If you know what an ETF in traditional finance is, then you would understand how decentralized indices work. An exchange-traded fund (ETF) is a type of pooled investment security that tracks other assets, such as equity indices, bonds, and commodities. An ETF is typically a collection of multiple assets and can be traded on an exchange like a stock.
DeFi indices allow you to invest in crypto assets without monitoring your positions all the time. Also, it is the best and most popular way of getting diversified exposure to the crypto market. To invest in a DeFi index, you buy index tokens that represent your share of the index fund. Your investment will appreciate or depreciate according to changes in the price of the index token.
As of 8 September 2022, decentralized indices have a market cap of $87 million. The biggest player in the sector is Index Coop founded by Set Labs Inc. in 2020 October. As of this writing, Index Coop has 6 indices: DPI (DeFi Pulse Index), GMI, BED (Bitcoin, Ethereum, DPI), MVI (Metaverse Index), JPG, and DATA.
DPI, the index with the largest market cap, has been developed by Index Coop and DeFi Pulse, a DeFi data provider. DPI is a capitalization-weighted index containing 13 tokens at the moment. It has been designed to track the performance of DeFi projects which have “significant usage”. To be included in the index, a token should meet several requirements across four dimensions. For example, the token should be available on the Ethereum blockchain, and one should be able to predict its supply over the next five years. Some underlying tokens of DPI are UNI, MKR, AAVE, and SNX.
Bankless DeFi Innovation Index (GMI) contains early-stage tokens which promise high growth but haven’t yet reached the level of blue-chip DeFi tokens yet. Some of the GMI components are Olympus DAO, Convex Finance, and Alchemix. BED is an equal-weight index containing, presumably, the three most important members of the digital assets industry: Bitcoin, Ethereum, and DeFi. It allows you to get passive exposure to the largest cryptocurrencies.
If you like the idea of Metaverse and want to invest in it but don’t know exactly which token to choose, MVI is the index for you. It focuses on the tokens which are in one of the following categories on CoinGecko: Non-Fungible Tokens, Entertainment, Virtual Reality, Augmented Reality, and Music. MVI is composed of the tokens of the premier Metaverse projects, such as Sandbox (SAND), Decentraland (MANA). If you love blockchain games, then this is the index you would consider buying because it contains Illuvium, Yield Guild Games, and Axie Infinity.
If you want to get exposure to NFTs, you should consider JPG index. JPG contains tokens of popular NFTs, such as PUNK and XMON.
The Web3 Data Economy Index (DATA) provides a passive exposure to the Web3 data economy. The index is composed of data-centric protocols, such as The Graph (GRT), which is an indexing protocol for querying data; Chainlink, which through a decentralized oracle network, allows blockchains to securely interact with external data feeds; Livepeer, a “decentralized Youtube”, is the first live video streaming network protocol that is fully decentralized.
Another big player in the decentralized indices sector is Indexed Finance. Indexed Finance develops passive investment strategies for the Ethereum network. As of 8 September 2022, the protocol has three indices: Degen, NFTP, and ORCL5.
Degen is the index composed of Ethereum projects that are believed to have “significant room to grow”. Some of its components are REN, an open protocol built to provide interoperability and liquidity between different blockchain platforms; 1INCH, a DEX aggregator which helps users discover the best trade prices for tokens; WOO, a deep liquidity network connecting traders, exchanges, institutions, and DeFi platforms with democratized access to the best-in-class liquidity and trading execution at lower or zero cost.
Like JPG and MVI indices on Index Coop, NFTP gives passive exposure to NFTs and the Metaverse. Other than SAND and MANA already mentioned, the index contains tokens of well-known projects, such as GALA, ENJ, RARI, etc.
ORCL5 focuses on decentralized oracle networks, protocols built to bring data from the external world to the blockchain. Oracles are systems that by leveraging multiple data sources connect off-chain data for use on blockchains. The leader in oracle protocols is Chainlink which is 58% of the ORCL5 index as of now. Some of the remaining components of the index are UMA, an optimistic oracle built for Web3; BAND, a cross-chain data oracle platform; ORAI, the world's first intelligent and secure solutions for emerging Web3, scalable Dapps, and decentralized AI.
In conclusion, decentralized indices give you passive exposure to crypto assets through various themes, such as DeFi, Metaverse, NFTs, and oracle networks. By getting diversification you’ll decrease your risk. But don’t forget that this will also limit your gains because instead of making concentrated bets on 1-2 tokens, you’ll invest in the basket of tokens some of which may not perform as others.