Research has revealed that overexposure to a few DeFi “blue chips” is a problem for indexes. New research suggests that indices based on decentralized funding tokens lack diversification. This is far from ideal for advanced investors seeking to mitigate risk.
Indices are a very popular way to get wide exposure to a market without having to search and buy individual assets. With the explosion of DeFi protocols and associated tokens this year, a number of indexes have been launched.
Analytics provider DeFi Pulse was one of the first to launch its own index in mid-September at the height of the boom. However, Messari analyst, Roberto Talamas concludes that indices strongly gears towards certain assets. He added that despite the positive attributes of large exposure and lower fees, index funds can become highly concentrated. This reduces the benefits of product diversification.
Biased DeFI clues
Diversification is one of the main reasons why investors flock to indices. But after analyzing the DeFi Pulse Index, the researcher found that only four assets accounted for 77% of the portfolio’s total risk. In terms of percentage contribution to risk, these four assets are Uniswap’s UNI token, which holds more than a quarter of the share (26.12%), Aave native token (20.18%), YFI from Yearn Finance (17.87%), and synthetix’s SNX token (13.29%).
These four alone represent more than three-quarters of the portfolio. As a result, any significant movement in any of them will affect the overall performance of the index. The problem seems to be common with other DeFi indexes such as Synthetix’s SDEFI which is also heavily weighted with only four tokens to include Compound, Maker, Kyber Network and SNX.
At the time of writing, DeFi tokens have followed the general decline of the cryptography market. The index-based token peaked just after the launch at $125. But dropped to its lowest level of $60 in the first week of November. However, compared to the overall performance of DeFi tokens, DFI has recovered much better.
Also, a large number of tokens, including SWRV, CRV, SUSHI, BZRX and MTA, remain more than 60% below their peaks. Indices are also available for general cryptocurrency markets. But they are also underperforming at the moment.
Crypto 20, or C20, was launched in an ICO as the first token cryptographic index fund in 2017. It tracks the top 20 cryptocurrencies by market capitalization. But is well down from its peak of nearly $4 in January 2018 and is trading at just $0.90 today. This is despite the return of the total market capitalization of cryptography to $560 billion. That’s 32% less than its all-time high of more than $830 billion in the same month.