What Is Hedging?
Hedging aims to reduce the risk of adverse price movement in an existing position, either by taking a position opposite of one’s existing position or diversifying into other assets. For example, if a trader uses 100% of their capital to buy Bitcoin, there is no hedge. However, if they use 50% for Bitcoin and 50% for stablecoins instead, some traders might argue that Bitcoin hedges against fiat, and the position in stablecoins hedges against Bitcoin.
Why Is Hedging Useful?
A diversified portfolio is the preferred strategy for many cryptocurrency enthusiasts. In a sideways market, for example, individuals can hold onto their stablecoins or fiat to see if the market will decline in order to buy in at a lower price. Alternatively, they can hold onto their crypto assets in case prices do not drop.
Additionally, someone whose main currency is GBP, for example, could be interested in holding a portion of their fiat holdings as USD stablecoins or vice-versa in order to hedge against their own currency. If their currency falls, they may be comparatively better off than someone who did not hedge. In other words, hedging reduces variance by dampening the effects of the markets.