Crypto markets move fast, and so do the assets within them. A token that dominates today can be irrelevant tomorrow, while new entrants quickly climb the ranks. For investors, the challenge is to ensure they are continuously increasing their exposure to tokens on the rise and reducing their exposure to those tokens that are losing relevance.
Rebalancing an index allows investors to systematically add or remove tokens at each rebalancing period that meet or fail to meet any criteria they had set. This means rebalancing can be more than just a risk-management tool, it’s a tool for staying aligned with where the market is moving, rather than where it has been.
This is especially critical when investing in a trend driven crypto narrative, like memecoins or artificial intelligence, where the landscape shifts rapidly. Tokens in these categories often have short lifespans, with new tokens emerging, capturing hype, and then fading just as quickly. Without rebalancing, an investor could end up overexposed to dying tokens while missing out on newly trending tokens that are driving the market.
To cater to this, an investor building an index strategy for memecoins may set qualification filters based on a range of criteria that they consider to be a marker of investability or lack thereof. Then at each rebalancing period, tokens that fail to meet this criteria get dropped, effectively removing those which are no longer investable, while new tokens are included that do meet the criteria, thus adding those which are investable.
To see this in practice, let’s compare the 365 day performance of a memecoin index built on Themelia with no rebalancing versus a memecoin index with weekly rebalancing. The universe of tokens available on Themelia by default applies filters of a minimum market cap of $1m and minimum daily traded volume of $100k, though an investor could choose to be more selective by increasing either of these, or applying any of range of other filters such as age, market cap rank, volatility, TVL or circulating supply.
The chart below demonstrates that rebalancing every week with this default market cap and daily traded volume criteria would have yielded an annual return of 133.94% versus 68.76% for a memecoin index where no rebalancing occurred.
One key consideration is that rebalancing incurs trading fees, which can eat into returns if not managed carefully. Investors need to weigh the cost of fees against the potential performance gains and prioritise exchanges with low trading fees to minimise the impact.
After fees are accounted for, not all rebalancing strategies are worthwhile. For example, take a megacap crypto index strategy, where there is less token rotation occurring. The chart below shows a 30 day rebalancing strategy for this megacap index yields annual returns of 53.78% versus 51.17% for the same index with no rebalancing. While the index with 30 day rebalancing marginally outperforms, fees are almost certain to completely wipe out the minor gains of this rebalancing strategy.
The key is to apply rebalancing where the performance differences of potential new inclusions are more pronounced, ensuring the benefits outweigh the costs.
This is why rebalancing can be incredibly powerful in an exploding segment of the market, like artificial intelligence. The chart below shows the impact a 7 day rebalancing frequency has on the return of an artificial intelligence index. This index strategy also employs the default Themelia market cap and daily traded volume filters, in order to determine what tokens qualify for index inclusion.
Rebalancing is a powerful yet often overlooked component in an effective crypto investing strategy. In fast-moving sectors, where tokens can skyrocket and fade within weeks, regularly adjusting allocations can significantly improve returns by keeping exposure to the most relevant assets. However, the impact of rebalancing varies across different market segments, and investors must weigh the benefits against trading fees and market conditions. In a space defined by rapid shifts, a disciplined rebalancing approach ensures portfolios remain aligned with opportunity rather than tokens well past their hype cycle.
