**What is a Hedging Strategy?** According to Investopedia, hedging is an investment made to reduce the risk of adverse price movements of an asset. Hedging strategies allow traders to use more than one bet simultaneously in opposite directions to minimize the risk of heavy losses. Hedging has long been a financial market strategy, as a form of risk management technique for crypto traders. Hedging allows you to maintain steady value for your investments (even without generating significant returns) during unexpected market conditions. While crypto hedging protects your assets from adverse market changes, while limiting the potential return you get from your crypto investment. However, for risk-averse crypto traders, this is a better option than losing all their assets due to adverse price movements in the crypto market. **Highly Volatile Cryptocurrencies** Since cryptocurrencies are highly volatile, sudden and dramatic price movements often occur when market sentiment changes. The value of cryptocurrencies often fluctuates rapidly, hundreds or even thousands of dollars at a time. In January 2021, the price of Dogecoin increased more than 800% in 24 hours and fell more than 500% the next day. **They Are Unregulated** Neither government nor central banks regulate cryptocurrencies. Although governments and financial institutions are starting to take notice, there is still uncertainty over issues such as whether they should be classified as commodities or virtual currencies. The lack of regulations limits the protection of sellers and buyers, leaving investors to rely on developments, individuals and personal experience when making investment decisions. **Trading Risk** Communication errors and delays in trading trader orders can lead to huge losses for crypto traders. Therefore, it is important to choose an exchange that can handle high volumes of transactions per second (TPS). For example, Bybit is leading the crypto industry by processing up to 100,000 TPS. Bybit also provides reliable methods for crypto traders. **Leverage Risk** With low margin and collateral deposits, traders can enjoy high leverage. Traders should be cautious about actively using leverage, which can increase losses under unfavorable conditions. After we’ve covered the downsides of cryptocurrencies, let’s dive into crypto hedging. **Golden Rules for Hedging** If you are too worried about the risk to your position, a full close or downsize is a safer option. But hedging can be a useful strategy if you want to maintain your crypto holdings and create a level of neutrality. Here are some principles you should keep in mind before applying a hedging strategy: 1. Opposing positions: A very simple rule. A trader must enter a position opposite to the current one. For example, if you predict an increase in the price of a cryptocurrency, you should enter a long position. 2. Liquidity Assessment: Traders and investors look closely at the liquidity of new assets to determine the integrity, speed of transactions, and market fluidity. Based on this assessment, traders exchange their assets for cash quickly without excessive slippage. 3. Diversification: It’s an open secret, diversification is one of the best money management techniques for traders and investors. You can open multiple positions in Bitcoin (BTC), Ethereum (ETH), Chainlink (LINK) and many other tokens to create a diversified portfolio of derivatives. **So how to prevent the above risks?** **1. Short Selling** Short selling means taking a position to sell an asset when a trader believes an investment will decrease in value. As a trader it may be desirable to make a profit by buying back at a lower price – or profiting from the difference. Short selling crypto protects against long exposure. According to Investopedia, **shorting** allows investors to hedge against the downside risk of a long position in the same or a related security. Selling often adds complexity to crypto. Therefore, be careful with this tactic, whether you are selling crypto for hedging or speculation. You can sell cryptocurrencies in a variety of ways, including: * Margin trading, where you can borrow from a broker to execute trades. Exchanges that allow margin trading also offer leverage, which can increase potential profits or losses. * Traditional short selling, where you borrow from a broker, credit platform or third party, then sell crypto and buy it back at a better price. **The Downside of Selling** The potential for loss is limitless when shorting. You can witness a cryptocurrency that can fluctuate to the price of 0 USD, resulting in total loss. So, to avoid a catastrophic loss, a trader would set a stop loss limit on his or her initial investment. **2. Futures Contract** In finance, the term futures contract refers to an agreement to sell or buy an asset at a specific date in the future for a certain price. Since it has its own secondary market, futures contracts can be sold before the agreed date. This increases the liquidity of investors and business owners. Futures contracts are part of a large category of trading instruments known as derivatives, including *Contracts for Difference* (CFDs), *Options* and *Swaps.* Money Futures Contracts Electronics work according to a similar concept. Due to the volatility of cryptocurrencies, most traders buy when prices are low and sell when prices are high. However, such trading can cause investors to miss out on potential profits. Cryptocurrency futures contracts allow you to stay open, thus maximizing the return on your crypto investments. Today, CME offers a number of Bitcoin futures contracts with different expiration dates, such as in the Bitcoin Futures Calendar. All contracts are settled in USD on the expiration date. Futures contracts protect your investments or lock in your profits in a volatile market like cryptocurrency. They are ideal for investors who want to hedge their risk in the cryptocurrency market for a reasonable period of time. **3. Perpetual Swaps** Perpetual Swaps are derivatives that allow you to buy or sell the value of the underlying asset without setting an expiration date for the position you take (you can choose a entry or exit point at any time). Perpetual swaps give you more buying power than spot trades. Thus, they put you in a better position to take advantage of price movements. Perpetual swaps operate on a funding rate mechanism, where you pay a fee or discount to continue to hold your position. Before using perpetual swaps as a hedging strategy, you need to determine your collateral’s funding rate mechanism and potential return. You also need to understand the leverage your chosen exchange allows (derivatives can allow up to 100x leverage). This strategy has quickly gained popularity in the crypto market. This trade allows traders to take advantage of positions with no expiration date. The main difference is that perpetual swaps are traded close to the index price of the underlying asset. Perpetual swaps also charge a funding rate. This encourages traders to buy perpetual swaps when the index price rises. Funding rates are usually designed to ensure price stability. Since they are not based on expiration dates, perpetual contracts go into effect quickly on BitMEX. They will soon be accepted by major crypto exchanges, including Bybit and Binance. **4. Options** Options are another type of derivative in crypto. They give investors the right – but not the obligation – to buy or sell an underlying asset at a specified price or before a certain date. You can use options as a way to protect cryptocurrencies by limiting deep losses in a declining market. A put option increases in value when the underlying asset falls below the option’s strike price, whereas a call option will decrease in value. This results in a large degree of leverage-based risk protection at a lower cost. You can also use options to speculate in the direction of cryptocurrencies. Options such as call or put options. Call options give you the right to buy shares, while put options allow you to sell shares. **Hedging Avoid 100% Risk No?** Hedging does not avoid 100% risk. While investors use hedging to protect themselves from fluctuations in the market, hedging also comes with risk. Hedging does not guarantee the success of your investment, nor does it guarantee that your investments will reduce risk. When choosing a crypto hedging strategy, the best approach is to consider the advantages and disadvantages of hedging for a particular crypto asset. You should also determine if the benefits of the hedging strategy you choose outweigh the costs that come with hedging. In some cases, hedging can backfire, especially when the market remains neutral (while you still have to pay the hedging cost). **Conclusion** Cryptocurrencies are indeed volatile financial instruments and come with certain risks for investors. Cryptocurrency traders should be aware of financial strategies, such as hedging, to minimize potential losses and protect their positions, regardless of market conditions. Hedging protects you from major losses that can be experienced in volatile crypto markets. Another reason why crypto hedging is necessary is because hedging protects your profits in the event of a crash or price correction.
Source: Collector
