What is a Crypto Index? The Basics.

Crypto Indices will grow to a $500B industry over the next three years. This is a huge opportunity for founders and investors. But what exactly are they? Let me get you up to speed and explain the basic concepts and terminology along the way.

Fundamentals first

An index fundamentally shows or point towards something.

Etymology: from latin 'in' (towards) and 'dicere' (say) / 'dicare' (show) and Proto-Indo-European 'en' (in) & 'deik' (show).

Like literally using the index finger or wagging it (as in the Vatican Index of Prohibited Books), or in indices of indices (don't go there Gödel, Escher, Bach).

Indices in Financial Markets and Crypto

In a financial setting, indices show the price of

a single asset (single-asset index) or
a basket of multiple assets (multi-asset index).

Single-asset indices

Single-assets indices aim to show the ‚true‘ price (and by proxy value) of one single asset at any given time. They're calculated from multiple data sources and corrected for potential idiosyncratic (uncorrelated) errors. They're a bit less commonly known.

Yet, they are fundamentally important for the functioning of financial markets. They serve as reference benchmarks for market participants that rely heavily on accuracy for their trading, operations and reporting. Financial institutions build their own products on top of reference prices.

In the end, financial markets are all built on top of each other and accurate pricing data is both the fundament, the grease and the glue. This is why the provision of single-asset indices as reference benchmarks is heavily regulated. More on that in later posts.

Multi-asset indices

Multi-asset indices like the S&P 500 are much more commonly known. They're basically a list of assets that make up a basket or portfolio. Each individual asset has a weight in the total basket (the index weight). Depending on its weight, each assets individual price action contributes to the overall price action of the index.

The aim is to track the performance of a certain area of the market in a standardized way. Due to the diversification effect idiosyncratic (ie. uncorrelated) price movements of single assets in the basket cancel each other out. This gives a smoother overall index price trend line and thus a much more robust signal. The composition and calculation of each index is always specified in an index methodology by the issuer of the index.

Crypto Indices

Crypto indices are either a reference benchmark for a single crypto asset or a basket of weighted crypto assets, replicating the overall crypto market or special sub niches, like DeFi.

Expanding the Index Universe

The universe of indices is limitless and growing. In traditional financial markets, there is a plethora of indices covering all sorts of different asset classes, industries, geographies and market segments, all with differing methodologies and by different index providers. But only a few are really relevant and widely known - it's a power curve.

In a fractal manner, the same holds true for the crypto market. You have the same level of specialization and complexity (if not more) and the same power curve of attention and market adaption, yet the industry is much younger. And it is growing at a breakneck speed.