How do index weightings work?
What are index weightings?
Index weightings are a way of calculating the individual amount of each asset which comprises the index.Because indices are made up of a variety of different assets, there needs to be some way of deciding how much to invest in each asset.There are a few different methods of weighting an index, and it’s important to know the difference between each when considering which to invest in.
Types of index weightings
In this section, we will go through the most popular methods of weighting an index. We will be referring to the table below, which shows basic data for an imaginary set of tokens, to explain each different type of weighting.
Price weighted indices, as the name suggests, gives a higher weighting to tokens that have a higher price. One of the most popular price weighted indices is the Dow Jones Industrial Average. In a price weighted index, each token is weighted by its own price relative to the cumulative price of all tokens in the index. Based on our table, Token A would have a weight of 50%. This is calculated by dividing Token A’s price of $5 by the cumulative price of all tokens, which is $10 ($5+$2+$3).
In this type of weighting, the component tokens of an index are weighted according to their market capitalisation. Market-cap, as it is generally shortened to, can be defined as token supply multiplied by token price. There are generally two types of token supply that are used: circulating or total. Circulating supply is concerned only with the tokens that are tradeable. In other words, tokens that are unlocked. Total supply is simply equal to the total number of tokens that have been minted regardless of whether they are locked or unlocked.
Component tokens that have a higher market cap are weighted higher in the index, in other words, the index will be more skewed towards these tokens than the smaller market-cap ones. To calculate the weight of a token you divide the token’s market cap(circulating or fully diluted) by the cumulative market cap of all tokens in the index.
The weight of Token A using it’s circulating market cap would be 6%. This is calculated by dividing Token A’s circulating market cap of $100mm by the cumulative circulating market cap of 1680mm for all tokens in the index. The same process can be applied to find Token A’s weight based on its fully diluted market cap, by substituting in the fully diluted market cap figures. The result is a weight of 14% for Token A.
Equally Weighted Indices
An equally weighted (also known as an unweighted) index is one where the component tokens have equal weight within the index. An equivalent dollar amount is invested in each of these component tokens, regardless of the current price, market-cap, or any other factor. In an equally weighted index, tokens with smaller market-caps can sway the index just as much as those with much larger market-caps.
Index products by Phuture
Phuture can support any one of the aforementioned weighting methodologies and we give the freedom to index managers to decide which strategy to choose. For investors, we offer a range of index products that provide exposure to key areas of the crypto market that are weighted using either the capitalisation, or the equally weighted method. All our indices are automatically rebalanced and updated so that you no longer need to manually manage your crypto portfolio.