Define “Tracking Error” in Relation to a Crypto Index Fund Hedge

Tracking error is the divergence between the performance of a portfolio (like a crypto index fund) and the performance of its underlying benchmark index. If a hedger uses a derivative on an index fund to hedge a portfolio of the index's constituents, the tracking error represents a form of basis risk.

A high tracking error means the hedge will be less effective in perfectly offsetting the portfolio's losses.