Bitcoin, ethereum and litecoin to be added to index fund

One of the world's top cryptocurrency exchanges is opening up a new way for investors to seek a return on digital currencies such as bitcoin - by launching an index fund that tracks four of the biggest virtual currencies on the market.

Known as the Coinbase Index Fund, the basket of cryptocurrencies resembles traditional index funds that mimic the performance of the S&P 500 or the entire stock market. And it marks the first time that Coinbase, the San Francisco-based cryptocurrency trading platform, has leapt into asset management.

"Index funds have changed the way that many people think about investing," said Reuben Bramanathan, a product manager at Coinbase, in a blog post. "By providing diversified exposure to a broad range of assets, index funds enable investors to track the performance of an entire asset class, rather than having to select individual assets."

Previously, investors who wanted to buy into the cryptocurrency craze would use Coinbase to exchange U.S. dollars for individual currencies, similar to the way equities investors buy stock in specific companies. But the new Coinbase fund will allow investors to hold virtual currencies indirectly through shares; the fund is currently composed of 62 percent bitcoin, 27 percent ethereum, 7 percent bitcoin cash and 4 percent litecoin, in accordance with their relative market caps. The fund is expected to add other coins in the future, and its allocation will be rebalanced every year.

The rise of index investing in cryptocurrency mirrors the fast-growing popularity of index funds in other types of assets. Much of the shift has been driven by research showing that actively managed mutual funds - in which a portfolio manager tries to beat the market with well-timed bets - rarely outperform funds that charge lower fees and simply try to stay abreast of an index. A 2015 Morningstar report found that between 2004 and 2014, actively managed funds almost universally underperformed compared to their passive competitors.

Access to the Coinbase index fund will be limited at first. The company is opening the fund to U.S.-based accredited investors, meaning those who are worth more than $1 million or who earn more than $200,000 a year. And there's an initial hurdle of a US$10,000 (NZ$13,800) minimum investment. But amid the rising demand for cryptocurrencies, it may only be a matter of time before index investing in the space becomes more common.

Coinbase isn't the first to launch an index fund. Last year, another Bay Area startup, Bitwise Asset Management, started its own fund known as HOLD 10, which tracks the performance of as many as 10 cryptocurrencies. That fund rebalances every month and includes other popular alternatives such as Ripple and Monero.

But Coinbase carries name recognition and a valuation of $1.6 billion - or perhaps twice that, according to some estimates - suggesting that the giant's move into asset management is likely to have major implications for many other cryptocurrency investors and businesses.