Over the prior ten years, the investment model in conventional financial markets has moved to passive investment. Since the beginning of 2020, index funds have managed over $ 10 trillion.
Why use an index?
An index fund is a kind of shared fund or an exchange-traded product (ETP) designed to provide direct exposure to a financial market index’s performance.
Many investors are attracted to these instruments because they want to outsource the complexity of active management. This is the process of selecting shares to invest in.
They also want easy access to a particular market, which in turn provides a well-diversified portfolio. Besides, index funds tend to adopt a passive investment strategy that generates lower fees than actively managed funds.
Decentralize The Financial World
Given the usefulness and popularity of index funds in traditional finance, it is no surprise to see the emergence of these services in the crypto ecosystem. Protocols such as Index Cooperative, Synthetix, and PieDAO have built up their respective Defi indices, allowing crypto investors to be easily exposed to the Defi sector without being a Defi expert.
Since the crypto ecosystem copies every conceivable financial product in traditional finance to crypto networks, you will also find tokens that function as indices for Defi assets.
Risk of Excessive Concentration
Despite the advantages of index funds in traditional markets, there are also disadvantages, such as concentration risks. For example, in recent months, the S&P 500 Index has been more dependent on the top five technology shares Apple, Microsoft, Amazon, Facebook, and Google than during the dot-com bubble. The same can be said for the broadest Defi index of crypto.
The Defi Pulse Index (DPI) is a market capitalization-weighted index that follows the performance of Defi assets on Ethereum. The DPI is updated monthly and does not include token derivatives, synthetic assets, or tokens linked to physical assets.
The S & P 500 Index contains the prices of 500 companies. So many different Defi tokens are not there. Also, many Defi tokens must come and go. As a result, DPI also has concentration risks. Currently, 30% of the Defi Pulse Index consists of only two assets: UNI & AAVE.
Also, 77% of the DPI’s total risk is determined by only four tokens: UNI, YFI, SNX, and AAVE. As a result, the yield of the index is extremely sensitive to these four assets’ movements.
What risk do you want to take?
If you want to invest in a Defi or cryptocurrency index, do a good study, and only after proper research should you invest. More than ninety percent of Defi tokens are scams. So be very careful with your investment.