What is a ‘Hedge’?
A hedge is an investment to reduce the risk of adverse price movements in an asset. Normally, a hedge consists of taking an offsetting position in a related security, such as a futures contract.
Hedging is the practice of purchasing and holding securities to reduce portfolio risk. These securities are intended to move in a different direction than the rest of the portfolio. They tend to appreciate when other investments decline. A put option on a stock or index is the classic hedging instrument.
The Downside
Every hedge has a cost, so before you decide to use hedging, you must ask yourself if the benefits received from it justify the expense. Remember, the goal of hedging isn’t to make money but to protect from losses. The cost of the hedge – whether it is the cost of an option or lost profits from being on the wrong side of a futures contract – cannot be avoided. This is the price you have to pay to avoid uncertainty.
Hedging volatile Cryptocurrency risk such as Bitcoin
To hedge exposure to anything, you need to establish a correlation between that asset and other assets.
“In the case of cryptocurrencies, this is unrealistic as they do not seem to behave in accordance with financial instruments and they do not respond to conventional market sentiment, environment or theories,” the Peregrine Treasury Solutions analyst said.
Peregrine said that the least complicated and ‘safest’ way to mitigate the risk of selling your cryptocurrency for less than you paid for it is to hedge for fiat money, such as securing a firm US dollar price per Bitcoin in the forward or derivative market.
“Options, for instance, will give you the opportunity to hedge your risk, but not be forced to sell the cryptocurrency should the cryptocurrency market move in your favour,” Bianca Botes, corporate treasury management at Peregrine said.
(Extract from Business Tech Staff Writer report, “Hedging the risk of cryptocurrencies like bitcoin and ethereum“.)
__________________________________________________________________
The U.S Commodity Futures Trading commission (CFTC) has given permission to a private company LedgerX to exchange and clear any number of cryptocurrency derivatives.
The New York-based startup was granted a rare derivatives clearing organization (DCO) license allowing it to clear and custody financial instruments backed by bitcoin, ether and any number of blockchain-based cryptocurrencies.
As part of the DCO license, LedgerX will be required to surveil the institutional investors it works with and create increased transparency about those customers for the regulatory agency. Eligible participants include broker dealers, banks, futures commission merchants, qualified commodity pools and qualified high net worth investors.
On 01 December 2017, the U.S. Commodity Futures Trading Commission (CFTC) said it would allow CME Group Inc and CBOE Global Markets Inc to list bitcoin futures contracts, opening the door to added regulation and more mainstream adoption of the cryptocurrency. This announcement paves the way for CME and CBOE to become the first traditional U.S. regulated exchanges where bitcoin-related financial contracts can trade.
To guard against volatility, CME and CBOE will enact stricter-than-usual risk-management safeguards, including initial margin requirements of 35 percent to 40 percent.
The bitcoin underlying the futures contracts will still be traded on lightly regulated over-the-counter markets. Still, putting futures contracts on highly scrutinized U.S. exchanges could convince other regulators to allow more cryptocurrency-derived products such as exchange-traded funds.
That move would give Bitcoin a level of credibility that established currencies have, and also provide an infrastructure for developing exchange-traded funds (ETF).
For those who are, firstly, open to a bit more complexity and, secondly, understand cryptocurrency, there are various crypto derivative platforms where you can trade derivatives engineered for the crypto market such as Deribit, Bitmex, or Coinapult.
___________________________________________________________________
Mike Novogratz—a former manager at the hedge fund Fortress Investment Group who says he has 10% of his net worth in cryptocoins—recently estimated it would be six to eight months before investment firms start to offer cryptocurrency products, like ETFs, to their clients. When they do, he added, it will make the buying process easier, allowing for the price “to go much higher.”
___________________________________________________________________
While waiting for offering of cryptocurrency ETFs to happen, do retail investors, have the means to hedge volatile cryptocurrency risk?
Many cryptocurrencies are like commodities, since there’s a finite supply, like with gold or oil. Volatility is increased by the fact that the overall cryptocurrency market is still tiny. All this trading and speculation is happening in a field where the total market cap is currently only about $300 billion USD. (Apple alone has a market cap of about $900 billion USD.)
They could consider Hedging Through Diversification. Strategically diversifying a portfolio to reduce certain risks can also be considered a—rather crude—hedge.
If you have the confidence of your selected pairs, find a cryptocurrency exchange that has your preferred cryptocurrencies listed and has the most traded volume. Why does that even matter?
1) Most volume implies the tightest spread. In other words, the difference between the buying and selling prices is likely lowest on the exchange. The wider the spread, the further price has to travel in a trader’s favour to put them into profitable territory.
2) Most volume also implies best liquidity. In other words, you could trade a large number of bitcoins (BTC) on the exchange without pushing the price away from you.
The Last Words on the above
John Maher, an advisor and CIO at CCR Wealth Management often responds to those who want to take a cryptocurrency stake by offering the thoughts of Mark Cuban. If you want to invest in it, Cuban said, then “pretend you’ve already lost your money.”
If you can stomach that kind of risk, you can handle trading in this market.
____________________________________________________________
If you would like to know whether you are ready for it, please read my recent post on “5 Tips To Trade Bitcoin Or Volatile Cryptocurrency”
For cryptocurrency starter, you may like to consider opening an account with Coinbase, a secure online platform for buying, selling, transferring, and storing digital currency.
Note:- If you buys or sells US$100 of digital currency or more through Coinbase using this link, you and your referral will both get US$10 worth of free bitcoin.
Disclaimer: This article should not be taken as, and is not intended to provide, investment advice. Please conduct your own thorough research before investing in any cryptocurrency.
If you’ve any comments, please drop me a line.
Thank you for dropping by.
Reuben Ong