Indexes – or indices – are how we make sense of the world. Through placing similar items into a shared category, it’s easier to keep track of them, whether we’re talking about a genre of literary fiction or precious metals. In the context of financial markets, indexes aren’t just useful for tracking similar items: they’re good for trading them, enabling investors to access a diverse basket of assets through a single mechanism.
While synonymous with traditional finance (TradFi), where indexes provide a benchmark for markets such as the S&P 500, Dow Jones Industrial Average (DJIA), and FTSE 100, they’re now starting to appear onchain, allowing DeFi users to track entire sectors of the cryptoconomy. And thanks to tokenization, it’s also possible to trade these indexes through purchasing just one token instead of many. The rise of crypto indexes, bringing this TradFi staple to DeFi, has expanded the opportunities for making money onchain while diversifying risk.
An Index for Everything
As early as 2021, DeFi developers were experimenting with tokens that track the price of a basket of crypto assets, albeit with mixed results. In the last 12 months, however, rapid growth in tokenized real-world assets (RWAs) has fueled a surge in indexes that allow users to track the RWA sector and passively invest in it too. One of the first web3 projects to produce an RWA index is financial data provider Truflation. Its Hedge Index includes a weighting of RWAs including equities, precious metals, commodities, and currencies and is one of several crypto indexes it’s created.
For DeFi users, the ability to consult indexes dedicated to a specific sector makes it easier to monitor performance in real-time and see how it holds up against other investment classes. But for individuals who don’t just wish to spectate, crypto indexes can also be traded directly, allowing for “skin in the game” without needing to obsess over which particular assets to acquire and in what weighting.
Not all indexes are designed to be actively traded incidentally; CoinDesk’s DeFi Index, for example, provides a benchmark for guiding investors. They use it for reference, in other words, before deciding which DeFi assets to invest in – or whether to invest in them at all – based on its performance.
The Case for Crypto Indexes
There are a number of reasons why investing in an index can prove attractive to crypto users. For one thing, it can provide a sound diversification strategy. Selecting a basket of DeFi assets, for example, reduces risk since if one token underperforms, losses will be minimized. At the same time, if the whole sector outperforms the rest of the market, the upside remains uncapped.
The other primary reason why assets are attractive to crypto investors is because they make it easy to gain exposure to a particular industry without needing to become an expert at it. You can be bullish on AI without knowing exactly which AI stocks or tokens are likely to perform best and an index solves for this.
The growth of tokenized RWAs coupled with a trend for DeFi reimagining the best elements of TradFi has made indexes an investment vehicle whose time has come. Greater onchain data availability has meant that web3 builders now have a wealth of options at their disposal, including the ability to create indexes that incorporate on- and off-chain pricing. As a result, expect to see new crypto indexes coming onstream catering to everything from commodities to memecoins. If it can be categorized it can and will be indexed.
The subject matter and the content of this article are solely the views of the author. FinanceFeeds does not bear any legal responsibility for the content of this article and they do not reflect the viewpoint of FinanceFeeds or its editorial staff.
