Tokenized Indexes

What are tokenized indexes? 

Tokenized index funds are similar to the index funds we are already familiar with. Utilizing blockchain technology, they offer broad exposure to crypto markets by

allowing investing across multiple securities. Similar to the S&P 500, they enable investors to reduce their risk by minimizing the impact any one security can have on

returns. 

Key Takeaways :

• Tokenized indexes provide DeFi investors with structured exposure to specific themes and asset classes in the crypto space;

• Tokenized indexes are collateralized by the index’s constituent assets which are locked in a smart contract, allowing tokenized indexes to remain pegged to the assets they are tracking at all times;

• While there is considerable room for active management in the crypto space, passive investment strategies are rising in popularity as information asymmetry decreases in the industry.

Introduction

Tokenized index funds are akin to the index funds we are all familiar with which are traded on centralized markets and exchanges, such as the New York Stock Exchange.

Index funds are incredibly popular given they invest across multiple securities, minimizing risk by reducing the impact any one security can have on net returns.

Tokenized index funds are used to achieve the same outcome in the crypto markets. In short, different index funds exist in the cryptocurrency market, each

includes an array of the best performing assets, and all have been created to help minimize investor risk.

Benefits of Investing in Indexes

Indexes are valued by investors for the following reasons:

• Low costs

• Ability to invest passively 

• Reduction of risk due to investing across multiple securities

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Passive investing, specifically through index funds, was popularized through the introduction of the efficient markets hypothesis outlined in Eugene Fama’s “Efficient

Capital Markets: A Review of Theory and Empirical Work.” The efficient markets hypothesis states that the price of assets in today’s market is reflective of all available

information, and that over the long term there can be no edge gained through active management.

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Overall, the efficient markets hypothesis has proven to be accurate over the decades in the equities market. In fact, there is a famous $1 million bet that was wagered

between Warren Buffet and Ted Seides, founder of Protege Partners, regarding whether a basket of actively-managed hedge funds could outperform an S&P 500 index

fund over a 10-year time span. The funds failed miserably at keeping pace with the S&P 500 index, and Buffet solidified the concept of efficient markets hypothesis

further in the process.

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Historically, the cryptocurrency market has been regarded as far from an efficient market. There have been countless scenarios where active management could have

been used to identify price and value dislocations that would have allowed active managers to extract excess profits from the market and outperform passive investors. 

However, as the cryptocurrency market has continued to mature over the last few years, accurate pricing models and strong fundamental analysis have led to the

gradual decline in opportunities available to active investors, making passive investment strategies more attractive.

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The result is that index funds have become more efficient at selecting high-performing, uncorrelated digital assets that create a “sum is greater than its parts” scenario.

Investors are not required to seek out the next “altcoin gem,” and can focus on reaping the benefits of the growth of the overall cryptocurrency market or specific sectors

within it.

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How are Tokenized Indexes Structured:

When leveraging a tokenized index fund, your aim is to make a profit from a basket of cryptocurrencies grouped together. Tokenized indexes are fully collateralized by

their underlying token holdings which are stored in a smart contract. When an investor buys an index token, what they are actually purchasing is a token that assigns

them rights to ownership of the assets held in the smart contract. This collateralization model allows tokenized indexes to accurately track the performance of the

underlying tokens. Depending on the levels of risk, time horizon, and expected returns, there are a number of indexes that have become popular choices with investors:

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1. DeFi Pulse Index (DPI)

Decentralized Finance (DeFi) seeks to democratize access to financial products by making them available on public blockchain networks. Numerous cryptocurrency

tokens have been launched in this space with varying use cases - all of which aim to achieve the objective of decentralizing finance.

The Defi Pulse Index (DPI) is a market capitalization-weighted index that tracks the performance of leading protocols in high-growth sectors of decentralized finance on

the Ethereum blockchain, such as: lending, yield farming, decentralized exchanges, synthetic assets, interoperability, and payments. Each token must have a strong track

record of adoption, in addition to meeting stringent threshold requirements as it relates to solvency, supply, and security. 

Through the DeFi Pulse Index, investors can gain exposure to the most innovative platforms driving the decentralized finance sector, including, but not limited to: Aave,

Synthetix, Uniswap, Sushiswap, Compound Finance, Yearn Finance, Ren, and Maker.

2. MetaVerse Index (MVI)

The Metaverse Index (MVI) was created to enable investors to capitalize on the growth of non-fungible tokens (NFTs), entertainment, music, virtual reality, and

augmented reality protocols launching across various blockchains. 

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Over the last 12 months, non-fungible tokens have captured headlines and public interest around the world. From record-breaking auctions at Christie’s to unique

collections launched by NBA stars, NFTs have transcended all socioeconomic boundaries on its journey to mainstream adoption. 

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Concurrently, blockchain technology has also begun disrupting an industry that was already experiencing meteoric growth: gaming. Unlike the traditional gaming

ecosystem, where the financial success of the game accrues entirely to the game developers, decentralized gaming has introduced a new model, dubbed “Play-to-Earn”

where users share in the revenues generated by the game simply by earning in game rewards, trading with other players, or selling in-game services.

As interest grows in this virtual sector, which includes NFTs and gaming, the challenge for investors is to identify which token to buy amongst the sea of options

available. The Metaverse Index solves this problem by aggregating exposure to leading projects in their respective niches and enabling investors to benefit from the

growth of the overall sector. 

3. BED Index

BED Index was created as a passive investment vehicle to provide investors with exposure to the leading assets in the three key use cases for cryptocurrency: store of

value, medium of exchange, and decentralized finance. 

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The result is an equally-weighted index that consists of Bitcoin, Ethereum, and DeFi Pulse Index - which in turn currently represents the vast majority of market

capitalization in the cryptocurrency industry. Similar to the utility of the S&P 500, BED provides investors with the opportunity to garner exposure to the overall

growth of digital asset industry while mitigating risk and volatility at the market level. 

Summary

In an efficient market, such as equities, passive investments have proven to outperform active investments for decades. While cryptocurrency is still considered

inefficient in certain regards, illustrated by the profit-generating edge that many blockchain insiders and influencers possess in the market,

the information gaps continue to shrink every day. With this information gap shrinking, passive investors will continue to look for opportunities

to gain broad market exposure to this new and exciting space.