Bitcoin still tends to grab the headlines, but in truth, it no longer dominates the crypto market to the same extent it once did. Two years ago, Bitcoin accounted for 70% of the market, currently, however, with the total crypto market valued at over ~$2 trillion, that share has dropped to under 40%.
It’s not that bitcoin is contracting, but rather that many altcoins are beginning to offer four and even five-digit percentage returns. Ethereum, for example, greatly outpaced Bitcoin in 2021, returning 399.2% on the back of the boom of NFTs and decentralized finance sectors. However, as an ironic consequence of Ethereum’s increased usage, transaction fees shot up, forcing user migrations to other smart contract platforms with lower fees.
Alternative budding smart contract and scaling platforms like Solana (11,634%) and Polygon (14,251%) have all had 4-5 digit percentage returns.
Finding and seizing new opportunities within ecosystems
As the crypto ecosystem continues to mature, altcoins present a good opportunity for cryptocurrency market investors to diversify their portfolios.
Polygon, for example, has already seen widespread adoption. It has the most vibrant and dynamic decentralized application (DApp) ecosystem with 7,000+ DApps deployed, including developments from Sushiswap, Dolce & Gabbana, and Ubisoft. Multiple developing virtual worlds, such as Decentraland and Sandbox, are already Polygon compatible, as are top DeFi services like Aave, Balancer and Uniswap.
With such an array of DApps deployed on Polygon, the issue for investors is seeking exposure to the best, lesser-known tokens, where gains can be significant and outperform the native MATIC token itself. A newly launched Polygon index token, which comprises GHST, QUICK, GNS, DFYN, as well as wrapped MATIC has become quite popular for investors gaining exposure to some of the top performers in the Polygon ecosystem, without having to spend vast amounts of time sourcing and investing in each individual one.
Solana tackles the same challenges as Polygon but takes a different tack. Rather than operating a separate layer on top of Ethereum, it offers an entirely new, carbon-neutral smart contract platform that is faster and more scalable than even the new Ethereum 2 currently rolling out. Growth has been spectacular, giving the network a place in the top 10 cryptocurrencies by market cap, after flexing its market maturity in a $314 million funding round led by Andreessen Horowitz and Polychain.
There have already been major success stories within the Solana ecosystem, investors who were able to spot them early on have generated significant returns. With 500+ dApps deployed and many more in the works, index tokens emerging on Solana can provide investors exposure to tokens like RAY, SRM, SLND and TULIP, together with MSOL, a staked version of Solana’s native SOL that captures 6% APY staking reward. What's more, as the index tokens tend to be rebalanced monthly, investors can rest assured they have continued exposure to the best performing projects, without having to stay across every new dApp deployed on the chain.
Index tokens simplify exposure to upside
As these examples show, the number and range of available options for investors are snowballing rapidly. Keeping track of all the possibilities, let alone assessing them as candidates for a portfolio, is beyond the abilities and time capacity of most people.
Many new investors have bought Bitcoin and maybe one or two other high profile coins in the expectation that they confer exposure to their broader network of hugely popular projects. But that’s not how it works. The upside from a highly successful project - such as AAVE on Polygon, for example — does have an impact on the value of Polygon’s MATIC token, but diluted to such a level that the impact on an investor’s profit is much less exciting than by direct exposure.
For many investors, the solution is index tokens, an emerging asset class in crypto which provides a straightforward way to achieve diversification across a range of assets. These are based on an idea borrowed from conventional securities, where diversification is achieved through a single product that provides exposure to a range of assets. A simple example is the current range of ETFs that track the performance of the S&P 500 index, giving investors exposure to a broad range of high performing companies listed in the USA.
In the crypto world, tokens that track the performance of a basket of digital assets deliver the diversification investors are looking for in the simplest manner possible. They contain multiple cryptocurrencies and related DeFi assets bundled together into a single product that is managed using smart contracts.
Users benefit from ongoing professional-grade research that automatically selects index constituents and ongoing monitoring of the selection criteria via smart contracts, ensures a regular rebalancing of the index’s constituents as their performance evolves over time. In well-managed indices, the constituents are usually selected via an algorithm based on a weighted average of market capitalization and DEX liquidity, to ensure investors can easily enter and liquidate positions.
They also have a big advantage over their traditional stock counterparts: They can be redeemed for their underlying tokens, and quite easily. This is not true for ETFs, which often don’t hold all the constituent parts of whatever index or market they are tracking, but seek to capture the underlying movements more efficiently by using fewer components.
The easy way to spread exposure to growth opportunities
For time-poor investors, index tokens perform all the hard work. They simplify the asset allocation process, reduce risk and maximize exposure to upside, serving to encourage participation in the digital asset class generally.
Index trading allows anyone to gain instant exposure to some of the top projects or market verticals of crypto — from specific L1s and L2s, to the metaverse, NFTs, DAOs and DeFi generally. Better still, it offers immediate diversification within that sector. In the time it takes to invest in one token, users can gain exposure to an entire ecosystem of projects or certain market segments.
While demand is still small, compared to conventional securities, bonds and derivatives, that’s changing as investors become better educated about digital assets and seek to adopt more sophisticated approaches to risk management. We expect to see many more index funds emerge as the crypto industry matures, and many more investors who will see how to take advantage of their benefits.
About The Author
James Wang is Head of Tokens at Amun, providing clients with diversified crypto exposure through index token products. Prior to joining Amun, James was Lead Analyst on ARK's Next Generation Internet Fund ARKW. Growing assets from $10 million to over $6 billion AUM.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.