In this article, I will explain how to hedge crypto with futures. The crypto market is incredibly volatile, and the price swings can happen suddenly and affect your holdings.
If the price goes down, for instance, traders can hedge their positions with futures contracts to curtail their potential losses and preserve their investments.
In this article, I will provide an actionable process to simplify and teach step by step hedging.
What Are Crypto Futures?
Crypto futures contracts allow traders to purchase a cryptocurrency and receive it on a set future date at its predetermined price. Futures contracts differ from spot trading because the trader does not own the actual asset. Prices can also be speculative since the trader does not own it.
These contracts can be perpetual (no expiry) or traditional (fixed expiry). Traders utilize futures contracts to speculate as a method of hedging or use them to gain more market volatility—often with leverage to increase potential gains or losses.
How Do u Hedge Crypto With Futures
Hedging Crypto With Futures on Binance
Let’s say you are worried about a short-term price drop and want to hedge against that while having 1 BTC in your spot wallet. You can do this by “shorting” Bitcoin futures on Binance.
Step 1: Open Binance Futures hard wallet
- With Binance you can go to the Binance Futures website and select BTC/USDT.
Step 2: What is needed to open Binance Futures
- To open Binance Futures you need to use a perpetual futures contract, this will ensure that you are able to carry on hedging.
Step 3: Estimating the Hedge Size
- If you have 1 BTC in your spot wallet you can open a short position of 1 BTC in futures.
Step 4: Executing the Hedge
- You need to place a short order which is usually done based on the price being offered.
Step 5: Continue To Monitor Position
- Adjust position sizes whenever necessary to ensure your BTC does not go below the value of spot.
Types of Crypto Futures
Perpetual Futures
Contracts that allow for continuous trading with no expiry date and settle via funding rates rather than expiry dates.
Traditional (Delivery) Futures
Contracts with a settlement on a specific date that must be closed or rolled over in crypto or USD.
Quarterly Futures
Futures that expire every three months and are primarily used by institutions for hedging and reducing funding rate expenses.
Inverse Futures
Futures that are priced in crypto and settled in USD that allow traders to speculate or hedge with the crypto.
Linear Futures
Contracts that are settled and priced in USD stablecoins, making the determination of PnL easier and crypto exposure lower.
Why Hedge Crypto Using Futures
Protecting Against Price Volatility
The value of a cryptocurrency can fluctuate by 5% to 10% a day. Price fluctuations can happen multiple times a day. Using hedging allows an individual to maintain their positional value as a cryptocurrency holder.
For example, you might have 2 BTC and wish to cash in on a short term value downtrend. A hedge would be to take a short position in Bitcoin futures. You can offset your losses by absorbing them, thus rest your portfolio in your free cash on hand without fear of a market drop.
Locking in Profits or Reducing Losses
Turning a futures contract allows you to cement a claim on your profits without needing to physically part with your cryptocurrency.
If Bitcoin sees a meteoric rise, then by depositing a rebate you can hedge the charge to a part of your profits, mitigating the hit you might face if there is a sudden drop in the Bitcoin market.
Emotional reactions like selling during market downturns is avoided. Your portfolio protects and strengthens itself.
Strategic Portfolio Management
Your portfolio will not let you down if you maintain a rigid framework of hedging. You will be able to multiply your returns while limiting your losses. Long exposure is possible when combined with short spot hedge, thus providing moonshot growth.
Downward exposure is capped in the case of a hedge. Investing and prudent risk management are combined seamlessly, providing all weather portfolio resilience to anyone who lacks.—
Risks and Considerations
Leverage Risk
Losses can be intensified by using leverage. Losing more than initially invested capital due to liquidation of a futures position is obnoxious but will happen with over-leveraging.
Imperfect Hedging
Funding rates, price discrepancies, and market gaps can all cut into futures. Risk mitigation when hedging can only go so far.
Funding Fees and Costs
To keep their position open, Perpetual futures constantly impose a fee. Even a small daily fee over a length of time can severely cut into profit when a position is constantly adjusted, or a long term hedge is placed.
Market Liquidity and Slippage
Low liquidity is one cause of slippage, when trades happen to open and close at less than ideal prices. The larger trade and more volatile the market, the more risk that is. Position slippage becomes a solidified risk to a hedge.
Conclusion
In conclusion, hedging crypto with futures is a useful way to safeguard investments and manage market fluctuations.
By using futures contracts in conjunction with spot holdings, you are able to mitigate losses and lock in gains.
While it certainly takes careful consideration to leverage, fees, and market places, if executed properly, a hedge is able to keep a sharp and supple portfolio in the bumpy crypto marketplace.
FAQ
Hedging with futures means using contracts to offset potential losses in your crypto holdings.
To protect investments from sudden price drops and manage portfolio risk.
No, hedging reduces risk but cannot completely prevent losses.
Exchanges like Binance, Bybit, and FTX offer reliable crypto futures.
Leverage increases potential gains but also amplifies losses; use it cautiously.