Defensive Weapons in the crypto market: Seven Hedging Strategies to Lock in Profits

In the highly volatile Crypto Assets market, knowing how to hedge risks is like buying yourself “insurance”. Whether you hold Bitcoin, Ethereum, or other digital assets, learning the skill of hedging can protect your hard-earned money when the market falls.

What is Hedging? Understanding Financial Concepts through Everyday Examples

Hedging is, in simple terms, the art of risk management. Imagine you bought a house in an area prone to flooding; just in case, you would insure the house. The principle of hedging in the Crypto Assets market is the same—by investing in an asset that moves in the opposite direction to offset potential losses in the main asset.

In traditional financial markets and the crypto assets field, the logic of hedging is consistent: you hold a position in one asset while establishing an opposing position in related instruments, so that when the main asset falls, the gains from the hedging position can offset your losses. It sounds complicated, but the core idea is quite simple – to use one hand to protect the investment of the other hand.

How Hedging Works: Three Core Steps

Step 1: Lock in your core holdings

Whether you directly hold digital assets such as Bitcoin or Ether, or gain price exposure through derivatives, you first need to have a clear position. This is the starting point for hedging.

Step 2: Identify potential risk points

Next, calmly ask yourself: what risks does my position face? Taking Bitcoin as an example, the most direct risk is a price fall. You need to accurately assess the nature of this risk and the possible range of its impact.

Step 3: Establish a reverse position to hedge against risk

Once the risk is identified, action should be taken. By opening a position in the opposite direction, this reverse position can profit when the main asset price falls, thereby offsetting the losses of the main position.

This sounds ideal, but in reality, achieving perfect hedging is very difficult. Moreover, any hedging strategy comes with a cost, so before proceeding, it is necessary to calculate whether this “insurance premium” is worth it.

Seven Major Tools for Hedging in the Crypto Market

Futures Contract: Lock in Future Prices in Advance

Futures are the most common hedging tools in crypto trading. You can set a future date and price on the futures market to “book” your asset price in advance.

Practical Operation: Suppose you hold Bitcoin and suddenly worry that the price will fall. You can sell a contract in the futures market, agreeing to sell Bitcoin at the current price at a certain time in the future. If the price indeed drops, this futures contract will generate profits to offset your losses in the spot position. Conversely, if the price rises, you will miss out on profits because you are locked in at the lower price.

Option Contract: Buy Call Option, No Obligation to Buy

Options give you more flexible choices. Buying a put option means you have the right (but not the obligation) to sell an asset at an agreed price. It's like buying a “exit insurance.”

Practical Application: If you hold Bitcoin, you can purchase put options and set a “stop-loss price.” Once Bitcoin falls below this price, you can sell at the price agreed upon in the option, limiting your losses. Of course, this right comes at a cost—you need to pay the option premium.

Contract for Difference (CFD): Hedging without actually holding the asset

CFD is a derivative that allows you to bet on price movements without owning the underlying asset. If you are bearish on Bitcoin, you can open a short position in the CFD market, and your profits will increase as the price of Bitcoin falls.

Risk Warning: Although CFDs offer flexibility, they involve leveraged trading, which carries higher risks.

Perpetual Contract: A 24/7 Hedging Tool

Perpetual contracts are a unique product in the crypto market. They have no expiration date, allowing you to hold positions continuously, and they support leveraged trading. If you expect Bitcoin to fall, you can open a short position in a perpetual contract and profit when the price actually drops.

The advantage of this type of contract is that liquidity is usually strong, and trading is also very convenient. The downside is that leverage amplifies risk.

Short Selling: Borrowing coins from the exchange to sell.

Some platforms allow you to borrow Crypto Assets, sell them immediately, and buy them back to return to the exchange after the price falls. The difference is your profit. This method is useful for Hedging positions — if you are concerned about the depreciation of your holdings, you can hedge by shorting part of your position.

Stablecoin: The simplest and most straightforward hedging method

When you feel that the market risk is too high, the most direct method is to convert part of the fluctuating assets into stablecoins. The price of stablecoins is usually pegged to fiat currency and generally does not fluctuate.

Hedging: While this method is simple, the cost is that you will miss out on the opportunity for market gains. However, sometimes that is precisely what you want - in an uncertain market, preserving your principal is wiser than betting on profits.

Portfolio Diversification: Don't put all your eggs in one basket.

Holding multiple Crypto Assets is in itself a form of Hedging. Different coins perform differently in the market. When Bitcoin falls, some other coins may remain stable or even rise, thus balancing the risk of the entire investment portfolio.

Practical Case: How to Hedge a Bitcoin Position

Let's take a concrete example to see how hedging works.

Assuming you currently hold Bitcoin worth $10,000. The current price of Bitcoin is $50,000 each, so you own 0.2 BTC. You start to worry that the price may fall in the short term, but you do not want to sell the asset directly.

Option 1: Purchase Put Options

You purchase a put option in the market, setting the strike price at $50,000. You pay a premium of $500 (the actual cost depends on market conditions).

Now, if the price of Bitcoin falls to $40,000, you can exercise the option to sell your Bitcoin at $50,000. Although you missed the depreciation from $50,000 to $40,000, you locked in your loss and only paid a “premium” of $500. Your net loss is $500.

Plan Two: Sell Futures Contracts

Alternatively, you can choose to sell a contract for 0.2 Bitcoin in the futures market, agreeing to settle at a price of $50,000 one month later.

If Bitcoin really falls to $40,000 in a month, you will sell at the agreed contract price of $50,000, offsetting the decline in your spot position. But the cost is that if Bitcoin rises to $60,000, you are still locked in at $50,000, missing out on a $10,000 increase.

The Costs and Risks Behind Hedging

Cost Issues

Hedging is not a free lunch. Purchasing options requires paying option fees, which will not be refunded regardless of market fluctuations. Futures contracts may incur handling fees and financing costs. These costs will directly erode your profits.

Profit Cap

When you use hedging tools, you often exchange potential large profits for small stable returns. If the market moves in an unexpected direction, it can be difficult to make a profit.

counterparty risk

Especially when using over-the-counter derivatives or certain stablecoins, the safety of the counterparty's (such as the stablecoin issuer's) funds is an issue. Once the counterparty defaults or is unable to fulfill commitments, your hedging will become ineffective.

liquidity risk

Some hedging tools may not trade when the market is quiet, or there may be significant price gaps. When you urgently need to liquidate, you may not be able to execute at your desired price.

regulatory changes

Regulation of crypto derivatives is still evolving around the world, with significant differences in rules across different jurisdictions. Policy changes may suddenly restrict or prohibit certain hedging tools.

execution risk

Hedging strategies may fail due to extreme market fluctuations. In extreme situations, the protective effect of options and futures may be far below expectations.

Strategy Complexity

Hedging involves a considerable amount of mathematical and financial knowledge. Any design or execution errors may lead to significant losses.

Five Tips for Hedging Beginners

Step 1: Clarify the risks before taking action

Before taking any hedging actions, it is essential to deeply understand the specific risks you face. What is threatening your investment? How significant are the risks? How well do different hedging tools protect against these risks? These questions must be thoroughly considered.

Step 2: Don't put all your bets on one asset.

Diversified allocation itself is a form of protection. By spreading investments across different crypto assets and other asset classes, it naturally reduces the impact of fluctuations in a single asset on the overall portfolio.

Step 3: Don't be greedy with complex strategies

Beginners often make the mistake of wanting to achieve success quickly by applying those complex hedging strategies that sound impressive. Little do they know that complex strategies often bring complex risks. If you are just starting out, simple and direct hedging methods (such as partially converting to stablecoins or buying put options) are sufficient.

Step 4: Regular monitoring and adjustments

The market is changing, and your risk exposure is also changing. You can't just set a hedge and forget about it. Regularly check market trends and adjust your hedging ratios and strategies based on new conditions.

Step 5: Use stop-loss orders and risk tools

In addition to hedging, there are other risk management tools such as stop-loss orders. By using a combination of various risk management methods, a stronger defense can be built.

Summary: Hedging is a necessary skill, but caution is also required.

Hedging in the crypto market is a double-edged sword. When done right, it can protect your investments when risks arise, but if done poorly, it can exacerbate losses. The key is to understand the costs, risks, and limitations behind each hedging tool.

Before executing any hedging strategy, it is essential to:

• Understand details such as marginal rates, commissions, and leverage options
• Understand the specific impact of related risks and costs
• Continuously monitor market fluctuations and adjust positions in a timely manner.
• Use stop-loss and other risk management tools for multiple protection

If you are unsure, it is best to consult a professional financial advisor first. After all, a wrong hedging decision could result in a loss greater than not hedging at all.

Important Risk Disclaimer: This article is for reference and educational purposes only and does not constitute any investment advice. The prices of digital assets are highly volatile, and investments may lead to a loss of principal. Any trading decisions should be based on your independent judgment and risk tolerance. Please consult a professional and fully understand the associated risks before engaging in any trading.