How can one hedge bitcoin exchange risk?
Adrian As cryptocurrencies continue to gain attention, traders have begun finding ways of protecting their bitcoin holdings from risk. Find out how to hedge bitcoin risk – including three cryptocurrency hedging strategies.
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What are the risks of trading cryptocurrencies?
There are a variety of reasons that cryptocurrencies, such as bitcoin (BTC), are considered risky. These include:
- Lack of regulation. As cryptocurrencies are decentralised, banks and governments have yet to understand how best to protect traders and investors who choose to buy and sell the assets. The decentralised nature of bitcoin has thrilled its supporters, but it could create legal and taxation issues as it grows in popularity
- Susceptibility to hacking. A considerable number of cryptocurrencies are stolen from digital wallets every year. In 2018 alone, it is estimated that $1.7 billion worth of cryptos were stolen and there is rarely a way to retrieve these losses
- Reliance on technology. Bitcoin and other cryptos are completely digital assets, which means that they are essentially worthless without access to technological resources. With gold, real estate or even shares, you are gaining ownership over something that can be exchanged, whereas cryptocurrencies have no collateral backing them up
- Market volatility. Cryptocurrencies are notoriously volatile, both in intraday trading and over longer periods. For example, bitcoin’s price experienced a sharp spike in December 2017, reaching a high of $19,763.50, before falling to a low of $3126.29 in December of the following year
However, for those keen enough to learn, there are ways to reduce the risk you take on, at least to a known amount. This is where risk management tools, such as stop-losses, and strategies, such as hedging come in.
How to hedge bitcoin
Hedging bitcoin, or any cryptocurrency, involves strategically opening trades so that a gain or loss in one position is offset by changes to the value of the other position.
Generally speaking, if you’re concerned about the risk to your position, it is probably safer to reduce your position size or close your position completely. However, hedging is seen as a useful strategy for traders who want to maintain their original bitcoin holding but create a neutral exposure. There are a variety of ways to achieve a cryptocurrency hedge, but three popular methods are:
- Short-selling
- Hedging with CFDs
- Hedging with futures