Innovation and startups are themselves evidence that over long (decades) time scales, this isn't true. When a company in the index falls on hard times and folds, where did its revenues go? Frequently, it's to some startup that was privately held until a couple years ago. By the time it IPOs and gets included in the index, much of the wealth has already been generated, and its inclusion in the index is a transfer of wealth from passive investors to the founders, angels, and VCs who funded it when it was far from a sure bet.
A similar situation would occur if a younger generation decides that stocks in general are a scam and that they're going to put all their money into cryptocurrencies. I've met 20-somethings who actually say that; if enough of them believe it, it becomes a self-fulfilling prophecy, and all the old folks whose retirements are in indexed 401(k)s end up holding the bag as those investments become worthless and a younger generation ends up inventing a whole new financial system.
If the world's investments cease to be made in actual companies, in favor of a meaningless commodity, we'll have much bigger problems.
Investing in Joe's Can Factory allows Joe to make more cans.
Of course, right now, the only thing practical to fund with cryptocurrency is a cryptocurrency or internet business, none of which provide truly useful or necessary services
This is not a problem. If cryptocurrencies become widely used and the associated business accumulate significant market value, major market indices will rebalance in such a way to include cryptocurrency businesses and the passive index investor will be fine.
In fact, it doesn't matter if the future is in crypto, plastic or tulips; equity index investors will be fine.
Basically, the index fund itself becomes a bet that the future will look much like the present, at least qualitatively, and that future investors will demand the same categories of securities as present ones do. If the future looks dramatically different from the present, then people who bet correctly with their particular version of the future reap the spoils, at the expense of all index fund investors.
(I should note that this is explicitly the purpose of indexing - by giving up the possibility of above-market returns and settling for market returns, you can eliminate the need for fees. If you believe that being average is good enough, this is a good bet. If you believe that the average person is going to get screwed and bad financial things will happen to the lots of people, why would you want to be them?)
More likely they will buy new crypto focused companies (Coinbase IPO) or that existing firms will adopt crypto based business lines. The investment is firms innovating, rather than the value of the underlying instruments or technology they use.
Between weird investment strategies, the length of the current boom, and the very low interest rates at the peak of the boom, this coming bust is going to be a massacre. I'm honestly not even sure whether the system as a whole will survive it.
This works as long as there are enough non-index investors trying to outsmart the market by actively trading.
The question then remains the same while changing. Do I invest in the market, or in canned goods?
But although you might get better returns picking the next strategy, you probably would do fine with index funds.
And timing the market has always been a loser strategy (except for a few lucky or skilled outliers).