Hedging Applications in the Crypto Assets Market: Seven Practical Hedging Solutions

To survive in the crypto world, Risk Management is more important than making money. Hedging is a compulsory course in this regard. Simply put, it is when you are bearish on a certain coin, you protect your existing assets through reverse operations to prevent total loss. This is not speculation, but insurance.

What is Hedging? A Simple Analogy

Imagine you have a house in a flood-prone area. You wouldn't just sit and wait; instead, you would buy flood insurance. The hedging principle in cryptocurrency is exactly the same—you hold a certain coin but are worried it will drop, so you use other tools to offset that risk.

In traditional financial markets and the crypto world, the logic of hedging is consistent: using one investment to compensate for potential losses of another investment. The key is to find a completely reverse position, so that when the main position declines, the hedging position can make money to fill the gap.

It sounds perfect, but in reality, it's not that simple. Perfect hedging is almost non-existent, and hedging itself costs money. That's why you must carefully weigh the costs and benefits before making any moves.

How to operate hedging? Three core steps

Any hedging strategy follows the same logic:

Step 1: Establish the Main Position You already own some assets—such as Bitcoin or Ethereum. Whether you hold the coins directly or simply have exposure to their prices, this is your “base position”.

Step 2: Identify Risk Points Next, you need to ask yourself: how could this asset harm me? For example, you might be worried that Bitcoin could drop. This risk is what you need to hedge against.

Step 3: Reverse Strike Since you believe Bitcoin will drop, go short in the derivatives market. This way, when it actually drops, the profits from the short position will offset your spot losses. The key here is the goal is not to make money, but to stem the losses. Ideally, the hedging profits completely compensate for the losses in the main position.

But reality is often harsh: constructing a perfect hedge is difficult, and there are costs at every step.

Seven Hedging Weapons in Cryptocurrency

In the crypto world, there are various tools for hedging. Here are the seven most practical methods. Note: Some methods may be illegal in certain regions, so be sure to understand local regulatory requirements.

1. Futures Contract - The Most Direct Hedging Method

Bitcoin futures allow you to lock in a future trading price. Right now it's $50,000, and you can sign a contract agreeing to sell at $50,000 in a month.

Suppose you hold $10,000 worth of Bitcoin and do not want to bet on its long-term direction. Sell a futures contract of 0.2 BTC (worth $10,000) with a settlement of $50,000 one month later.

The moment to make money has arrived: If Bitcoin drops to $40,000, you can buy back that 0.2 BTC at a lower price to complete the delivery, and the profit will compensate for your spot losses.

But the cost also comes: If Bitcoin rises to $60,000, you still have to settle at $50,000, and that increase has nothing to do with you. This is the “cost” of hedging — you give up a portion of the upside gains in exchange for downside protection.

2. Options Contract - A More Flexible Umbrella

Options give you a choice (note, it's a choice, not an obligation): the ability to buy or sell an asset at a certain price.

It's still that $10,000 Bitcoin. You can buy a “put option” that allows you to sell at a price of $50,000 at any time. You pay a premium of $500 for this right.

Critical Moment: When Bitcoin drops to $40,000, you exercise the option to sell at $50,000, locking in the loss. You only incur a premium cost of $500 (equivalent to 0.01 BTC).

Advantages of Futures Comparison: What if Bitcoin rises? With options, you can choose not to exercise them, while holding onto spot to enjoy the increase. However, this flexibility comes at the cost of a premium.

3. Contract for Difference (CFD) — does not require holding actual coins

CFD is a type of derivative that allows you to bet on price changes without actually owning the asset. You sign a contract with a broker, and the two parties exchange the price difference.

If you hold Bitcoin, you can short in the CFD market. When Bitcoin depreciates, the CFD position profits, fully hedging the spot loss. On the reverse, if the market rises, the CFD loss will offset the spot gain.

4. Perpetual Futures - Unlimited Hedging

This is a tool that has only become popular in recent years. Perpetual futures have no delivery date and track the spot price in real-time. What I love the most is being able to use leverage - controlling a larger position with less margin.

Is Bitcoin going to drop? Open a $10,000 perpetual futures short position. Make money to compensate for spot when the coin price goes down. This perpetual feature allows you to not worry about forced liquidation due to contract expiration.

5. Short Selling - Old School but Effective

Some platforms allow you to borrow coins to sell, then buy them back after the price drops. Borrow 1 BTC to sell, and when it drops, buy it back at a lower price; the difference is your profit. This profit can offset losses from your other investments.

6. Stablecoins - The Most Conservative Escape

Stablecoins (such as USDT, USDC) are pegged to fiat currencies (usually the US dollar). Afraid of a market crash? Exchange volatile coins for stablecoins to ensure the safety of your funds.

Of course, the cost is that you give up the gains from the market rebound. This kind of hedging is more like a “ceasefire,” waiting for the market conditions to improve before re-entering. But there is a risk: if the issuer of the stablecoin has issues, your “insurance” becomes invalid.

7. Diversify multiple coins - hedge risk management

Different coins have different trend logics. When Bitcoin falls, a certain altcoin may rise. Holding multiple coins with low correlation naturally forms a hedge – the loss of one coin is compensated by the gains of another.

This method requires you to understand the correlation between coins and choose assets that do not interfere with each other.

Real Case: Protecting a $10,000 BTC Position with Options

Scenario: You hold 0.2 BTC, the current market price is $50,000 each, and the total value is $10,000. Unsure about the subsequent market trends, you want to protect it.

Plan A: Buy Put Options

• Purchase put option: strike price $50,000, pay $500 premium
• Suppose the coin price drops to $40,000
• You exercise the option to sell at $50,000, with a loss limited to $500 premium.
• Spot $10,000 asset protection secured at $9,500

Plan B: Sell Futures Contracts

• Sell 0.2 BTC 1-month futures, locking in a price of $50,000
• The coin price dropped to $40,000
• You bought back 0.2 BTC at $40,000 and settled at $50,000, earning $2,000 to compensate for spot losses.
• But if the coin price rises to $60,000, you are trapped at $50,000, missing out on $2,000 in profit.

Both solutions have their strengths. Options provide flexible protection but require premium payments; futures offer complete hedging but forfeit potential gains.

Seven Major Risks of Hedging You Must Know

cost issue

Every hedge costs money. Option premiums, futures fees, spread costs—these all need to be considered when making your decision. If the market only moves by 5%, but the hedging cost is 3%, then the hedge is not worthwhile.

Profit is handcuffed

The most frustrating point when hedging with futures: you can't make any money. Bitcoin rises by 30%, but you are locked into the original price by the futures contract, rendering all the gains void.

counterparty risk

If you are using over-the-counter derivatives or a certain stablecoin, can the other party really fulfill their promise? Once the other party defaults (for example, if the issuer of the stablecoin runs away), your hedge turns into a trap.

Hedging Failure

In extreme market conditions (such as a sharp drop or rise in coin prices), the expected protective function of hedging tools may fail. Options and futures may not be delivered as expected during price gaps, and stablecoins may decouple.

Regulatory Variables

Countries' attitudes towards derivatives are changing. In some places, regulations on leveraged trading are tightening, and your hedging tools may suddenly be banned or restricted.

liquidity exhaustion

Some hedging tools (especially derivatives of small coins) may be difficult to trade quickly. When you want to close a position, no one is taking orders, and the spread is ruthlessly crushed by you.

Complexity Trap

The more advanced the hedging tools, the easier it is to make mistakes. A single operational error can amplify losses rather than protect the position.

Three Golden Rules for Hedge Newbies

Learn before you act

Every tool has its traps. Before operating with real money, it is essential to understand every aspect. Look at the literature you don't understand, ask experienced people, and practice on paper.

Don't put all your eggs in one basket.

Having a single coin and a single hedging method is very dangerous. Diversify into multiple coins, multiple asset classes, and multiple hedging tools. This way, a single point of failure won't be fatal.

The complexity must match the experience.

Beginners should avoid complex strategies. Simple ones—like holding stablecoins or diversifying across multiple coins—are often the most effective. Once you are proficient, then consider options and leverage as these “weapons”.

Ultimate Advice on Hedging

Hedging is a defensive technique, not an offensive one. When used correctly, it can be lifesaving; when used poorly, it can lead to self-harm. A true expert does not hedge in the most complicated way, but rather chooses the hedging method that best suits themselves.

Before choosing any hedging strategy, check each item:

• What is the cost of this tool?
• What will happen if the other party defaults?
• Can it be used in extreme market conditions?
• Does my jurisdiction allow this operation?
• Do I really understand this tool?

Common risk reduction tools include stop-loss orders and gradual position reduction. This is much more practical than fancy hedging. If you're really unsure, seek out a professional financial advisor.

Volatility in the crypto market is the norm. But volatility does not mean one must take risks. Choosing to hedge is a mature attitude.