Gain a hedge with crypto derivatives

The crypto market has witnessed a small bullish with the Bitcoin mining reward halving around the corner. This has not surprised people since similar bullish has nearly took place every time before halving. What makes traders start to worry is that the bullish trend seems coming to an end and the market now goes through ups and downs to probe a new trend. With great uncertainty, it’s time for all crypto traders to set up their hedging strategy to limit potential risk and similar to traditional markets, derivatives market is a good choice. 

What is a Crypto derivative?

A derivative is a contract between two or more parties whose value is based on an agreed-upon underlying financial asset. It is a popular instrument with a great flexibility. It can be used to hedge a position, speculate on the movement or add leverage to your asset. Most of the investment institutions are using derivatives to fulfill their risk management strategy. 

Crypto derivative is an emerging market. To duplicate and optimize the mechanism of financial products such as commodity futures and interest rate swaps, BTC derivatives products now offer three major types: bitcoin Perpetual Swaps, bitcoin Futures Contracts and Options, among which Perpetual Swaps and Futures Contracts are the most common in the market.

Compared to futures contracts, Perpetual Swaps usually has the following advantages:

1. No expiry date and has lesser chance of market pump/dump;
2. Uses the Mark Price, minimizing the impact of short-term volatility and;
3. Funding mechanism limiting price divergence between the spot market and swaps market.

Given those advantages, DueDEX offers Bitcoin Perpetual Swaps to traders.

Hedge with Perpetual Swap? 

Hedging integrates betting in opposite directions to limit the potential risk of a severe loss. Basic strategies of hedging include:

Current Status	Potential Risk	Hedging Strategy
Hold	Price falls	Short
Buy	Price rises	Long
Sell	Price rises	Long

To further illustrate, we will use an example on how to hedge bitcoin risk with perpetual swap. The key idea is short selling Bitcoin on the perpetual swap platform in order to hedge the risk in the spot market. 

If you already own Bitcoin, but you think the price might fall.  Instead of selling what you have, the smarter move would be opening a short position at a Bitcoin perpetual swap platform. In this way, if the market falls, you can cover some of the loss to your initial position with gains on your short position. 

Let’s say you buy one bitcoin in the spot market at the price of bitcoin at 10,000 USD and the proper hedging strategy would be to open a short position with certain leverage applied and worth the same value in the perpetual swaps market. Therefore, if the price of BTC goes up, you will earn profit from the spot trading and if the spot price of BTC goes down, you can take a profit with the short position in the perpetual swaps market. 

As you may notice that by using a hedging strategy, your profit rate will be affected since some of your fund to hedge the risk. It is worth mentioning that hedge your bitcoin risk doesn't mean to maximize your profit. It is the strategy to prevent severe loss from market dump. It isn’t easy to sell a significant amount of bitcoin without spreading market fear. Hence an alternative is to put hedges in place to reduce the overall exposure in a long term.

Summary

It’s essential for a qualified trader to apply hedging strategies to their investment portfolio during the ambiguous Bitcoin halving conditions. Hedging does not mean that there is no risk at all. With proper strategies on both sides, hedging can limit your risk to the lowest possible. You can test your strategy with DueDEX testnet (testnet.duedex.com) and start using the risk management tool only from DueDEX.com.

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