Recently Bloomberg and Galaxy Digital Partners announced a partnership to provide an index to the digital asset space. They have initially decided to include 10 of the largest cap cryptocurrencies for exposure to this new asset class. Although this is not the first index for the digital asset space, the partnership with bloomberg and their reach to the financial community lends credibility and a higher probability of adoption. What problem does this specifically answer and why might this be important? First , this allows investors a way to gain exposure to an asset class without having to specifically pick winners and losers. Secondly, this provides a benchmark where other investors and traders can qualify there risk adjusted returns.
What is an Index?
An index is a sample of a larger data set which is meant to track and measure the performance of an asset. It is a a statistical measure of a composite of holdings and can be comprised of equal weighting, percentage weighting or market cap weighting. The first index was the Dow Jones Industrial Average created by Charles Dow in 1896 which tracked the 12 most important stocks. Indices can be stand alone benchmarks or they can be invest-able through many types of securities. Today there are indices on almost anything and is important part of the rise in passive investing and exchange traded funds (ETFs).
Why it matters
Indexing not only allows for passive investing , it also sets benchmarks to measure performance of traders and funds. In fact the performance measure has led to the terms Beta, meaning the index or market return and alpha which would be excess return over the index. More importantly, indices bring many different types of investors and speculators that are looking for new avenues of returns whether it be retail clients or large institutions. So what happens when there is a universally accepted index for an asset class? Indices entice hedgers, traders and speculators along with investors who are looking for diversity across their portfolios in either real or risk adjusted returns. This is also truly the engine of Wall S.t as they act as middlemen in providing access and liquidity to markets. The index will include Bitcoin and Ethereum at 30% weighting followed by Ripple at 14.4%. Bitcoin Cash, EOS, Litecoin, Dash, Monero, Ethereum Classic and ZCash round out the index in smaller weightings and its defined in US Dollars.
Proof of work
Looking back and examining the most profound indices as they emerged may possibly shed light on the the future of digital assets. An argument can be made that indices have had a direct impact on these asset classes and have been profound in its growth. The main asset classes are equities, fixed income, commodities, cash and their equivalents and real estate. The NAREIT index for commercial real estate provides some insight into the return profile, however it really is just a tracking index and not viably invest-able. It's worth noting that there has been an explosion of Real estate investment trusts (REITs) over the last 30 years with most of them having an equity type of profile. So lets take a look at equities, fixed income and commodities and how they developed after having benchmark indices:
1) S&P
The S&P 500 was first established in 1957 as a 500 stock cap weighted index, although its predecessor was an composite index of 10-90 stocks dating back to the 20's. The index opened an Jan 1, 1957 at 386.36 and doubled over the next decade. Having the bench mark of 500 stocks has led to futures trading, derivatives and ETFs which have all helped to grow the equity market profoundly both domestically and internationally. The Chicago Mercantile Exchange(CME) introduced the S&P 500 futures contract in 1982 and a mini contract a few years later which has fueled trading volumes and new instruments like options and volatility.
2) Lehman Brothers Aggregate bond index
This index was created in 1986 as a way to benchmark to investment grade bond investing. The bond market in 1980 stood at @ 3 trillion dollars and was a sleepy coupon collecting mechanism. Over the next 35 years the bond market grew to 35 trillion with 300 trillion of notional traded through derivatives that hedge interest rate risk and credit risk. Sub indices now exist as markets grew in high yield, municipals and sovereign debt.
3) GSCI Goldman Sach Commodity Index
In 1991 Goldman Sachs created a weighted index of 20 commodities that are traded as futures contracts. With an invest-able index, commodities became an appealing option for institutions looking for non correlated returns and inflation hedges in their portfolios. Volume and prices for the West Texas intermediate (WTI) and the Henry Hub Natural gas contracts on the NY mercantile exchange (NYMEX) exploded as energy became deregulated. Electricity also became a trad-able commodity and the CME, who purchased NYMEX, now handles 3 billion energy contracts a year. The ability to mitigate price risk in turn has been a boom to oil and gas exploration with new emerging technologies emerging.
-for more info: (https://us.spindices.com/index-family/commodities/sp-gsci)-
Why you should care
Coinmarketcap.com lists 1601 separate coins with a total market cap of 290 billion, down from its highs of 800 bln with BTC accounting for a dominant 40%. The space, although arguably in a bear market or correction territory, remains robust in interest and new projects. What is truly exciting is that everything needs to be built and developed including an accepted index. So what conclusion can we draw from having an established index? Well, If history tells us anything, watch for the digital asset space to grow exponentially. We should expect more trading around the index and look for a 10x growth of digital derivatives as new players emerge creating a 3 trillion dollar market. The market will also grow substantially organically as traditional securities markets tokenize, leading to a 30 trillion plus market of digital assets.
It's hard not to be optimistic about this growing market and it's potential. Perhaps, to use a baseball reference, this seems like we are in the top of the second inning of what will surely be an exciting and action packed game.