The cryptocurrency market has been bearish over the past few weeks, while trading volumes have plummeted since the beginning of the year. The cryptocurrency space is experiencing a bull run currently, and while many believe the cycle is likely to last at least a few months, the market’s future direction is unpredictable.
During a market downturn, when prices are falling, investors may be tempted to sell or ignore risk management strategies, significantly impacting their portfolios.
Crypto’s “HODL” mentality, which advocates holding and not selling all investments, might be the best strategy for everyone. This article is aimed at those who want to succeed in the crypto market. Several strategies can be used to hedge portfolios.
Strategies to Help You Hedge Your Crypto Portfolio
1. Dollar Cost Averaging
Perhaps the simplest way to manage risk in the market is simply taking profits. However, there is a risk in selling. Exiting the market too early could mean missing out on huge gains if prices climb. The popular “Dollar Cost Average” (DCA) strategy comes into play. DCA involves incrementally buying or selling an asset rather than deploying capital in one purchase or selling the entirety of one’s holdings. DCA is particularly useful in volatile markets like crypto.
DCA helps manage price action uncertainty; it’s useful for deciding when to sell. Rather than attempting to identify the top of the bull market, one can simply sell in increments as the market rises.
Many successful traders implement the strategy in one form or another. Some use DCA to buy crypto with a portion of their paycheck every month, while others may make purchases daily or weekly. Centralised exchanges like Coinbase offer tools to employ a DCA strategy automatically.
Historically, crypto bear markets have offered the best times to accumulate assets. Bull markets, meanwhile, have offered the best times to sell. DCA is, therefore, best utilised when the cyclical nature of the market is factored in.
2. Buying Options
Options are a derivative contract that allows buyers to buy or sell an asset at a set price. For those long on a crypto portfolio, put options can be an effective way to hedge risk. Put options offer the right to sell an asset at a determined price in a determined time frame. This allows investors to protect their portfolios by going short in case of a downswing in the market.
Conversely, call options offer an opportunity to buy an asset at a set price in the future and are effectively a type of long bet. If an investor takes profits early in case of a downturn, holding call options can allow them to buy back in at a certain price if they believe that the market will likely rally in the future. Options are complex products recommended for advanced traders and investors, but they can yield lucrative returns for users.
3. Yield Farming and Staking
The advent of DeFi and stablecoins has offered a way for investors to earn yield on their portfolios. Holding a portion of one’s holdings in stablecoins offers a way to capture the lucrative yield farming opportunities while reducing exposure to market volatility. DeFi protocols such as Anchor and Curve Finance offer double-digit yields. At the same time, the rates offered in other newer liquidity pools can be significantly higher (newer yield farms are also considered riskier).
Staking crypto tokens is another effective method of generating passive income. As staked assets appreciate at a price, so do yield returns. Meanwhile, liquid staking through projects such as Lido Finance offers a way to earn yield through tokens representing staked assets. If the asset decreases in price, staking allows the holder to continue earning interest on the asset.
4. On-chain and Technical Analysis
While trading and technical analysis require a level of knowledge and skill, learning the basics can be useful for those, who are looking to get an edge in the market. That’s not to say that one needs to buy expensive trading courses or spend time making short-term trades. However, it can be useful to know a few key indicators, such as moving averages, to inform decisions about when to take profits.
Many tools also offer ways to analyse on-chain activity, such as whale accumulation and funding rates. Other types of technical analysis include finding the “fair value” of assets. It can also be useful to analyse the overall picture of the market from a macro perspective as there are so many factors that can influence the market. For example, ahead of crypto’s Black Thursday event, Coronavirus’s fears indicated that markets could be preparing for a major selloff.
5. Storing Assets and DeFi Cover
One of the most important aspects of protecting crypto relates to storage. It’s crucial to use the right kind of wallet and safeguard private keys. Cold wallets such as hardware wallets are recommended for significant portions of funds, while hot wallets such as MetaMask are generally not considered the best place to store crypto.
While investors often lock assets such as ETH in smart contracts to leverage DeFi opportunities, there are ways to get protection against hacks and other risks. Projects such as Nexus Mutual, which resembles insurance for DeFi, offer ways to hedge risk on crypto portfolios by selling cover against exchange hacks or smart contract bugs.
6. Portfolio Construction
Portfolio construction is another important aspect of managing risk, and choosing what assets to buy and at what quantities can have a great impact on the overall risk level of a portfolio. It’s important to consider the amount invested in crypto relative to other assets and savings accounts. Moreover, selecting the right crypto projects to invest in is a crucial part of managing risk. Similarly, for those who trade assets, it is important to distinguish the proportion of a portfolio that can actively be used for trading.
As a general rule, it is worth considering the market capitalisation of each asset in a portfolio. While major cryptocurrencies like Bitcoin and Ethereum are volatile, they are considered less risky than many lower cap projects as they are more liquid and benefit from the Lindy effect. However, projects with lower market caps can also yield greater returns. Portfolio construction ultimately depends on the risk appetite, financial goals, and time horizons of each individual. The historical data shows that investing in larger cap projects can be profitable for a long time horizon.
Portfolio allocation also pertains to different types of assets. This year’s NFT explosion has yielded great returns for many collectors who participated in the market, but NFTs are less liquid than most other crypto tokens. NFTs are not interchangeable, whereas assets like Bitcoin and Ethereum trade at almost the same price across every exchange. This can also make it harder to find a buyer at a set price when interest in the market dries up. As NFTs are an emergent technology in a nascent space, investing in them is still very risky.
Crypto investing can offer huge returns. Historically, crypto has offered outsized upside potential unmatched by any other asset in the world. Fundamentally, though, more potential reward comes with more risk. Employing a variety of hedging strategies can help minimise the risk and increase the rewards the space offers.