The 3 F’s of Crypto Index Funds

Wednesday, March 14, 2018

The TokenData Take: Fees, Forks & the Fidelity of Crypto Index Funds

Custodial services, more regulatory certainty and robust cryptocurrency index funds are all requirements for institutional capital (pension funds, endowments and insurers) to enter the cryptocurrency space. So, when Coinbase launched their aptly named Coinbase Index and Coinbase Index Fund last week, we decided to compare the handful of cryptocurrency index funds that are out there already:

It’s slim pickings in the land of cryptocurrency index funds but there are a few key differences that are worth highlighting.

Traditional vs Tokenized – Decentralized Index Fund Management
The Coinbase, Grayscale and Bitwise index funds operate similarly to existing (equity) index funds from Fidelity, Vanguard etc: They’re centralized entities with a similar legal setup and requirements for investors.

The “Tokenized” funds are (partially or completely) decentralized versions of an index fund: smart contracts control the deposits/withdrawals of funds and trading/rebalancing of underlying assets. The shares in the fund are tokenized and can be traded on cryptocurrency exchanges. One of the tokenized funds, Crypto20, even held an ICO – raising $38M in Nov ’17 – of which 98% was used to buy the index’ underlying assets. Nonetheless, the impact of tokenized funds has been very limited so far, which is evident in the relatively small size of Assets Under Management (AUM).

Number of Assets – Broad Exposure vs Outperformance
Coinbase and Grayscale position their funds as a way for investors to get exposure to digital assets in general. They achieve that by including just the top 4 or 5 cryptocurrencies which make up more than 75% of the total cryptocurrency market right now. The other indexes – especially the tokenized ones – position themselves more as vehicles to outperform the large cap cryptocurrencies and include more cryptocurrencies as a result. Fees – Not that surprising and not that interesting…Most criticism about the Coinbase announcement centered around the fund’s 2% fee. The 2-3% fees charged by Coinbase/Grayscale/Bitwise are relatively high compared to equity index funds (<1%) and you could replicate the indexes by just buying the same assets on any of the crypto exchanges. However if you take into account the small variety of index funds, regulatory uncertainty and a lack of good (and cheap) cryptocurrency custodial services, the fees do not seem that unreasonable.
Forks are the new Dividends
Crypto index funds approach forks very much the same way as equity index funds approach dividends. When a cryptocurrency forks, a fund can either include the forked token (similar to reinvesting dividends back into the fund) or the fund can exclude the forked token (not reinvesting the dividend). Both approaches are being taken by the index funds we’ve looked at.

Fidelity of Crypto – Size matters, but…
Size does matter for index funds because size equals lower trading fees, This is where Coinbase’s index fund has an edge right now, because it has access to a leading cryptocurrency exchange (GDAX). However, it’s too early to compare most of these funds on either an AUM or risk-return basis. Additionally, to become the “Fidelity of crypto index funds” any of the above mentioned funds will face new challenges besides the classic race to the bottom on fees:

What if an existing fiat focused fund manager enters the crypto game? What if there is no centralized “Fidelity of crypto”. Theoretically speaking, smart contracts could form any index or basket of cryptocurrencies.  A publicly available ‘index smart contract’  paired with (de)centralized exchanges could mean that anyone can own an index by simply invoking a smart contract. As farfetched as that might sound, we found a project (Set Protocol) that’s active in this area, and will give you a few more minutes of crypto index fund nerdiness.
More information and sources:

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