, non-processed foods while on a tight budget.
However, upon accumulating knowledge and learning more about projects, industries, and economies, one might come to the conclusion that the project they’re staring at is but a piece of a bigger picture, and that other, similar projects may address different aspects of the same core problems. In other words, two or more projects could be connected in such a way that if one of them performs well due to external circumstances, chances are that most of them will follow suit — and vice versa.
So if investing in a specific project carries a certain amount of risk, but fundamentally speaking, the nature of the project displays promising solutions to well-defined problems, would it not make more sense to conveniently invest in one product that represents a variety of similar projects to avoid putting all your eggs in one basket?
In many cases, it does, and the word you’re looking for is ‘index funds’.
Indexes and Index Funds in Crypto
Indexes aren’t at all a new concept and have existed in traditional stocks for a long time; in fact, the first stock index, The Dow Jones Industrial Average (DJIA, also referred to as the Dow) was launched in 1896 for the purposes of evaluating the stock market. The S&P 500 is perhaps the most popular example of a stock market index, which tracks the performance of 500 major companies listed in US stock exchanges.
However, that’s the stock market, something that has existed for over 2 centuries, based on companies that have had a direct impact on economies, jobs, and lives for generations. Cryptocurrencies, on the other hand, are rather new, and have yet to see the same amount of indexes from credible financial institutions. The S&P Dow Jones Indices, for example, does track a variety of cryptocurrency indexes, however when it comes to publicly-traded cryptocurrency index funds, options are rather scarce.
But can’t DeFi protocols use smart contracts to create crypto index funds? Yes, and no. There are investment strategies, not too different from index funds in a broad sense, that invest in multiple tokens simultaneously. However, they are limited in their reach. To put it simply, this is because the process can get really complicated when multiple blockchain networks are involved, and interoperability has to be taken into consideration. While some networks are interoperable with one another to some capacity, the more interactions you involve, the more complex the process becomes.
Given how the native tokens of blockchains are the most promising most of the time, you are tasked with, by default, at least a dozen or so blockchain networks you want to interact with, with every purchase. Once we begin to factor in the projects that are building on top of these networks, we begin to understand the sheer level of work required to have proper on-chain, decentralized, and publicly-traded crypto indexes.
Until the industry matures to the point where interoperability is seen as a challenge of the past, the only viable players in this space that are capable of creating index funds for cryptocurrencies are centralized exchanges. However, given the ambiguous legal state of most cryptocurrencies, it’s safe to say we won’t see such solutions anytime soon.
This is a shame, of course, considering the advantages that index funds offer. While you may trade off some profits because you’re not cementing your position in one specific project, you also mitigate risks by assuming that most of the projects in an index fund are honest and well-managed enough to persist and grow. You would also save a lot of money in gas fees, and in that same vein, you don’t have to purchase dozens of gas tokens to make regular purchases. It suffices to say that index funds are far more convenient than most other trading strategies, and to some extent more efficient, and this fact especially rings true for cryptocurrency markets.
Examples of Crypto Indexes
There are numerous approaches to creating an index for cryptocurrencies, these may include:
- Broad selections such as 100 different and legitimate projects spread across various categories and blockchain networks.
- DeFi protocols that pertain to everything related to finance on decentralized marketplaces.
- GameFi applications that leverage blockchain technology for a wide range of video games.
- NFT projects that issue unique tokens to represent digital or real-life items and concepts.
- Metaverse platforms that combine various blockchain-based concepts into one digital realm.
- Digital currency tokens that facilitate global Peer-to-Peer payments in a trustless and permissionless fashion.
As the space matures, more and more indexes will appear, tracking the collective performance of a host of different blockchain-based tokens from a wide range of categories. For now, unfortunately, users will have to invest individually at best, or design their own indexes at worst.
Alternatively, They Can Choose Sentient
Sentient is by no means an index fund, but a parallel can be drawn where both index funds and Sentient both make an assumption about the market. In the case of the latter, we assume that the crypto market is volatile and contains many opportunities such as price inefficiencies across many centralized and decentralized marketplaces — which is more of a fact than an assumption. Gas fees and manual trading are — just like index funds — not required after making a deposit into one of Sentient’s investment pools, but unlike indexes, users do not need to worry about the direction of the market or the price action of individual tokens. There is also the added benefit of incorporating more strategies in Sentient’s algorithm, whereas index funds tend to be more concrete in nature, which can crumble when faced with the inevitable force of change.
Stay tuned for a chance to try out Sentient’s beta! In the meanwhile, let us know how you plan to use cryptocurrency indexes as they develop!