investment strategy

Crypto Index Funds: What You Need to Know

December 28, 2021

Cryptocurrency is on investors’ minds these days, and it’s easy to see why. The prices of many coins have surged, making crypto one of the best-performing asset classes of the last decade. 

Plus, the blockchain technology that powers crypto has the potential to disrupt many industries — creating profitable new businesses in the process.

But crypto has a problem — you can’t really “invest in cryptocurrency” itself like you can with the stock market using total market index funds. 

Instead, you must invest in specific tokens, such as Bitcoin, Ethereum, or Solana. 

Plus, it’s difficult to hold diversified crypto assets in normal brokerage accounts, let alone retirement accounts. All this creates some friction, particularly for newcomers to the world of cryptocurrency. 

There isn’t really a crypto index fund where you can make one investment into the entire crypto ecosystem. 

Or is there? 

This comprehensive guide will discuss the topic of crypto index funds — the options that exist today and the options that may be available soon. We’ll also discuss the option to manually build your own “index fund” with cryptocurrencies.

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What Is a Crypto Index Fund? 

A crypto index fund is a financial product designed to give investors access to a diversified basket of digital currency assets. Unfortunately, as of early 2022, a true crypto index fund does not yet exist in the United States. 

To better understand the concept, let’s first look at what an index fund is. 

An index fund is an investment product that’s structured as an exchange-traded fund (ETF) or mutual fund. It’s a single investment that holds a wide variety of assets in one “package.” 

Index funds seek to mimic the performance of a certain financial index. For instance, the S&P 500 index tracks 500 of the largest publicly traded companies in America — and there are many index mutual funds and ETFs set up to track this index. 

The fund managers buy each stock that’s included in the index in the same proportion. The idea is to have an investment product that individuals can buy directly to get the same performance as the index without having to buy hundreds of individual stocks. 

Index fund basics
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Most index funds invest in stocks or bonds. For example, here are some popular index funds:

  • Vanguard S&P 500 Index Fund (VOO) holds shares in each of the 500 largest companies in the U.S. It’s designed to track the S&P 500 stock market index.
  • Fidelity U.S. Bond Index Fund (FXNAX) holds a diversified basket of U.S. government bonds, U.S. corporate bonds, and mortgage-backed security bonds. It’s designed to track the Bloomberg Barclays U.S. Aggregate Bond Index.
  • Vanguard Developed Markets Index Fund (VTMGX) holds over 4,000 stocks from all over the world, focusing on developed markets (and excluding the U.S.). It’s designed to track the FTSE Developed All Cap ex U.S. Index. 

A cryptocurrency index fund would theoretically track a certain “index” of cryptocurrency assets. For instance, it may track the prices of the top ten cryptos, the top 100, or even the “total market” for digital assets. 

Unfortunately, there are no true crypto index funds available today (as of early 2022). There is BITW, a top-ten index fund discussed below, but this is far from a “total market” type index fund that many investors are looking for. 

Is There a Cryptocurrency “Index”?

With stocks, we have hundreds of indexes to look at to gauge the performance of the overall market. But what about crypto? 

We have a few options, but crypto indexing is currently far less robust than equity indexing. 

S&P Dow Jones Cryptocurrency Indexes

The most official indexing effort for the cryptocurrency world comes from S&P Dow Jones (the same company behind the infamous S&P 500 index). 

S&P Dow Jones cryptocurrency indexes
(Image Source)

The company now maintains eight individual indexes following the crypto market. The S&P Cryptocurrency Broad Digital Market Index is perhaps the most useful, as it tracks over 250 top cryptocurrencies. 

Note: There are no investable index funds that track these indexes; the S&P indexes are solely for informational purposes.

CoinMarketCap

The S&P crypto indexes only track a maximum of a few hundred cryptos — but there are well over 15,000 individual cryptocurrencies. 

CoinMarketCap maintains a global cryptocurrency market capitalization index based on the total values of all known cryptocurrencies. They also have some historical charts that show the long-term performance of different crypto coins.

Graph of cryptocurrency market capitalization
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Again, there is, unfortunately, no way to directly invest in this “index” without individually purchasing each token. 

Crypto Index Funds You Can Invest in Today 

So far, it seems like cryptocurrency index funds are merely theoretical. Are there any available that you can actually invest in today? 

Bitwise 10 Crypto Index Fund (BITW)

The only publicly-traded “index fund” in the crypto world is the Bitwise 10 Crypto Index Fund

This fund was originally sold as a private placement, meaning that it was only offered to hedge funds and accredited investors. 

However, it’s now publicly traded, which means anyone can buy it on the open market through a brokerage account. The fund now trades under the ticker symbol “BITW.”

Note: Bitwise Asset Management offers other crypto index funds, but only for accredited investors. BITW is the only publicly-traded option available to everyone. 

As the name suggests, the Bitwise 10 Index Fund invests in the top ten most valued cryptocurrencies (weighted by market cap). Currently, these are the holdings of the fund:

  • Bitcoin (roughly 60% of holdings)
  • Ethereum (roughly 30% of holdings)
  • Solana (roughly 3% of holdings)
  • Cardano (roughly 3% of holdings)
  • Polygon (<1% of holdings)
  • Litecoin (<1% of holdings)
  • Algorand (<1% of holdings)
  • Chainlink (<1% of holdings)
  • Bitcoin Cash (<1% of holdings)
  • Uniswap (<1% of holdings)

This breakdown is subject to change, as the holdings are rebalanced each month. 

Interestingly, Bitwise excludes stable coins and focuses solely on crypto tokens. Since stable coins are designed to stay even with the value of the U.S. dollar, this is actually a positive for investors seeking long-term price appreciation. 

While BITW sounds pretty good on paper, there’s one big problem: It charges a 2.5% expense ratio (charged annually). This is a very high fee and will really eat into long-term performance. 

Partly because of the high fee, BITW trades at a price that’s different from the net asset value (NAV) or the combined price of its actual holdings. Right now, it trades at a discount. 

Net asset value of BITW
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The image above shows the price of BITW per share (green line) combined with the net asset value/NAV (blue line) per share. 

As you can see, BITW does not accurately track its underlying holdings, partially because investors are weighing the long-term effects of its high expense ratio. 

So BITW is far from perfect, but it’s a good start. The main benefit is that you can buy it in a normal investment account or even a retirement account. And you don’t have to worry about managing the coins or crypto wallets. 

But what if you want more customization, more diversification, or lower fees? 

Building Your Own Crypto “Index Fund” 

The alternative to established funds like BITW is building your own “index fund.” This involves buying cryptocurrencies directly using an exchange. 

There are both pros and cons to this approach:

Pros

  • You directly own the cryptocurrencies
  • You avoid ongoing management fees
  • There are no “tracking errors” in how the index fund performs compared to the underlying assets
  • You can customize based on your investment preferences

Cons

  • It’s more effort, particularly for rebalancing
  • You may need to use multiple exchanges to get all the coins you want
  • You need to manage your assets and keep them safe
  • Tax reporting may be more complex 
  • There are still fees to buy and sell (although there are no ongoing management fees)

How to build your own crypto portfolio

How do you actually go about building your own “index fund” out of cryptocurrencies? Here are the basics. 

Crypto trading app
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Sign up for a cryptocurrency exchange (we recommend Gemini).

  1. Decide how many crypto assets you want to invest in. A top 10 coin index is a good starting point. 
  2. Calculate your allocations to each coin. Market cap weighting is the best way to mimic an “index” approach.  
  3. Use the charts on CoinMarketCap to find the market dominance of each coin you want to invest in (more on this below).
  4. Buy the appropriate amount of each crypto asset from the exchange. 
  5. Rebalance as needed, but beware of the tax implications of selling assets (consult your tax advisor). 

How do you figure out market cap weighting for constructing your own crypto index fund?

You can calculate it manually, using the market cap of each crypto token divided by the market cap of the total crypto market. Or, you can use the charts provided by CoinMarketCap, which calculate the “market dominance” of each of the top ten coins. 

Crypto market cap rankings
(Image Source)

So following this example, you would allocate around 41% of your investment to Bitcoin, 21% to Ethereum, etc. 

If you choose to exclude stable coins like Tether and USD Coin, you’ll need to calculate your own appropriate percentages. 

Additionally, if you choose to invest in coins that aren’t in the top ten, you’ll need to calculate everything manually. 

For instance, if you want to invest in Chainlink (LINK), which is not in the top ten, you would calculate the percentage to allocate like so:

  • Find the latest data on market prices on CoinMarketCap
  • Find the LINK market cap ($8 billion, for example)
  • Divide it by the total market cap for all cryptos ($2.1 trillion, for example)
  • Multiply the result by 100 to get the percentage
  • In this case, you would invest 0.38% of your investment into LINK to represent its appropriate market cap weighting

“Half and half” approach

What if you could combine direct crypto ownership and ETF-style investments to enjoy the best of both worlds? 

It’s becoming easy to buy Bitcoin in ETF form, and we’re likely to see Ethereum ETFs launch in the near future. This presents an interesting opportunity for investors.

Crypto investors could choose to buy Bitcoin ETFs in their retirement accounts or taxable brokerage accounts while also buying other cryptocurrencies directly with exchanges

This approach gives investors the tax benefits of holding crypto in their tax-advantaged investment accounts while also allowing them to invest in a wider variety of coins directly. 

For instance, if you wanted to invest $10,000 in the crypto market, you might:

  • Buy $4,100 of the ProShares Bitcoin Strategy ETF (BITO) in your Roth IRA (41% of investment).
  • Buy $2,100 of Ethereum in your Gemini exchange account (21% of investment).
  • Buy the remaining $3,800 worth of a variety of other coins in your Gemini account (38% of investment), with allocations based on each coin’s market cap.

As you can see, this custom indexing approach can be as complex or as simple as you want to make it. 

Until we have better options for true crypto index funds, this customized approach may be the best choice for experienced crypto investors. 

Don’t want to overcomplicate things? Bitcoin and Ethereum make up over 60% of the total market capitalization of all cryptocurrencies — and that figure is even higher if you exclude stable coins. 

Thus, investing in just BTC and ETH still gives you a lot of exposure to the overall crypto market — while smaller allotments to the remaining top 10–15 coins can round things out if you’re willing to put in the effort. 

Other Ways to Invest in Crypto 

Not satisfied with the lackluster offering of crypto index funds? Well, there are now many ways to buy crypto assets. Here’s an overview. 

Directly buying cryptocurrency on an exchange 

Buying coins directly from a trusted cryptocurrency exchange gives you access to a wide variety of tokens (50+ with most exchanges) and offers the benefit of direct ownership.

Gemini crypto exchange
(Image Source)

Right now, exchanges provide the most diversification opportunities, as they allow you to invest in a wider variety of tokens and construct your own cryptocurrency portfolio mimicking an index fund.

Some top crypto exchanges include:

  • Gemini
  • Coinbase Pro
  • Binance.US
  • Crypto.com 

These exchanges allow you to buy, sell, and swap cryptocurrencies with other owners, with the exchange serving as a middle man. They can also store your coins for you, or you can choose to transfer them to a crypto wallet.

Exchanges have fees for buying and selling but generally don’t have ongoing fees for management/custodial services. 

If you’re new to crypto, check out our introduction to cryptocurrency guide for more information on how exchanges work. 

Buying crypto ETFs & mutual funds

Investors now have access to cryptocurrency ETFs and crypto mutual funds. As of early 2022, these funds focus almost exclusively on Bitcoin, so they are not a diversified index-style investment opportunity. 

However, we are likely to see more funds launching in the coming years as more gain regulatory approval from the Securities and Exchange Commission (SEC). 

Buying equities with exposure to crypto 

Prefer investing directly in publicly-traded companies? This approach offers the benefit of tighter regulation while still offering some indirect exposure to cryptocurrencies.

Investors could choose to buy stock in crypto exchanges (Coinbase is publicly traded), Bitcoin miners, or other crypto-adjacent industries. 

There are also a few crypto-related equity ETFs, such as BITQ, BLOK, and SATO.  

Conclusion 

As of early 2022, investors don’t yet have access to a true crypto index fund.

As crypto becomes more mainstream and investor demand soars, this could change in the coming months or years. 

For now, the best option is to utilize crypto ETFs and mutual funds or to build your own diversified crypto portfolio. 

New to crypto? Check out EarlyBird’s introduction to cryptocurrency and our crypto safety guide.

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