In our series of articles on cryptocurrency, we’ve discussed what cryptocurrency is, how to get started with cryptocurrency and how the cryptocurrency market works. This is the last article devoted to crypto, and today we invite you to delve deeper into cryptocurrency index funds and how to start investing in them.
Cryptocurrency investing is a quickly-growing field, but researching, buying, and maintaining a portfolio in this fast-paced, risky environment requires a lot more time and resources than most people have available. That’s why crypto funds (mostly index funds) are starting to gain in popularity: much like mutual funds in the stock market, they allow you to outsource the selection and maintenance of your portfolio to experts in the field. They also provide a much-needed layer of security, as they either hold the cryptocurrency for you or help you set up secure wallets, which can be a bit technically challenging for those new to the technology.
You don’t need to understand how Bitcoin works to invest in it, but knowing at least a bit about cryptocurrency is essential, and having good enough research skills to uncover potential red flags is a nice bonus. Most currently-available cryptocurrency funds are index funds, though, and since cryptocurrencies tend to rise and fall with Bitcoin, interested investors should probably try to keep their exposure relatively low and diversify as much as possible.
Cryptocurrency basics: what is this asset class?
Bitcoin, Ethereum, Ripple, Libra, and Litecoin are some well-known examples of cryptocurrencies, all of which operate on the same general principle: blockchain. A blockchain is essentially a ledger where every transaction is recorded and stored. While the actual technology can be difficult to understand, most cryptocurrencies have several main selling points: they’re decentralized (run by many people around the world), immutable (records can’t be changed once they’re published), and secure (attacking a big blockchain requires a lot of computing power).
Blockchains can be used for other things besides money — like tracking items on supply chains or connecting smart devices — but the wild price swings and potential future value of cryptocurrency have made it a popular investment instrument. However, the long-term future of Bitcoin and cryptocurrency, in general, is still uncertain, and short-term trading carries a lot of risks. In general, investors interested in this asset class should hold just a small part of their portfolio (1-5%) in cryptocurrency.
Cryptocurrency index funds
Crypto funds provide some protection against both short and long-term risks by diversifying your assets into different cryptocurrencies. It’s completely possible to do this yourself, but this often means doing a lot of research, navigating multiple sites, figuring out different types of wallet software, and staying up-to-date on cryptocurrencies.
A cryptocurrency index fund, however, allows you to easily buy a pre-selected bundle of assets which it will manage for you, periodically responding to changes in the market, so you don’t have to constantly check and adjust. Every crypto fund works a little differently, however, which makes them less straightforward to buy than the cryptocurrency index funds you’d typically find on a stock exchange.
Sites and apps
The easiest cryptocurrency index funds to invest in generally have their own dedicated sites or apps that function like exchanges. All you have to do is register for their service and deposit money into the crypto fund. Some services keep your funds securely stored for you (custodial funds), while others automatically set up and manage wallets on your device (non-custodial), meaning you own the coins on the blockchains. Some will allow you to deposit fiat currency, while others can only be funded with Bitcoin or some other cryptocurrency. These are a great choice for investors who are looking for the simplest, least-techie way to get some crypto exposure.
Tokenized crypto funds
Other cryptocurrency index funds are tokenized, meaning they are cryptocurrencies themselves and have to be bought on exchanges. This is more convenient than buying lots of different cryptocurrencies, and many tokenized funds manually or automatically manage the actual assets behind their tokens, but buying and storing any sort of cryptocurrency token can be difficult. This makes tokenized funds best for investors with prior crypto experience.
Cryptocurrency hedge funds
It’s important to note that cryptocurrency hedge funds, which are expertly-managed funds trying to beat the market, aren’t typically available to retail investors. You’ll need a lot of money to invest in something like Pantera Capital or Polychain Capital. Retail investors (average people) are mostly limited to cryptocurrency index funds and buying stocks in blockchain-related companies.
How to choose a cryptocurrency index fund
Trust and security
The crypto landscape changes fast and so do the available investing tools. The hottest new products aren’t necessarily the safest, though: look for cryptocurrency index funds that are widely considered trustworthy and secure and possibly overseen by some third party or regulator, especially if they hold your funds for you. Cryptocurrency exchanges are frequently targets of hacks, and scams are unfortunately quite common with digital currency. Before you download an app or transfer any Bitcoin, do some research and ensure that the fund you’re looking at is considered reliable.
Another factor to consider is how many crypto-assets the cryptocurrency index fund has invested in. Most coins tend to move with the value of Bitcoin, which makes this factor less important than in traditional investing, but holding a coin that dramatically outperforms the others may both help your profits and protect you from losses.
More advanced cryptocurrency investors may want to evaluate the assets the fund has decided to invest in, as it might provide some helpful clues about the cryptocurrency index fund’s strategy and trustworthiness. A portfolio full of small-cap coins with sketchy reputations would be a big red flag, for example; large, established coins should make up a decent proportion of any fund.
The bigger cryptocurrency index funds are pretty much limited to investors with a significant amount of funds, so unless you’re one of those, you’ll need to find a service that allows you to invest with relatively low minimums. There’s no minimum if you want to buy your own cryptocurrency, but index funds are trying to make a profit, so they will often require that you deposit a certain amount in order to participate.
Management and rebalancing strategies
If all the cryptocurrency index funds were doing was selling you a few different coins and letting them sit there, they really wouldn’t be worth the fee. A good index fund will be using experts and algorithms to create and execute strategies for you. If one of your assets gains 300%, for example, the safest strategy is to sell off some of it and use the proceeds to buy more of your other assets. Otherwise, the coin that ballooned 300% will take up a disproportionate share of your portfolio and expose you to more risk than you want.
Check to make sure that the cryptocurrency index fund you’re investing in is using effective strategies for their customers. Some funds will do this automatically, while others will give you advice or ask for your permission to change your allocation.
Ease of use
If you’re out of your depth technologically, you may not make the best investment decisions. Don’t decide to invest in a tokenized fund unless you know you have the technical skills to securely obtain and store those assets, for example.
Other funds may require at least the ability to perform basic cryptocurrency transactions. You don’t need to know much about how everything works behind the scenes, but if the cryptocurrency index fund requires you to buy and transfer in Bitcoin to fund it, that’s something you should be comfortable doing.
If the world of cryptocurrency intrigues you, there are a lot of ways to get involved! Buying cryptocurrency index funds is a great way to broad exposure quickly, but if you want to have more detailed insights into the markets, you can use exchanges to buy and sell individual coins or even invest in ICOs. A safer option, though, might be to find a list of companies that are investing in or developing blockchain technology and buy stock in them on a traditional exchange. Their value is more tied to their products than the price of Bitcoin, and the demand for blockchain technology in the future may be significantly larger than the demand for cryptocurrencies. Obviously, this also comes with some risk, but investing in both sides of blockchain will make your portfolio significantly safer than even a cryptocurrency index fund.