For example, in January 2021, Dogecoin’s (DOGE) price received a generous boost within 24 hours from around $0.008 to about $0.08. However, the price plummeted by approximately 72% the next day to $0.022. Even though DOGE’s price climbed higher and higher in the following months, not all cryptocurrencies made the same recovery. The regulatory environment for cryptocurrencies and related financial instruments is evolving and varies by jurisdiction. Changes in regulations can affect the value and availability of certain hedging instruments. You must fully understand the regulatory requirements in your local jurisdiction and stay compliant at all times.
Some platforms allow for short selling, where you can borrow a cryptocurrency, sell it, then buy it back later to return it. If the price drops as you anticipate, you would make a profit, which can offset losses in other investments. Thanks to their ‘funding rates’ mechanism, perpetual contracts also trade closer to the index price of the underlying asset, compared to traditional futures. Suppose that on 15 January a manufacturer agrees to provide 100,000 tons of steel on 15 July. On 15 January, the spot price of steel is $630 per ton, and the futures price for July delivery is $600 per ton. The manufacturer can hedge its position by taking a long position in futures contracts and closing its position on 15 July.
Please note that the availability of the products and services on the Crypto.com App is subject to jurisdictional limitations. Crypto.com may not offer certain products, features and/or services on the Crypto.com App in certain jurisdictions due to potential or actual regulatory restrictions. Staking crypto tokens is another effective method of generating passive income.
If the price of bitcoin drops, the increase in the put option’s value would offset the loss in the bitcoin’s value. An unexpected strengthening of the basis worsens the hedger’s position since the hedger needs to pay a higher price for the asset after considering gains or losses from the futures contract. If the basis weakens unexpectedly, the hedger’s position improves.
What are the risks of trading cryptocurrencies?
It can be tempting to use complex hedging strategies in an attempt to maximize profits or minimize losses. If you’re not a sophisticated investor, simpler strategies are usually better. Consider investing in a variety of cryptocurrencies and even spreading your investment across different asset classes. This can help protect against volatility in any one particular asset. Counterparty risk is especially significant with over-the-counter derivatives or when stablecoins are used as a hedging tool.
Holding a range of different cryptocurrencies or diversification can also act as a hedge. You have an existing position in a specific asset, such as bitcoin or ether. We do not give personalized investment advice or other financial advice. The information on this website is subject to change without notice. Some or all of the information on this website may become outdated, or it may be or become incomplete or inaccurate. We may, but are not obligated to, update any outdated, incomplete, or inaccurate information.
- If the price of bitcoin increased instead, up to $11,000, you would be obliged to sell your bitcoin for $10,000.
- The investor is then protected from any losses due to a decrease in the asset’s value.
- With daily settlement, the payoff from the futures contract is realised day by day throughout its life.
- Historically, crypto bear markets have offered the best times to accumulate assets.
However, it just runs in perpetuity instead of betting on a price and worrying about reestablishing positions every time the contract expires. The futures contract will be a standardized amount and transparent. The futures market will match up a buyer and seller and essentially track your market’s future expected price. We want to clarify that IG International does not have an official Line account at this time.
A future is a type of financial contract between two or more parties that have agreed to trade a particular crypto asset at a predetermined price on a specific date in the future. However, when applying hedging strategies, traders should take note of the transaction fees and the risks to using leverage that may cut into their earnings. Hedging is a risk management strategy employed by individuals and institutions to offset potential losses that may incur on an investment. Portfolio construction is another important aspect of managing risk. Choosing what assets to buy and at what quantities can have a great impact on the overall risk level of a portfolio. It’s important to consider the amount invested in crypto relative to other assets and savings accounts.
They are particularly popular in the cryptocurrency space, as they allow traders to hold leveraged positions without the burden of an expiration date. When opening a futures position, users need to pay a margin deposit irrespective of whether they buy or sell a contract. For options, the buyer pays the premium when the contract starts and does not have to post a margin; only the option seller must pay a margin. If the asset to be hedged and the underlying futures contract asset are equivalent, the basis equals zero at the expiration of the futures contract. Prior to expiration, the basis can be positive or negative, and changes in basis can improve or worsen a hedger’s position. An increase in the basis is known as a strengthening of the basis; while a decrease in the basis is known as a weakening of the basis.
Step 1: Establish a primary position
Crypto futures allow investors to buy or sell a cryptocurrency at a predetermined price at a specific future date. For example, if you own bitcoin and fear its price might drop, you can sell a bitcoin futures contract. If the price of bitcoin does drop, the profit from the futures contract would offset the loss in your bitcoin holdings. If you are worried about Bitcoin or any other coin you own falling, you could short the futures market for that coin. If the futures contract goes against you, it is closed, and the profits from the longer-term holding offset the losses from the futures trade. While you lost a bit on the futures position, the risk management aspect worked fine, offsetting potential problems.
For example, in highly volatile markets, options and futures may not provide the expected protection due to extreme price movements. For example, if you hold bitcoin and want to hedge against price decreases, you would open a short (sell) position on the bitcoin CFD. The profit you make on the CFD position should offset the loss incurred on your Bitcoin holdings if the price decreases. Futures are legally binding contracts that require both buyers and sellers to respectively purchase and deliver the underlying assets according to the terms. As for options, the buyer has the right to buy (call option) or sell (put option) the underlying asset, and it is not a must for the buyer to exercise the right. This is a particularly important feature for hedgers, who need to be able to protect themselves against declining assets.
CFDs are complex instruments and come with a high risk of losing money rapidly due to leverage. You should consider whether you understand how this product works, and whether you can afford to take the high risk of losing your money. Options are a type of derivative contract that give buyers the opportunity to buy or sell an asset at a set price. For those who are long on a crypto portfolio, put options can be an effective way to hedge risk. Put options offer the right to sell an asset at a determined price in a determined time frame. This allows investors to protect their portfolio by going short in case of a downswing in the market.
An in-depth guide to hedging against crypto risks.
Even if you do find a willing lender, they are able to recall their asset at any time – this could mean you would have to buy the coins back for a much higher market price. Having a diversified portfolio can be the simplest, fool-proof way for traders to minimize losses in the cryptocurrency market. Diversification refers to purchasing various crypto assets instead of investing all funds into one cryptocurrency. Finally, hedging strategies can be complex and require a deep understanding of financial markets, especially those with leverage. A CFD is a derivative product that allows you to speculate on the price movements of an underlying asset without actually owning the asset. You usually enter into a contract with a broker to exchange the difference in the price of the asset from the time the contract is opened to when it’s closed.
Moreover, selecting the right crypto projects to invest in is a crucial part of managing risk. Similarly, for those who trade assets, it is important to distinguish the proportion of a portfolio that can actively be used for trading. Many tools also offer ways to analyze on-chain activity such as whale accumulation and funding rates. Other types of technical analysis include finding the “fair value” of assets. It can also be useful to analyze the overall picture of the market from a macro perspective as there are so many factors that can influence the market.
Beginner’s Guide: How to Hedge Your Crypto Portfolio
Exiting the market too early could mean missing out on huge gains if prices continue to climb. That’s where the popular “Dollar Cost Average” (DCA) strategy comes into play. DCA involves incrementally buying or selling an asset rather than deploying capital in one purchase or selling the entirety of one’s holdings. Perpetual swaps work almost precisely like futures contracts, with the main difference being that there is no expiry. They offer the exact contract sizes and leverage, allowing the trader to take advantage of more prominent positions than their account would typically support as futures do.
The investor is then protected from any losses due to a decrease in the asset’s value. For example, if you use futures contracts to hedge against a price drop and the price rises instead, your gains will be capped at the futures contract price. Crypto options give the holder the right, but not the obligation, to buy (call option) or sell (put option) the underlying cryptocurrency at a set price within a specific time period. If you hold bitcoin and worry about a price drop, you can buy a put option.
Regulatory risk
Short-selling bitcoin is a common hedge against a long exposure, whether this is a bitcoin holding or a speculative trade. If you already own bitcoin, but believe it is due to fall in the short term, you might decide to reduce your exposure by opening a short position on the cryptocurrency at the same time. This way, if the market falls, you can cover some of the loss to your initial position with gains on your short position. For example, if you anticipate a potential price decline in bitcoin, you can open a short position on the Bitcoin perpetual swap contract. If the price of bitcoin falls, the gains on the perpetual swap contract should offset the losses in your bitcoin holdings. Let’s say you sell a futures contract for 0.2 BTC, agreeing to sell Bitcoin at $50,000 in one month.
Meanwhile, liquid staking through projects such as Lido Finance offers a way to earn yield through tokens representing staked assets. If the asset decreases in price, staking allows the holder to continue earning interest on the asset. PrimeXBT Trading Services LLC is incorporated in St. Vincent and the Grenadines as an operating subsidiary within the PrimeXBT group of companies. PrimeXBT Trading Services LLC is not required to hold any financial services license or authorization in St. Vincent and the Grenadines to offer its products and services. Let’s say you own $10,000 worth of BTC and you want to hedge against a possible decrease in its price. Each of these strategies comes with its own risks and costs, so it’s important to understand these before proceeding.
You can practice risk management using CFD markets in almost any amount you need. Specific strategies can then be developed to address each type of risk such as setting stop losses or taking profits when appropriate. As the market direction changes, the initial profitable position may turn negative. On the other hand, the secondary position taken during hedging will produce a profit, covering part of the losses from the initial position.
Futures are a type of financial contract in which two parties agree to trade an asset, in this case bitcoin, at a predefined price on a specific date in the future. Bitcoin futures are seen as providing a legitimate way for market participants to lock in a market price. This helps you to reduce the average cost of your shares, balancing out market fluctuations over time.
While the hedging strategy on a trade can limit losses, it will often also limit gains. This is because the two trades will work against each other, at least temporarily. The trader will then get rid of the second position as soon as the primary one starts to work in their favor again. For example, let’s say you borrowed a bitcoin to short-sell when the market price was $10,000. You would have to buy the bitcoin back at the higher market price and would have taken a $2000 loss.