Cryptocurrency Index Funds: A Less Risky Way to Trade Cryptos

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Cryptocurrencies have emerged as the new asset class that everyone is raving about. One spectacular thing about cryptos is the large range of movements that occur in many pairs on a daily basis. Unfortunately, these large movements make cryptocurrencies very risky to trade. The risks are so high that many forex brokers that feature cryptocurrency pairs on their platforms have applied very high margin requirements for traders interested in trading cryptos. A typical leverage setup on a forex platform will see Bitcoin/USD or other crypto pairs assigned a leverage of 1:10, or a 10% margin requirement. This is far beyond what you will ever see for any currency pair, or for any other CFD asset. The situation is even more serious on exchanges, as traders are not provided any leverage. They therefore have to come up with the full amounts of money required for trades on cryptocurrency exchanges.

One other point which will probably never get mentioned anywhere, is that it is also very expensive to hold overnight positions on crypto pairs. If you are long on a crypto pair which features the lower-yielding asset as the base pairing, leaving the position overnight can not only erode all your unrealized profits, it may even lead to a margin call on the account.

We have to put this into some form of context, understanding who is actually trading cryptos right now. The institutional traders are largely out of the market, as the lack of regulation is a great disincentive for them to trade. Institutional traders are mostly pooled from banks, which are regulated entities that can only operate within a strict regulatory code provided by the central banks. Therefore, the crypto market presently features the retail investors, also known as the unsophisticated investors due to their general lack of professional training and knowledge of how markets work. Ironically, the structure of the crypto market makes it unsuitable for retail investors, many of whom are under-capitalized and simply have no business taking on such market risks.

It is for these investors that cryptocurrency index funds have been created, as a low-risk, encompassing way of trading the cryptocurrency markets.

What are Cryptocurrency Index Funds ?

These are market instruments which are made up of a basket of cryptocurrency assets, pooled together to form a single tradable fund. Some fund operators issue a token to symbolize this basket.

There are several methods used in composing cryptocurrency index funds. The commonest method is the weighting method, which assigns a weight to the constituent cryptocurrency using a standardized metric such as the market capitalization of that crypto.

Why Cryptocurrency Index Funds?

Crypto indices are by nature, a low-risk investment. Market risk is reduced by assembling a basket of cryptocurrencies in such a way that no single crypto takes up too much weight in the basket. This prevents a situation where a steep rise or fall in the overweight crypto ends up dragging the entire basket with it, which defeats the very essence of the creation of crypto index funds.

Cryptocurrency Index Funds: A Less Risky Way to Trade Cryptos

Furthermore, the structure of crypto index funds allows traders to invest smaller amounts of money than they would be required to if they gain full exposure to the crypto markets on broker platforms and exchanges. This allows for smaller risk, low-entry trading.

Cryptocurrency index funds are also easier to manage and track. Some of them have correlations with the movements of certain cryptocurrencies or certain industries/ecosystems. For instance, some crypto indices are tailored to track crypto assets derived from the FinTech industry. Others may be tailored to track agricultural assets, or even advertising companies. It all depends on what the crypto is tracking. Such correlations can then be used to make buy or sell decisions for the crypto index funds being traded.

How to Start Investing in Crypto Index Funds

If you want to take advantage of the low-risk environment that cryptocurrency index funds offer, here is a step-by-step description of how to get involved.

Step 1: Understand What You Want to Trade

When it comes to individual performance of assets, the crypto market is just like any other. Some assets will outperform the others in a given time frame. So you need to choose a crypto index which features assets that generally tend to have some good movement.

A Typical Index Allocation Basket ©2018 BBIndex

A Typical Index Allocation Basket ©2018 BBIndex

Do not choose indices that have some deadbeat assets squeezed in with the good ones.

Step 2: Choose Crypto Indices With a Good Track Record

In a market which is largely unregulated and where it is very difficult to separate the wheat from the chaff, you need some background information to work with in terms of choosing an authentic crypto index. Therefore, you should ideally go with one which has been in existence for some time and which has shown a good track record of not just performing well, but even outperforming the major cryptocurrencies over a time period. A single index platform may have different cryptocurrency indices, so you can make an informed choice by studying the performance metrics of each one.

Step 3: Prepare Your Know-Your-Customer (KYC) Documents

Most cryptocurrency index providers like to know whom they are dealing with. So verification of identity and submission of a proof of address document is something investors will have to perform so as to be allowed to trade on the index platforms. You need an international passport and a utility bill/bank statement that is not more than three months old to be able to pass KYC requirements.

Step 4: Select an Acceptable Payment Method and Deposit Your Funds

Choose from a list of acceptable deposit methods provided by the crypto index fund providers and deposit funds to start investing in your preferred cryptocurrency index fund.

Conclusion

So far, many of the well-known cryptocurrency index funds have outperformed Bitcoin in the last one year. The emphasis on cryptocurrency index fund investment is in the asset allocation and not in the timing of entries. This segment of the cryptocurrency market still has a lot of upside potential. Therefore, you need to start looking at cryptocurrency index funds as a low-risk, passive method of benefiting from the cryptocurrency market.

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