The massive drop in the price of cryptocurrencies like Bitcoin and Ethereum has not gone unnoticed by cryptocurrency investors and non-investors alike. Since the start of 2018, the price of cryptocurrencies has fallen by a whopping 90%.
So far, nobody can really pinpoint one exact reason for what most investors are calling a “correction”. Whatever it might be, fact remains that since December 2017, over 75% of portfolio values have been wiped out. Naturally, this begs the question “Is there anything we can do to protect against such eventualities in the future?“
Drop in Value of Bitcoin and ETH (All time high, and year-to-date)
Protecting against the plunge
What we will try to do in this 3-part blog series is to shed some light on how to weather this storm in crypto. There are ways to secure yourself against the volatility that is inherent in this market. We will share with you ways to soften the blow of crashes in the cryptocurrency market and keep your investment hedged against big losses to some extents.
Here are some of the hedging strategies we will be covering:
Strategy 1: Get out
It is important to understand the importance of cutting your losses and getting out. Nothing is wrong with that. The more critical thing is to be able to time the exit. We will talk about the pros and cons of opting to get out when the waters start getting too choppy.
Strategy 2: Derivatives as a hedging tool
Derivatives ‘Put’ and ‘Call’ options as they are also known as are a great way to hedge your investments in traditional financial assets as well as your crypto assets. We will talk in detail about the benefits and challenges of opting to purchase options as a safeguard against sudden dips in price.
Strategy 3: Trade & Try
This is one of the most favored strategies of retail investors. It might feel like a supercharged adrenaline ride, with results that are just as extreme. This is perhaps one of the most misunderstood options as a hedge.
Strategy 4: Deploy your crypto assets to earn passive income
When you really think about it, putting your assets to work and earning passive income off of them seems like a no-brainer. It may well be a no-brainer too. You will find out as we explore this particular strategy in details later.
Price Maker Vs Price Taker
Before exploring the options available for hedging against such a price drop, it is important to understand your role in the world of cryptocurrencies.
If you are a crypto mining tycoon or have the ability to move the market with a Tweet, you are most likely a Price Maker. You have the power to dictate and influence market prices. Obviously, such whales with significant market influences are few and far between and to be typically found mostly in imperfect markets with a monopolistic or oligopolistic structure.
We will highlight some more opportunities to generate revenue for the Price Makers, but that will not be the focus of this particular series of articles.
Barring these select few, most of you are Price Takers. Since you have no real influence on the market, you are forced to accept the market price and do with it the best you can. In the cryptocurrency market, anyone holding small investments of, say Bitcoins or Ethereum, is a Price Taker. As a Price Taker, you watch the price of your favorite coins rise and fall.
The Price Taker is the group that is the main focus of this article and a couple more that will follow.
Everyone is a genius in a bull market
The first thing about hedging and risk management is that it is something that should be high on your mind regardless if it is a bull or bear in the market.
Everyone is a genius in a bull market.
When the prices are going up steadily, jumping in and making money at any point is not that hard. In 2017 and early 2018, when the cryptocurrency market was enjoying a long bull run, we had many people coming to WhaleLend boasting about the performance of their portfolios.
It is because we have a carefully set up risk management system which allowed us to weed out the good, the bad and the ugly of the lot that walked in when it came to their risk management practices.
A great number of these same “expert crypto-algorithmic traders”, “cryptocurrency hedge funders”, and other types of “cryptocurrency financial wizards” had disappeared after the plunge of late 2017 and early 2018.
To survive long term in the market, it is essential to have a risk management plan in place. It helps cushion your investments against unexpected lows and ensures that you are not completely forced out of the market.
Hedging as a Risk Management practice for Price Takers
Any investment worth his or her salt, whether engaged in cryptocurrencies or other financial assets, has a risk management plan. Hedging is an integral part of this plan. After all, the protection of your portfolio is just as important as its appreciation. Risk Management and hedging are all the more important for “Price Takers” since they have virtually no control over the price of their favorite assets. As such, they are a lot more vulnerable to sudden changes in the price of the cryptocurrency they are holding.
Having said that, it is now time to explore some of the choices that you could make to control your risks in the cryptocurrencies market. Remember, hedging is not the only way to safeguard your investments against a bear market. There are other options available to you as well. In the risk management strategies that follow, some will involve hedging and some will not.
Stay tuned for part 2!