The cryptocurrency market has gained significant attention since 2017 due to the exponential growth trajectory of its market capitalization. This has made major players from the financial services sector say banks and funds to embrace the crypto-instruments. One such instrument is indices just like the one in equity and bonds.
What are cryptocurrency indices?
The overall performance of various sectors of the market is gauged by the equity and bond indices. An equity index highlights the performance of the stock market or a particular portion of it. Similarly, the cryptocurrency index assists investors to monitor the state of crypto-market. It serves as a smart benchmark for all cryptocurrencies. There is no need to look out for each crypto-currency separately. Such an index is based on market capitalization. It is recalculated once a day, a week, a month or a quarter.
What are the guiding principles of the cryptocurrency index?
- Diversified: The constituent cryptocurrency forming the index should be diversified. No single constituent should exceed 30% or contribute below 1% of the market capitalization of the index. This particular rule is followed by the Bloomberg Galaxy Crypto Index.
- Representative: The index should be a proxy for the broader cryptocurrency market.
- Continuity: The index should be responsive to the changing dynamics of the market. Such changes should be in a way that does not completely reshape the character of the Index from year to year.
- Data Integrity: The constituent cryptocurrency in the index should meet the criteria as defined in the index methodology calculation.
How is the Cryptocurrency – index calculated?
Let us study the cryptocurrency index calculation of the CCI30 index to understand the methodology. The study is divided into three sections
- Index Construction
- Index Calculations
- Index Maintenance
The eligibility criteria are set for the selection of the constituent crypto-currency in the crypto-currency index. As far as CCI30 index is concerned, the eligibility criteria are as follows:
- The constituent must be a cryptocurrency or a crypto token
- The constituent must be traded on at least 3 public, non-decentralized exchanges that report the last traded price and the last 24 hours trading volume
- The constituent must have an average daily trading volume over the last 30 days greater than $1m on at least one supported exchange
- For market cap ranking, an accurate circulating supply figure is required.
Market capitalization is calculated by multiplying the price of the cryptocurrency by the number of currency circulating in the market. In this case, the exponential weighted average method of market capitalization is used. It smoothens the volatility to give the most accurate figure of the market capitalization at any point.
As far as the number of currency is concerned it uses circulating supply. It means, the index does not consider the coins that are locked, reserved or unable to be sold on the public market. Since those coins cannot affect the price and thus should be omitted to determine the market capitalization.
CCi30 uses the top 30 cryptocurrencies by adjusted market capitalization. The reason behind using 30 currencies is it is the minimum number necessary to be statistically significant. If more than 30 constituents are used, it would generate higher fees with no significant improvement in performance. On the contrary, if less than 30 is used, it would risk reduced performance, compromise statistical significance and lead to insufficient diversification. By the inclusion of the top 30 cryptocurrencies, the CCi30 index captures around 90% of the cryptocurrency market capitalization.
Each constituent cryptocurrency is weighted according to the market capitalization of that particular currency. The greater the capitalization, the greater is the weight it carries. The square root of the adjusted market capitalization is chosen to accurately weigh the constituent cryptocurrency based on the current status of the cryptocurrency market.
Index Value Calculation
Consider there are N cryptocurrencies in the index. If the weight of the cryptocurrency at time T0 is W1,…Wn, then the value of the index at time t is given by:
Where P(t) is the price of the coin I at time.
Adjusted Market Capitalization Calculation
Market capitalization should be calculated before calculating the weights for each cryptocurrency. The formula used to derive market capitalization is
The value thus obtained is rounded to 3 decimal places.
The weight of each constituent cryptocurrency is calculated by measuring the square-root of the adjusted market capitalization. So at a particular time t, the weight of the constituent cryptocurrency 0 will be:
The weighting factor is rounded to 4 decimal places.
The index and the constituent cryptcurrency is monitored and checked for compliance at regular intervals. This process is undertaken by the Index committee and any material deviations from the existing procedures have to be approved by this committee. Any change, when executed is immediately informed to the public.
In this phase, the index is reconstituted (revaluation and change of constituents) on the first day of each quarter. It is announced and implemented on the first Index Business day of the next quarter.
The weight of the constituent is changed on the first calendar day of each month.
The crypto derivatives exchange software takes care of all the above-mentioned guidelines.
Which are some of the major crypto index in the market?
- Cryptocurrency Index 30 (CCi30)
- Bloomberg Galaxy Crypto Index (BCGI)
- Coinbase Index
- Huobi Index (HB10)
- Bitmain Big10 Index (BLC10)
Can one invest in the cryptocurrency index?
Yes, one can invest in cryptocurrency indices via cryptocurrency index funds. It is better as well as a safer investment instrument than the cryptocurrency coins. The best advantage of investing in the cryptocurrency index is that it allows gaining profit from the un-forecastable appreciation of some cryptocurrencies while putting a check on losses deriving from the fall of others.
The indices calculator is one of the major parameters in the trading platform. We have got a dedicated crypto derivatives exchange development team for helping you in developing your platform with all the above-mentioned features. We are just a call away!