Stock indexes have become a staple of the stock market. In the stock market, these are most often traded as exchange traded funds (ETFs).
Basically, a single stock gives you ownership of an underlying portfolio made up of many stocks.
Cryptocurrency never really had that ability until DeFi came along and changed everything. These days there are a few cryptocurrency indexes available to purchase on DeFi. And the industry is only growing.
This article will focus on some of the DeFi cryptocurrency indexes available for purchase. We will also discuss the strengths of this financial tool.
DeFi Pulse Index
DeFi Pulse Index is an index that uses market capitalization weighting to determine the amount of cryptocurrency held in the index. It was launched in September 2020.
As the name DeFi Pulse implies, this index focuses on the ten most popular DeFi tokens when sorted by market capitalization. Wrapped tokens and tokens that come from unscrupulous projects are not held by the index.
This index only focuses on the best DeFi tokens, so your investment is safe from rug pulling or other scams that plague DeFi at the moment.
Also, unlike other DeFi indices that are simply derivatives or contracts that do not own the underlying token, DeFi Pulse Index owns the underlying tokens. And these tokens are held in a smart contract vault that is publicly accessible.
In this sense, DeFi Pulse is pretty much identical to a standard ETF.
PieDAO Indices and Power Index by PowerPool
PieDAO has two indices available for purchase and Power Index is a single index. These also operate similarly to an ETF with one main difference:
Ownership of the token allows voting about the different tokens purchased by the index.
This is something that makes DeFi indices much more different than a standard ETF. Remember, in a standard ETF it is not possible to vote on the different tokens and token allocation for the index.
However, this does open up the possibility that malicious actors can vote for scamcoins to be included in the index, so it’s not without risk.
Which DeFi index is most popular?
The most popular DeFi index is the DeFi Pulse Index, and it’s not even close.
It has a market capitalization of nearly $40 million while PieDAO has approximately $4 million in market cap and the PowerPool has about $500,000.
This shows that the idea of voter governance for DeFi indices is popular; the reality is that people prefer some sort of centralization for their DeFi index. You should not be surprised by this, a voter governed index is open to attacks by malicious actors.
The Problem with Crypto Indices
Crypto indices have always faced one major problem:
This is not diversification of the underlying assets – there are plenty of cryptocurrencies available to purchase. The problem is that cryptocurrencies have a tendency to track Bitcoin at a 1:1 ratio.
In other words, if the price of Bitcoin drops, then the price of every other cryptocurrency will drop. This defeats the purpose of having a diversified portfolio if everything in it just tracks the price of Bitcoin.
You may as well just hold Bitcoin.
Now, this is not a huge problem because there are still some cryptocurrencies that have exponential gains (ie. Polkadot) while others collapse (ie. Ripple). The difference just is not nearly as large as with the standard stock market.
In our opinion, this diversification will be the biggest problem with cryptocurrencies indices. However, it will likely change over time as the cryptocurrency further matures and more altcoins emerge.
That’s a brief overview of investing in indices using DeFi. It’s certainly possible and these indices do work at diversifying your crypto holdings.
However, the analysis of these indices does indicate that it’s often better to simply hold Bitcoin because the gains from the one or two good cryptocurrencies are not enough to outperform Bitcoin once the losers in the index are factored into the equation. Still, if you want to diversify your crypto holdings, then this is the best option for doing that.