Indices play a critical role in the financial ecosystem. Yet so far, in the evolution of the digital asset sector, sophisticated, institutional-grade indices and indexing services have been slow to emerge.
This article will examine the role indices can play in helping to advance the maturity of the digital asset markets and review the state of progress to date.
In financial markets, indices are used to track the price of assets – typically a bundle of related assets – in a standardized way. An index provides a basis for benchmarking assets against comparators in the same class, segment, or geography. Indices are often referenced in investment theses as a way of demonstrating how an asset may perform and are frequently used by the media as a proxy for general market performance. Some of the best-known and most frequently-cited examples are the S&P500, FTSE100, and the Nikkei, which track the performance of large-cap stocks in the US, UK, and Japan, respectively. However, indices are used across a wide array of assets and have become a powerful tool for investors seeking objective, qualitative data to support their portfolio allocation.
In more recent decades, indices have also been used as the basis of passive investment vehicles such as exchange-traded funds (ETFs). The scope of this article is limited purely to the role of indices in benchmarking digital assets, while cryptocurrency index investing will be explored in an upcoming post.
Over recent years, the crypto markets have grown to encompass many thousands of assets of various types – native cryptocurrencies, utility tokens, stablecoins, NFTs, governance tokens, and more. The rate of development has been so rapid that, in many cases, it has outpaced the ability to develop the kind of standards and infrastructure that exist in the traditional markets. This is the case with indexing. In the earlier stages of its evolution, there was a lack of professional investors in the crypto markets, creating any demand for indices or benchmarking.
Moreover, the earliest indices to emerge, such as the NYSE Bitcoin Price Index, which launched in 2015, simply tracked the price of Bitcoin on two or more exchanges. Single-asset indices such as these can provide investors with a high-level view of price movements that cuts through short-term fluctuations on exchanges, particularly those with lower liquidity or that may be subject to price manipulation.
However, when it comes to indexing segments or types of digital assets, the standards and norms that exist in financial markets have yet to develop fully. There is not even a universally agreed nomenclature or categorization for digital assets in the same way as in traditional finance. For instance, stocks, bonds, or futures all have clear definitions, which makes it easier to develop indexes and benchmarks that compare performance.
The lack of global definitions and standards is compounded by the pace of innovation in crypto, where new types of assets or hybrids are always emerging.
Ultimately, a lack of indexing capability leaves the industry with little ability to benchmark the risk or returns of any given asset against comparators, no ability to extrapolate correlation between different assets or segments, and few options for passive investment in regulated ETF-like structures.
In many cases, portfolio managers have little choice but to collate their own data from many sources and attempt to perform their own analysis on assets using a variety of on- and off-chain information.
Progress to date has been relatively slow, but the influx of institutional funds following the last bull market has begun to yield fruit. Nevertheless, there is still plenty of room for the development of digital asset categorizations and indices.
For individual assets like BTC or ETH, there are now several institutional-grade indices issued by established service providers such as Bloomberg or NASDAQ, which track prices across multiple venues as well as indices that collectively track large-cap crypto assets.
Finer-grain, professional-level indices have also now begun to emerge that allow benchmarking and comparison across more diverse assets or across segments and geographies. Threeo institutional-grade providers stand out for the diversity of their offerings – MarketVector, CF Benchmarks and Vinter. Van Eck spinoff MarketVector is a regulated administrator of benchmarks operating under the supervision of BaFin, the German Federal Financial Supervisory Authority. CF Benchmarks was created in 2016 by Crypto Facilities, a crypto futures exchange that was eventually acquired and integrated into Kraken. CF Benchmarks is regulated by the UK Financial Conduct Authority. Vinter is a newer company but has built an impressive array of multi-asset benchmarks and are working with some of the leading Crypto Fund and ETP Managers. These firms provide a broad array of indices for digital asset investors, covering both single assets and many different segments of the market and validates the healthy growth of institutional adoption.
More recently, established financial services operators have begun to expand their reach into digital asset indexing. In November 2022, Goldman Sachs announced it was teaming up with MSCI and Coin Metrics to launch a new benchmarking service, while in the same month, indexing service provider FTSE Russell released a new series of indices covering digital assets. Indeed, the Datonomy service launched by Goldman Sachs, MSCI and CoinMetrics is a strong and welcome industry initiative to bring a normalisation and categorization of sectors and which digital assets should be allocated to each sector classification by using a rigorous and definable methodology. TradFI has had SIC (Standard Industry Classification) codes since 1937 to bring industry standardisation and Datonomy is bringing similar to Crypto. This will help asset allocators better make mandate selection decisions between Funds when there is a common understanding of their sector-based allocation and performance.
In December, CME Group launched three new reference rates and real-time indices covering DeFi assets, including Aave, Curve, and Synthetix, reflecting an increasing interest in DeFi among institutional investors.
Many crypto-native firms have also branched out into indexing services for digital assets in a way that reflects the diversity of indexing services in traditional markets, with long-standing providers ranging from publications to trading houses. In the crypto sphere, companies including news outlet Coindesk and centralized exchange Kraken are two examples of companies providing digital asset indices in addition to their core offerings, while CoinMarketCap (owned by Binance) and CryptoCompare offer indices as part of their aggregation platforms. However, it is worth noting that crypto-native firms offering indexing services may not be regulated, and the methodology for inclusion or weightings may not be transparent in all cases.
The surge of activity toward establishing a systematic way to categorize and index digital assets shows that it is becoming a priority for service providers and investors alike. The availability of reliable benchmarks will create more and better insights into the markets and allow investors to make more informed decisions about portfolio allocation, increasing the opportunity for alpha.
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