Stakero Blog

What are the ways to hedge a crypto portfolio?


Basic points

— Investing in crypto assets carries risks due to volatility.
— Different ways of hedging risks reduce the likelihood of losses in crypto investments.
— Asset allocation, yield farming, proper token storage, and a few other tactics lower crypto investment risks.

Crypto investors can use several strategies to lessen the risks connected with digital assets.


A Manual of Cryptocurrency Risk Hedging

The high profitability of the cryptocurrency market also has a downside — it is a big risk. The volatility of coins is several times higher than the volatility of traditional assets pairs. Therefore, let’s face it, investing in cryptocurrencies is not for the faint of heart.

Most of the top digital coins have made good price advancements in recent years, however, there have been periods of decline. If such circumstances arise, investors on a long-term strategy wait out an unfavorable time, suggesting a temporary nature of the price decline.

But active investors are implementing special measures that protect the crypto portfolio and increase its profitability. The method of just waiting out the decline is not suitable for everyone and not in all situations. There are several tactics to preserve and increase capital on downtrends.


Dollar-Cost Averaging

It is very difficult to find the best time to exit and make a profit, as well as to buy an asset. In the strategy, the average dollar cost purchase occurs regardless of the price of the asset at regular intervals. This strategy eliminates much of the detailed work involved in trying to set the market time to buy stocks at the best prices.

Averaging the dollar value can be used in the long term to protect a crypto portfolio and accumulate money or assets. It is also an investor’s way of neutralizing short-term volatility.
DCA reduces the overall impact of volatility on the price of a target asset. Since the price is likely to change each time one of the recurring investments is made, investments are less prone to volatility.

A key benefit of dollar-cost averaging is that it reduces the impact of investor psychology and market conditions on his portfolio. By adopting this approach, investors avoid the risk of making counterproductive decisions out of greed or fear.


Locking Assets for Yield Farming and Staking

Decentralized finance has significantly transformed the cryptocurrency market. Traders are interested in this segment as a promising infrastructure scheme within the crypto-industry. Also it gives an opportunity to benefit from the dynamic movements of tokens, as well as protection of investments from volatility through the use of stablecoins. From the beginning, the DeFi segment has been a favorite with investors as decentralized finance gives them more control over their money.

The investor includes in his portfolio the most promising, undervalued and non-overlapping DeFi projects. This eliminates the risk of a severe drawdown in the portfolio due to only one asset. You can determine promising tokens by the ratio of market cap to the total value of locked funds.

Tokens with a minimum ratio of these indicators can be considered undervalued. This means that there are reasons to expect assets will at some point catch up with others in their valuation and grow. Therefore, by buying such cryptocurrencies, a trader stabilizes his portfolio in the medium and long term.

You can also reduce the risk of capital drawdown with staking tokens. The cryptocurrencies of some DeFi projects make it possible to make money just on storage. To protect your portfolio from large fluctuations, you can invest in stablecoins with staking options.

Thus, passive income from tokens can both increase the overall return on investments in the DeFi sector and smooth out possible losses in case of a market drawdown. Moreover, a financier can limit his losses to the amount of possible staking reward. As soon as the losses on positions reach the value of the profit from staking, the investor simply closes them.


Analyze by Yourself

There are a lot of information sources about digital assets today, so everyone can find whatever they want to learn about the topic. Almost every cryptocurrency exchange has a chat room where traders share their opinions and predictions. Also, there are many blogs, forums and other platforms dedicated to cryptocurrency trading and investing.

On such websites, many users consider themselves an expert. However, it is worth remembering that the advice for managing your money gives someone else, who will not lose if something goes wrong. The worst way to invest in cryptocurrency is based on someone’s advice and guidance.

Your task, as an investor, is to independently analyze and select information. Yes, it will take a lot of time and effort. But, you don’t need to be lazy and shift the work to somebody. For your cryptocurrency portfolio to bring you profit, you need to use competent information resources and thoroughly understand the objects of your interest.


Store Your Assets Properly and Use DeFi to Shield Them

Safe storage of digital assets is directly related to the risk of losing them. So, to safeguard your coins or tokens, it is worth choosing the most suitable wallet for certain purposes. As you know the one who owns the private keys owns the cryptocurrency. In order for your keys to remain yours, they need to be stored where hackers cannot get them, that is, outside the network.

Cold storage is the most reliable way to store large amounts of cryptocurrency today. These include hardware wallets and physical media such as special cards or plain sheets of paper. Hot wallets are convenient and fast for operations with crypto assets. It is worth transferring tokens from cold to hot wallets only as needed and in the required amount.

Many crypto investors use DeFi to protect their assets by locking smart contracts. Some DeFi projects that act as assets insurance offer cryptocurrency protection against hacks and code mistakes.


Build your Portfolio

Diversification is one of the risk management strategies in portfolio investment. It involves a variety of assets to distribute risks. You probably already know that you should never invest all your money in just one asset. The idea is that the greater the variety of assets, the lower the risks. If you have invested all your money in the only asset, then your portfolio will greatly depend on the dynamics of its rate. It is contrary to the principles of risk reduction.

If the price of the cryptocurrency collapses, your portfolio will fall in value sharply. It is known that money does not appear out of nowhere and does not disappear anywhere. Money simply flows from one market to another. Diversification is based on this mechanic. By adhering to the diversification rules, you will be able to reduce the risks. In the event of a collapse, some positions will bring losses, while other assets will bring you profit.

The selection of assets depends on your risk profile. The more aggressive your profile is, the more high-risk assets will have a share in your portfolio. In case you are a more conservative investor, then Bitcoin will dominate the crypto portfolio. But the picture does not always look like this. Some assets may fall in price more, while some less.

Speaking of diversifying a crypto portfolio, we are talking about not only different coins. The NFT boom in 2021 showed that you should not underestimate the potential of assets that were previously used as technical assets.

The prices of some tokens, for example, from the CryptoPunks collection, reached enormous values in millions of dollars. These tokens bring huge profits to their holders.

Although the liquidity of most NFTs is noticeably less than that of many coins, the popularity burst did its job. It should be borne in mind that if interest in NFT falls, lower liquidity can cause a loss of money. This is why it is so important to diversify investments.


Options and Futures

When it is not clear in which direction the price will move, the best way out is to open an opposite position of an equal amount. Classic trading instruments do not allow you to do this, and for this, you can use derivatives like futures or options.

When using these instruments, you need to calculate the deal so that the short position is equal to the original in size. In case of liquidation of the position, the losses do not exceed the profit by the long.

For example, when you are not sure whether the price of bitcoin will rise or fall, then you open the same position to ensure capital. Simultaneously you open the opposite direction by buying options. In case Bitcoin suddenly falls in price by a certain percentage, you will profit in the same amount from a short position, excluding commissions. Then you can close the short and fix the profit on it, continuing to hold the cryptocurrency and closing the original position. If the cryptocurrency rises, then the short position will bring a loss, which is compensated by the profit on the long. This is how hedging works with options and other derivatives.


Ultimately

Hedging will help neutralize losses or reduce them to a minimum in the event of a collapse in cryptocurrency prices. This method will be useful when the dynamics of rates become uncertain and you want to protect your portfolio from a severe drawdown. To hedge a crypto portfolio, you can use different strategies, the choice of which depends on the investment goals and many other factors.