The promoters of a new cryptocurrency index tout it as “an important step in the evolution of the digital assets space.” Maybe so, but those high-flying sentiments merit closer examination.
What the new Bloomberg Galaxy Crypto Index appears to be is another step in Wall Street’s perpetual crusade to turn everything into a tradable asset. At the moment, that marries nicely with crypto-entrepreneurs’ desire to surround their offerings with all the trappings of legitimacy.
Perceptions matter when you’re dealing with a product as immaterial and controversial as digital tokens. Bitcoin, the best-known cryptocurrency, plunged after Warren Buffett said it was “rat poison squared” on Saturday. His business partner, Charlie Munger, went even further, stating that profiting from bitcoin was only slightly more moral than “trading freshly harvested baby brains.”
So will the new index, launched on Wednesday by Galaxy Digital Capital Management LP and Bloomberg LP, do anything to improve cryptos’ rather tattered reputation? In theory, it shouldn’t. But in practice, it just might.
Let’s talk about the theory first. An index typically adds value by making it easier for investors to gauge their performance against a market composed of dozens or even hundreds of individual securities. By functioning as a benchmark, an index can also become an important investment in its own right.
The S&P 500, for instance, serves as a fine measuring stick for investors who want to benchmark their performance against an enormous slice of the U.S. stock market. Better yet, S&P 500 index funds allow people to instantly buy a stake in the hundreds of stocks that make up the index – something that would be difficult for most of us to achieve on our own without running up enormous transaction costs.
Sadly, the new crypto-index doesn’t seem to offer much in the way of equivalent advantages. At the moment, it tracks only 10 cryptocurrencies. The four largest – bitcoin, ethereum, ripple and bitcoin cash – make up about 85 per cent of its initial value. While the weighting of individual cryptocurrencies will change as the market evolves, it’s fair to ask why you need a sophisticated index to track four investments.
At the moment, the index is just an index. But if some enterprising asset manager decides to use it as the basis for an index fund, the same questions apply: Why do you need a fund to act as a middleman when you’re purchasing just a handful of securities?
Maybe it will eventually prove its mettle as new cryptos emerge and the universe of alternatives becomes more complicated. Equally likely, though, is that one or two of today’s offerings will emerge as the dominant players and the index will become even more bare bones.
But that’s all theoretical for now. In practice, the new index does fulfill one purpose rather splendidly: It makes crypto more respectable. By treating virtual tokens as an asset class, akin to stocks or bonds or commodities, it implies that crypto is just as solid as those other investments.
Crypto-entrepreneurs will love this. They’re struggling to avoid regulators’ heavy hand and fight back against insinuations that the primary utility of cryptos lies in criminal activities and tax evasion. They can now tell government overseers: “See? We have an index. We’re not buccaneers. We’re an investable asset.”
Wall Street will applaud, too, if it encourages trading. Brokers don’t care what investors trade so long as they trade something, because that’s how fees are generated.
Investors should remember that the creation of an index doesn’t imply an official seal of approval. Neither does trading in that index. Wall Street has laboured for years, for instance, to turn stock market volatility into an asset class of its own. You can now bet on VIX, the best-known volatility index, through any number of products. But this doesn’t imply that volatility has somehow become a good thing.
The same goes for cryptos. A new index can encourage trading. But it won’t change Mr. Buffett’s opinion – and it shouldn’t change yours.