Crypto Volatility Protection: Best Practices
Since Bitcoin’s introduction in 2010 when it cost just a few cents, the price of this cryptocurrency has been experiencing numerous ups and downs. In December 2018, Bitcoin fell down to around $3,200 while in spring 2021, it jumped to around $30,000 – 50% more than its 2017 peak.
Currently, the price of Bitcoin is nearly $60,000 (six times as big as it was in September 2021), and it’s hard to predict when we could expect the next pump or dump. Such rapid crypto price movements – referred as crypto volatility – are an integral aspect of any crypto asset.
Prior to going into detail about how you can protect yourself from crypto volatility, let’s analyse the main reasons.
We define 4 major factors that contribute to crypto volatility. So, here we go…
What Are The Reasons For Crypto Volatility?
#1. The Crypto Market Is in its Infancy
Compared to traditional finance, the digital asset market is young, partially regulated, not widely-adopted, and still in its rapid growth phase. Until volumes scale, even relatively small groups of investors possessing big amounts of cryptocurrencies can instantly influence the market causing price volatility.
#2. Cryptocurrency Prices Are Still Driven By Speculators
Like many new technologies, speculation is a driving force in its development. Speculators are risk takers willing to invest their money in unproven technologies with the hope that the returns will be massive. The same goes for crypto. A large portion of the speculative capital is shortsighted looking to take profit opportunities as soon as they arise.
#3. Crypto Fundamentals Have No History, Little Utility, And Are Built On Trust
Cryptocurrencies are purely digital assets. This means they are not backed by any asset. Thus, the price of crypto is purely defined by what value the market participants believe is the right value. With very little history, asset prices are often set on price discovery phases letting the markets define price levels – causing (often) steep price changes.
#4. Crypto Prices Are Easily Impacted By Influencers
When the Chinese government announced that it would ban institutions from conducting crypto transactions and warned investors against crypto speculation activities, it affected the markets around the whole world.
A similar impact was caused by Elon Musk announcing Tesla’s decision to [buy bitcoin / accept bitcoin payments / stop accepting bitcoin payments / (and soon – resume accepting bitcoin payments].
Now that we covered some of the reasons for crypto volatility, let’s discuss some battle-tested and effective strategies to protect crypto investments from price fluctuations.
Note: While the tools mentioned below are all used by investors, not all of them may be suitable for every situation. They come in various forms, prices, risk levels, varieties, and regulatory constraints, and it is up to each and every investor to analyze the pros and cons of each instrument.
1. Diversify Your Portfolio
Since every cryptocurrency is vulnerable to price changes, investing in one crypto is a bad strategy. To decrease your chances of getting wrecked, diversify within your crypto portfolio, by holding multiple cryptocurrencies. On top of that, considering investing in different crypto asset classes and instruments will also help minimize the risks of suffering from speculation and supply/demand changes.
2. Sell Call Options
Selling calls on your cryptocurrencies is a good way to mitigate the loss risks and even make some additional earnings. When you sell calls, the buyer of your call option can purchase the underlying asset at a specific price and on a specific day. In return, you get an instant premium to spend on additional portfolio protection.
3. Buy Put Options
Another way to protect your portfolio is to buy put options. When you buy put options at some premium, profits are earned after your cryptocurrency falls down in value. Puts enable you to sell your cryptocurrency at a specific price, on a specific date. The most you might lose by buying puts is the premium you buy them at – and since it is known in advance, you can manage your risk and calculate your potential maximum loss.
4. Build A Collar
A collar strategy combines the two strategies mentioned above, while holding the underlying asset – constraining steep price movements in any direction (limiting losses but limiting profit). Buy a put option below the market price (out of the money) and (at the same time) sell a call above the market price (out of the money). This is also a tested way to balance your portfolio risk. When you buy a put, you must pay a premium to protect your crypto from price volatility risks. However, when you sell a call, you immediately get a premium which means no money is lost which makes the protection less expensive.
5. Invest In Stablecoins
In volatile times, a good way to both diversify your portfolio and get protection is buying stablecoins. Stablecoins are cryptocurrencies with a price linked to a non-crypto index, this way creating a stability component. Stablecoins can be backed by a currency (fiat money), a precious metal (gold, silver, etc.), or a commodity (like oil).
Exchange highly volatile crypto assets for stablecoins (there is a bunch of them nowadays, like DAI, Ampleforth, Augmint, DefiDollar, Digix, EOSDT, Gemini Dollar, HUSD, Money on Chain, TrueUSD, and more) or spend a part of your capital to add them to your portfolio, along with other cryptocurrencies.
6. Try Diversifi
Diversifi is the world’s first tech platform for crypto asset management that offers institutional crypto investors (investment banks, funds, brokers, family offices, and corporations holding crypto treasuries) access to regulation-compliant risk-mitigation crypto investment strategies.
Our solutions include a variety of investment strategies that address crypto price volatility. On top of that, they help optimize profit, mitigate regulatory risks, and decrease environmental impact:
• Controlled Exposure – a set of strategies that help handle exposure to an individual crypto-asset or a group of crypto-assets while protecting from losses. Our first product – Protected BTC – mitigates the risks of bitcoin price volatility,
• Smart Hedge – a set of products that hedge a large variety of crypto-assets against poor market performance (beta hedge),
• Green Crypto – a product that eliminates the carbon footprint of crypto assets held by investors,
• Balanced Portfolios – ML-based products that balance investors’ portfolio risk and reward, and
• Programmable Indices – baskets of assets managed by proprietary machine earning models.