Equal weight
Equal Weight - is a percentage distribution of assets where each cryptocurrency has the same weight in the index. This means that each coin is represented in the index with an equal percentage share, making it much easier to track its performance.
Example:
If you have 10 cryptocurrencies in your index, dividing 100% by 10 gives a 10% share for each coin.
Market Capitalization
Market capitalization is calculated by multiplying the current market price of a cryptocurrency by the total number of coins of that cryptocurrency in circulation. The larger the market capitalization of a cryptocurrency, the greater its weight in the index. This allows your index to better reflect the current state of the overall market and brings it closer to the total return of all cryptocurrencies.
Example of calculating the market capitalization of a cryptocurrency:
If one unit of a cryptocurrency is currently trading at $10, and the total number of these coins in circulation is 1,000,000 units, then the market capitalization of this cryptocurrency would be $10,000,000.
You can easily find the current price, quantity, and calculated market capitalization for each cryptocurrency on the Coinmarketcap website.
Detailed example of coin distribution in a index:
You've added 2 coins to your index (market capitalizations of the coins in the example are calculated as of the article's creation date).
- Market capitalization of BTC = $550,181,989,570.
- Market capitalization of ETH = $219,642,873,971.
First, let's find the total market capitalization of the two coins: $550,181,989,570 + $219,642,873,971 = $769,824,863,541.
Then, let's determine the share of each coin in their combined market capitalization:
- BTC: $550,181,989,570 / $769,824,863,541 = 0.7146
- ETH: $219,642,873,971 / $769,824,863,541 = 0.2854
Thus, the coin distribution in this example index would be:
BTC = 71.46% and ETH = 28.54%.
Square Root of Market Capitalization.
This method of percentage distribution of asset weights in an index uses the square root of the value of each asset to reduce its influence on the index. As we saw in the example above, Bitcoin accounted for 71.46% of the index's value. This is considered risky as a large portion of the index is concentrated in a single asset. To make the distribution of funds in the index more even, the square root of market capitalization can be used.
Let's see how this changes the final asset distribution taken from the example above.
- BTC weight = $550,181,989,570^(1/2) / ($550,181,989,570^(1/2) + $219,642,873,971^(1/2)) = 61.27%.
- ETH weight = $219,642,873,971^(1/2) / ($550,181,989,570^(1/2) + $219,642,873,971^(1/2)) = 38.73%.
Using the square root of market capitalization makes the distribution of funds across assets more even.