Crypto index funds: What you need to know

The cryptocurrency industry has evolved significantly in recent years. As a result, many investment opportunities have arisen. The majority of these investment opportunities came from the traditional finance space, for example, crypto index funds.

This guide will explain what cryptocurrency index funds are, how they work and their pros and cons. Understanding them can come as a major advantage to those interested in diversifying their investment portfolio.

What is a crypto index fund?

A crypto index fund works just like any other traditional index fund would. It simply tracks the performance of a particular cryptocurrency index, which consists of a basket of Cryptocurrencies. 

By investing in a crypto index fund, investors gain exposure to the entire index, without having custody of the crypto. Owning crypto is typically the biggest problem for institutional and major individual investors as it comes with its own set of problems such as storage and security. These may not seem like major issues, however, those unfamiliar with digital assets might feel uncomfortable storing the assets.

As such, crypto index funds represent a much more familiar approach to investing. Institutions and wealthy investors aren’t scared of volatile assets, however, they are reluctant to engage with crypto due to the lack of regulation. This is exactly why crypto index funds were introduced.

Crypto index funds are managed by professional fund managers. They select the coins that make up the index and rebalance the portfolio when needed. That way, investors don’t have to constantly worry about their investments. More importantly, there is no need for them to conduct research into each individual crypto.

How does a crypto index fund work?

Crypto index funds offer investors a simple way to diversify their crypto portfolio. By investing in a group of crypto assets, crypto index funds can help mitigate risk. This is the basic rule of diversification. The more diversification a crypto index fund has, the less risk there is associated with it. If one crypto within the basket was to perform negatively, a well diversified crypto index fund will help dampen those losses.

All that is left is for investors to buy shares in the fund, and receive crypto market exposure. Crypto index funds are also considered to be one of the best passive investment strategies. After all, fund managers will not actively buy and sell the underlying assets. 

Advantages of crypto index funds

Investing in crypto index funds comes with a number of benefits that investors should be aware of. Apart from providing diversification, crypto index funds are also managed by financial experts. Therefore, investors don’t have to worry about which crypto assets are included, which saves them a lot of time that would have been spent researching certain projects.

Another benefit is that you no longer have to worry about liquidity. This is something that is a common concern in crypto trading. Investors sometimes wish to buy an asset that lacks liquidity, this makes it risky to hold, especially considering how volatile cryptos are. With that being said, buying assets with sufficient liquidity is the first step towards quality risk management.

Lastly, we should also note that a big advantage of crypto index funds is tax efficiency. Not only are crypto funds tax-efficient, but they also offer certain tax advantages. To keep it simple, as there is only one fund/investment, investors aren’t penalized for cashing out profits on multiple cryptocurrencies.

Disadvantages of crypto index funds

While crypto index funds have their advantages, there are also a few disadvantages to keep in mind. For example, you don’t really have any control over what assets are contained in the index. You simply have to trust that the index managers know what they are doing. Another thing to remember is that index funds typically come with higher fees. If you bought multiple cryptos directly, you would likely pay less in fees than what you pay through an index.

One major downside is geo-location. Investors in developing countries that are not supported by exchanges that offer crypto funds won’t be able to invest in them. This is an example where buying individual cryptocurrencies is better. Blockchain is borderless, which means you can buy and sell coins and tokens no matter where you are in the world. Unfortunately, this is not the case with crypto index funds.

Finally, crypto index funds may suppress investor knowledge. As investors simply invest in the fund, there is no need for them to research the specific coins and/or tokens within the crypto index fund as they entrust the asset manager to deal with that aspect of the investment.

What are some examples of cryptocurrency indexes?

Traditional stocks have hundreds of indexes available, however, the same cannot be said for cryptocurrencies, as indexes are still a relatively new thing within the space. With that being said, there are a few options out there.

For example, you could consider exposure to one of the S&P Dow Jones Cryptocurrency Indexes. This is one of the most official examples of a crypto index. The company has eight different indexes that track the crypto market. The most useful one, in general, is said to be S&P Cryptocurrency Broad Digital Market Index.

Crypto index funds vs. Traditional index funds

One of the common questions asked in regard to crypto funds is how do they compare to traditional index funds?

The two are similar in the sense that they track baskets of assets. In addition, they share diversification as their biggest advantage over other investment vehicles. However, the two are far from being identical. 

One major difference between the two is the underlying assets that they track. Traditional index funds focus on stocks, bonds and other securities. On the other hand, crypto index funds track digital currencies, which are listed on crypto exchanges..

There is also a major difference in risk and volatility. Traditional index funds are not nearly as volatile as cryptocurrencies. This is why risk management is of extreme importance for anyone dealing with crypto. That, of course, includes crypto funds. 

Lastly, another big difference is the fact that traditional index funds track regulated, established assets. Stocks, bonds and alike are all recognized by the government and fully regulated. In the US, for example, the crypto industry is not regulated at this point in time. This further increases the risks of investing in a crypto index fund.

What other ways of investing in digital assets are there?

Apart from investing into crypto index funds, there are several other ways to get exposure to crypto. For example, you could:

Buy cryptocurrencies on exchanges

The oldest and most direct approach is to purchase crypto on an exchange. This comes with its own issues, such as management, security and a lot of research. However, if you choose this option, you have total control of your investment.

Of course, the riskier the assets you choose, the greater the chance of experiencing losses. With that said, be ready for a lot of trial and error before you become an expert in this field.

Buy equities with exposure to digital assets

Another option is to invest directly into publicly traded crypto companies. This approach does not offer exposure to cryptocurrencies directly. However, certain investors may prefer this option, since it is far more regulated.

Buy cryptocurrency ETFs and mutual funds

You could also consider buying cryptocurrency ETFs or crypto mutual funds. These funds started focusing primarily on Bitcoin as of 2022. As such, they are not as diverse as crypto index funds. 

Are crypto index funds a good investment?

The final big question is — is it worth investing into crypto index funds? 

Most of the market participants and experts have concluded that it is. Crypto index funds allow you to get exposure to crypto without having to buy the coins. You don’t have to become an expert in crypto trading, or learn everything about every coin and token. You don’t have to worry about securing your wallet, remembering private keys or managing your assets. You simply invest in a single fund, and let others do the heavy lifting. However, like we discussed there are some disadvantages to crypto index funds, such as high fees and lack of control. It is therefore crucial you carry out your research and make your own decision about them. 

FAQs

What are the best crypto index funds?

While there aren’t many crypto index funds out there at the moment, there are several options to consider. S&P Dow Jones Cryptocurrency Indexes, for example, where 8 of them are available. One of the available options is S&P Cryptocurrency Broad Digital Market Index.

Is there a cryptocurrency index ETF?

Cryptocurrency ETFs are available, and they are also considered a less risky option than buying cryptocurrencies. However, as of 2022, their focus is still primarily on Bitcoin.

Is crypto better than index funds?

Investing in cryptocurrency directly does have some advantages over index funds. However, funds also have their own advantages over crypto tokens. In the end, investors’ crypto expertise will be the deciding factor regarding which is a better option.

How do I buy crypto index funds?

Start by researching different crypto funds, and choose the one that you like the most. Open an account with a fund manager, deposit some money, and buy the shares of the fund. Apart from that, you should regularly monitor your investment, but most of the work is on the manager.