Index Investing. Index investing refers to investing in a basket of securities which have something in common. The S&P 500 stock index, for example, contains the securities of the 500 largest companies (by market cap) listed on the NYSE. Possibilities for assembling an index are endless, they range from whole market indices which include pretty much every stock on an exchange (such as the Vanguard Total Stock Index) to ones focused on large or small cap companies, or a particular sector of the market, such as retail stocks, etc. Index investing has proven to be very successful and most professional investors tend to judge the performance of money managers by their returns relative to large indices, such as the SP500. Thus a money manager is generally judged by his performance relative to the market, not on nominal returns.
There are currently some interesting attempts to develop index trading for cryptocurrencies. Coinbase is said to be preparing a fund comprised of the currencies traded on its exchange such that investors can gain exposure to cryptocurrencies without actually going through the complex process of buying and holding it themselves. Other indices such as CCI30 are simply comprised by the largest crypto’s by market cap. Both of these systems have flaws.
The Coinbase index is pretty arbitrary, Coinbase unilaterally decides what coins it lists on its exchange, and they are usually only higher market cap coins, excluding returns of promising startup coins. The CCI30 index has a similar problem, and since crypto is so volatile, that too frequent computation and regular rebalancing of an index add significant costs. Both of these are pretty inefficient ways to gain exposure to crypto tokens.
So this begs the question: how do we build a proper crypto asset portfolio? We have stated that current efforts underway are lacking in several ways. But how do you solve for issues such as “investor bias” or go beyond the Kindergarten metrics of coin market cap valuation? I propose a new index, one I will call: NS100 (or Not-Scams 100). I posit that investors will have the greatest success by investing in an expanded pool of startup and established coins, weighted by market cap the main criteria of which is that coins not be “scams”.
What do we mean by “Not-Scams?” This is a little harder to pin down but there are some metrics that can help us out. There are several articles that examine ICO tokens, and detail that almost half of them die between pitch and the first six months after launch; this data can likely be extrapolated outside the ICO marketplace and into the token as money economy. So that’s our first criteria, a token younger than six months can not be in our index.
The second criteria is also objective, the presence of a technical White Paper (as opposed to a marketing White Paper. White Paper’s should be an exposition of technology, not a sales pitch. I suspect a good 30–60% of tokens will also fail this test. The final criteria is a bit subjective, we are looking for novel technology, that although it may have the functions of Bitcoin like systems, (the ability to cheaply transfer money) is not an incremental development of Bitcoin code but rather contains a radical technology that can be promisingly exploited.
Let’s go with some examples. I recently made my first crypto buy in almost a year and it fits perfectly within this criteria so let’s go with it: Nano. Nano ticks our first box pretty quickly, Nano (preciously RaiBlocks), dates its ANN thread to February 29, 2016, so check.
The coin has a short, concise, and technical White Paper. Check.
On the technology side, Nano is a token that generally works like Bitcoin (or at least like original Bitcoin), it is intended to be a form of digital cash, but it sharply deviates technologically. Nano does not use mining on a global chain to agree on a set of transactions, but creates a blockchain for every single account (address) and settlements happen between account ledgers directly, as opposed being globally pooled into blocks and chained. This allows Nano to create near instant transactions, with virtually no ecological footprint. Its security model is completely revolutionary and relies on weighted opinions of representatives delegated by addresses and weighted by coin volume. This is not a Bitcoin clone, it does things its own way, and improves upon Bitcoin, with sub ten second transactions and orders of magnitude larger scalability due to its consensus mechanism. Novel Technology: Check.
I would wager that a majority of the few tokens which pass these three filters would go on to have at least limited success. Someone who invested around the 6–8 month mark (assuming the other checks were passed) would be hard pressed to lose their capital. Someone who invested in an index (basket) of these coins and re-weighted them at long term intervals (say the 1–3 year mark), would, in my humble investing experience, be on sure footing.
I’ll post more as the index evolves.
Free copy of Pablo’s well reviewed book, focused on the principles of crypto investing: https://pablo-lema.squarespace.com/s/Crypto-Success-V2.pdf