Trading cryptocurrency is a risky business. So how can you hedge cryptocurrency to protect yourself against that risk? While the cryptocurrency market is growing rapidly, and ways to hedge are continually being developed, everything is so new and untested it’s hard to know the best option.
Hedging is a risk reduction strategy that typically involves taking an offsetting position on one’s primary asset. Hedging provides insurance, reducing the potential for loss. In the stock market, hedging typically involves trading derivatives, like futures or options. These derivatives make up a secondary market that is in its infancy stages in the crypto world.
While we’ll touch on the cryptocurrency derivatives market a bit, I will present three fairly simple strategies for hedging cryptocurrencies. Although they are not the most advanced ways to hedge, they are easy to access for the everyday crypto trader. Let’s get started.
First, let’s talk about diversification.
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Diversification is a common way of mitigating risk in the stock market, but it looks a little bit different in the cryptocurrency market. The stock market extends across a multitude of industries, and therefore it can at times be easier to pick offsetting stocks according to the industries they operate in.
In cryptocurrency, most coins are very volatile and the market generally trends together day to day. The most widely regarded diversification strategy for hedging against too much risk is to build the foundation of your portfolio on the most tenured, reputable coins. Bitcoin, Ethereum, and Ripple generally are the least volatile and can be decent hedges against other riskier coins. Diversification is all about a maintaining healthy mix, so try a few different configurations to see what works best for you.
Second, stay liquid (ie, keep some cash handy) so you are ready.
The second simple tip for hedging cryptocurrencies, is to make an account on an exchange that lets you hold money in fiat currency as well as cryptocurrency. This makes it easy to transfer money in between and not get stuck in a bind if a major crash occurs. This also allows you to quickly take advantage of optimal exchange rates and adjust the proportion of money you have invested. You can also invest in Tether, a cryptocurrency that tracks its value with that of the U.S. dollar, and trade in and out of other coins that way.
Third, use options and/or futures.
Finally, we come to crypto derivatives. Although they involve more capital, more risk, and more advanced trading knowledge, derivatives are the truest forms of hedging. Sites like Bitserve, Hedgy, or Coinapult allow you to hedge cryptocurrencies by buying options or futures contracts. Additionally, the CME group, which controls the largest derivative market in the world, facilitates trading Bitcoin derivatives and will probably add more currencies in the near future.
Before jumping into derivatives trading, do some research about the inherent risks. Although it can be a very smart way to structure your investments, it takes a lot of know how.
Hopefully, we can all trade with less risk now that we have some hedging strategies under our belt. Keep trading away this month, and stay tuned out for more articles and videos to come!