The buffer zone for a dynamic index is the allowable buffer before assets are swapped in or out of the portfolio. Since constantly adding and removing assets from a diverse portfolio can lead to excessive trading fees, the buffer places limits on when these swaps can occur.
As an example, when a buffer of 5% is set for an index, this means an incoming asset must acquire enough market cap to become 5% more than the next largest asset in the index.
Say we have an index of 2, using the example above with BTC and ETH.
- BTC Market Cap: $137,008,021,275
- ETH Market Cap: $26,081,172,184
Since ETH currently has a market cap of $26,081,172,184, that means the only way for ETH to be removed from this index is for a different asset to reach a market cap of 27,385,230,794 or greater. Notice although the market cap of ETH is only $26,081,172,184, an incoming asset would need to acquire an extra 5% in order to be able to cause the swap. This prevents constant swapping of assets in and out of the index.
Bitwise Investments is an example of an index fund provider which uses a 5% buffer zone for their funds. You can find more information by visiting their methodology documentation here: