Hedging in crypto: working safely is the goal, regulation is not

Most investors have realized that the crypto market is a quite volatile place. Prices can suddenly drop or surge, often within just hours. Given this reality, many are asking – is there any way to protect their assets from the market’s unpredictable movements? The answer: hedging.

Hedging: What Is It Really?

Hedging is a risk management technique used to reduce exposure. It is not a guaranteed way to make profits – rather, a method to limit losses. Like insurance in advance, it is there for the day when it might be needed.

Let’s consider a common example: imagine you hold a significant amount of assets. But what if prices fall? Hedging allows you not to sell everything but to offset potential losses with an opposite position.

Why Is Hedging Considered a Waste in Crypto?

Asset Value Reservation

Crypto asset prices are highly unpredictable. Some projects see price increases during launches and new feature releases. During these times, prices spike, and users hope to profit. But then? Often, prices deepen some more.

An investor who bought at a high price faces real risk of loss. If they had used hedging in time – opening a short position equal to their holdings – their losses could have been limited or significantly reduced.

Preserving Profits Without Selling the Portfolio

Another common scenario: you have an asset that has increased significantly in value. Your holdings are now substantial. But suddenly, pressure mounts – the market might reverse.

Solution: hedging. You could open a short position that covers your profits, while your original asset remains in your possession. So, if the price drops, your short position compensates for most of the loss.

Diversifying a Portfolio Through Hedging

In most cases, valuable investors hedge not just one asset but the entire portfolio. Example: some altcoins have small futures markets, making it difficult to open short positions. In such cases, the investor might open a short on a more liquid main asset, like (Bitcoin or Ethereum).

This approach reduces correlated risks: when the main asset falls, altcoins tend to fall as well. A short on the main asset can offset most of the losses from altcoins.

Covering Financial Liabilities

Large funds and protocols may hold assets in crypto but have expenses in fiat. When crypto prices fall, their holdings decrease in value, making their financial position even more strained. Opening short futures on these assets helps in such situations – covering expenses from profits.

Main Methods of Hedging in Crypto

Futures Contracts

This is the most popular method. The investor opens a short futures position equal in size to their holdings. If the asset drops, the futures position gains, offsetting the loss.

Key point: choosing the exchange with high liquidity. High liquidity, good pricing, and fair funding rates make hedging more practical.

Using Options

Options are contracts giving the right, but not the obligation, to buy or sell an asset at a set price. Example:

You fear Ethereum might drop. You buy a “put option” – a contract giving you the right to sell Ethereum at a fixed price. If the price falls to that level, the option becomes valuable. If the price rises, the option expires worthless.

Options have a premium – the price you pay. However, they provide a way to limit potential losses.

Cross-Asset Hedging

Some protocols are highly specialized. If they hedge their assets, they are only relevant within certain functions. Especially if they have correlation with Ethereum, they might hedge on Ethereum.

Insurance and Other Instruments

Crypto insurance is still a new industry but is gaining traction. Large funds or protocols can buy insurance that compensates for losses if a contract is breached or a hack occurs.

This adds extra security but also involves costs, which reduce overall profitability.

What Is Available for Hedging in Crypto?

Lack of Instruments

In traditional financial markets, hedging instruments are attractive and accessible. In crypto, they are still in development. This makes hedging a more complex process.

Quick to Implement

Developing a hedging strategy requires deep market understanding. You need to see risks, consider correlations, and know how to use financial instruments. This is professional expertise.

Fixed Costs of Insurance

Hedging is worth it. The cost of futures funding, option premiums, or insurance premiums – these are expenses to consider. If the risk is small, hedging might be less justified, as the costs could outweigh the potential losses avoided.

Conclusion: Hedging Is Difficult but Possible

The crypto market is a field full of risks. Despite your size or luck, a proper hedging strategy can be the difference between protecting your assets and suffering catastrophic losses.

Carefully consider all risks, study available instruments, and develop a strategy suited to your situation. Always remember: hedging is a form of protection, not a guarantee.

Important note: This material is for educational purposes only. Before making investment decisions, seek proper guidance, assess risks, and act responsibly.