How do I hedge Bitcoin risk?
AnthonyLooking for ways to hedge out your cryptocurrency exposure?
Perfect. As I cover 4 different methods to hedge out your cryptocurrency exposure with a brief section at the end of “why people hedge” to show some of the use cases for this type of strategy.
As I am a fan of TL DR summaries I have created a summary ranking table below (based on my opinion) for you to reference (though I would highly recommend reading the sections you are interested in):
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Selling vs Hedging
Guess the first questions people would ask is why do we need to hedge when we can just sell? This is a good point and the answer can vary depending on what hedge you go for (which I’ll cover in each section) but at a high level comparison:
#1 — Short Selling
The most straightforward method is to short sell the crypto that your are looking to hedge so that you end up with something like this (assuming you want to fully hedge):
All cryptocurrency references below are used only as an example.
#2 — Futures
“Futures are financial contracts obligating the buyer to purchase an asset or the seller to sell an asset, such as a physical commodity or a financial instrument, at a predetermined future date and price.” — from Investopedia.
Just like in traditional finance there are futures in cryptocurrencies which you can use to hedge out your position. Generally the crypto market comes with one of two types of futures:
1) Futures that trade in USD pricing and 2) settle in USD
#3 — Perpetual Swaps
Perpetual swaps (perpetuals) have recently grown in popularity as more and more crypto exchanges have started to offer them. Their use is very similar to that of inverse futures with the main differences being:
- A periodic funding rate (usually 8 hours)
- No expiration date
#4 — Options
Options in cryptocurrency space are still a fairly new and limited. The only exchanges that offer it are currently Deribit and Bitmex. However they have been around in the financial markets for ages and often used for hedging purposes.
Hedging with options can be pretty complicated and there are multiple ways you can build the payoff you want. However below is one of the most straightforward ways to hedge out your downside risk that I know of. It is not the cheapest hedging method, as there could be a version of it where you sell call options etc. to bring down trading costs (in exchange for upside potential), but this method is the easiest to implement. It also gets you started on using options for hedging.