How to hedge risks when investing in Bitcoin

Cryptocurrencies are high-risks Investments, even if we are talking about the largest and most stable ones, like Bitcoin. While investing in crypto offers huge potential profit, there is a very real risk of losses up to the complete loss of all funds invested. So tools that help minimize the risks are extremely important for any reasonable Bitcoin investor. So let’s talk about how you can hedge your risks when investing in Bitcoin

The concept of hedging

The basic idea of hedging is “not to keep all eggs in one basket”. A lot of different approaches are tucked under this umbrella term – from investing in multiple assets to opening market positions in different directions. We’ll briefly talk about the former approach, as it is much more straightforward, and cover the latter in more detail.

Investing in different assets


Investing your capital in different assets is the very basic advice for any beginner investors. While it is undoubtedly the correct advice, there are some pitfalls you have to keep in mind while investing in Bitcoin.

It is worth remembering that in most cases altcoins follow the Bitcoin price movements. Let’s say if you invest half of your capital in Bitcoin and half – in other crypto assets, and Bitcoin price falls – other assets that you invested in will also fall. Thus, you can’t hedge risks of investing in Bitcoin by investing in other cryptos. Bitcoin is a hedging instrument for other digital coins, but not the other way around.

So if you invest in Bitcoin and want to hedge your risks – the other part of your capital should be invested in assets not related to crypto at all (shares, currencies, metals, indices, etc.). Even investing half of your free money into Bitcoin and leaving the other 50% idle in dollars can be seen as a very simple way to hedge the risks albeit far from perfect.

Hedging on exchanges

The basic idea is simple: if you are not sure about short-term Bitcoin prospects, you open a position for an amount equal to your investment, but in the opposite direction.

Let’s say you buy 1 BTC for $48,000, but the market doesn’t show a clear upward trend, so you are not sure whether to expect further growth. So you open a short position to sell 1 BTC at the price of $48,000, using derivatives like futures and perpetual contracts, or using margin trading.

If Bitcoin drops to $40,000, you’ll lose $8,000 on the first position but gain $8,000 on the second one. So your losses will be only equal to trading fees.

Then it’s time to make decision and pick one of the options:

  1. Lock in the short position, get your $8,000 profit and continue to hold the long position. It is a great solution if Bitcoin starts growing again, but if the fall continues, you lose funds.
  2. Leave the short position open and close it only when there is a clear upward trend.
  3. Close the short position with a profit and open a new short position at $40,000. The amount, for hedging purposes will be the same in BTC, but different in dollars equivalent.

Hedging Bitcoin via exchangers

Not only full-fledged exchanges can be used for hedging risks. Ordinary crypto exchangers that allow you to sell or buy Bitcoin for fiat currencies and even wallets with similar built-in capabilities also can be used for that purpose. Moreover, you can sometimes fix additional profits if  Bitcoin grows.

The thing is that some exchangers, due to price differences between market makers, can offer rates slightly higher than the market average. Usually the margin isn’t huge – 5-10% and it doesn’t happen with reliable regularity on any given platform, but it does happen and is worth watching for.

So let’s say the average BTC price is $48,000, but you spotted an exchanger that allows you to sell BTC at $52,800. You purchase 0,2 BTC for $4,800 and store 0,1 BTC in your wallet. The other 0,1 BTC you immediately sell via the exchange service where you spotted a favorable rate for $5,280.

So in the end you purchased 0,1 BTC, 50% of your free money is still free and you earned a nice $480 bonus. Of course, exchange fees will diminish the profit somewhat, but it will still be nice. Moreover, even if BTC drops by 10% – you still will break even. 

Conclusion

There are different ways to hedge your risks while investing in Bitcoin, and every method has its advantages and disadvantages. Relying on other classes of assets can be less than ideal if you don’t understand their respective markets, storing funds in exchange accounts is not safe, exchangers may charge excessive fees, etc.  So pick an option best suited for your specific situation: volumes, style of investments and\or trading, etc. And don’t forget to constantly monitor the situation and consider new options.The crypto market is incredibly dynamic and effective crypto hedging is not a passive process.

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