Crypto Index Investing.
Ethereum 2.0 vs Polygon vs Celo. Decentralisation versus Transaction Speed.
Crypto Index Investing
Just as there is the S&P500 index for stocks, indices are emerging in crypto to allow for easier diversified investing.
The largest index by market cap is the DeFi Pulse Index, which is a capitalisation weighted index of DeFi protocol tokens (e.g. Uniswap, Compound, Aave etc.) that can be bought on the Ethereum blockchain (using Ether). At the time of writing, there is just under $200M worth of funds in this index. So, it’s tiny compared to the trillions of dollars in equity index funds.
Since crypto allows for easy programmability, platforms like Tokensets and Balancer have emerged that allow you to put together your own portfolio. Doing so though is not quite as easy as it seems, and some of the barriers include:
Gas/transaction fees in setting up an index
Regulatory challenges (technically, setting up an index would require regulatory approval as a fund in many countries)
Tax management – rebalancing transactions can be taxable and complicated to manage.
Earlier this week I wrote an overview of different ways to build index funds in DeFi. In the future, as more assets move to blockchains, I see crypto based index funds as growing in importance. You can read the full article here.
Ethereum 2.0 vs Polygon vs Celo
The original Ethereum (and the main version still running today) is a proof of work protocol like Bitcoin, and suffers from slow and expensive transactions. There are different philosophies on how to address these issues.
Ethereum 2.0 is one such philosophy and involves sharding (think splitting) the network into multiple pieces so that computers (known as nodes) supporting the network will only need to handle a portion of the overall network. This process has been slow and it is still not known when Ethereum 2.0 will be up and running.
In the meantime, other protocols, such as Polygon and Celo have gone ahead and already allow faster and lower cost transactions than Ethereum 1.0. How is this possible?
The answer is in the trade-off between transaction speed/cost and decentralisation. Quite simply, whereas Ethereum 2.0 is designed to operate on a large network of ordinary computers, protocols like Polygon and Celo operate on a restricted network of higher powered computers. With more high powered the computers supporting the network, Polygon and Celo can get higher transaction speeds. However, high powered computers are expensive, so less people are able to participate, making the Polygon and Celo networks less centralised than Celo.
As a concrete example, there are currently 110 validators (think computers) operating the Celo network. By contrast, there are over 210,000 node operators already up and running in anticipation of the rollout of Ethereum 2.0.
In many ways, the starting point for network performance and decentralisation comes down to specifying minimum hardware requirements for node operators. Each network thinks about this differently. For a deeper dive, I recommend these two articles:
Understanding how nodes are compensated in Ethereum 2.0 vs Celo (my own writing)
That’s it for this week. If you’d like to get this newsletter weekly, you can subscribe at Pinotio.com .