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Crypto markets are extremely volatile. They can swing 10 to 30% in a single day, exposing traders and investors to sudden losses. Hedging in crypto refers to strategies used to reduce that risk by offsetting potential downside in an existing position, typically through futures, options, or inverse positions.
TL;DR
- Hedging reduces downside risk without selling core crypto holdings
- Spot hedging lowers exposure by reallocating capital
- Futures hedging creates inverse exposure to offset losses
- Hedging is useful during risk imbalance, not based on fear
- Hedging reduces volatility, not risk entirely
Hedging Definition: What is Hedging?
Hedging is a risk management strategy that reduces potential losses by taking an offsetting position in a related asset, so that adverse price movements in one position are partially or fully balanced by gains in another.
In investing, losses are often discussed in terms of drawdown, which simply means how much the value of a portfolio falls from its recent high before it recovers. Hedging works by reducing drawdown, making the drop in portfolio value smaller during unfavorable market moves.
To implement a hedge, the investor, after market research, deliberately selects a hedge asset that is expected to move,
- either differently from,
- or in an opposite direction to, the original holding.
This way, the losses in the primary position are reduced or balanced by gains or stability in the hedge position during adverse market movements.
Instead of aiming to maximize profit, hedging prioritizes capital protection, volatility control, and downside mitigation while maintaining core exposure
In this example, Priya adds PAXG alongside her Bitcoin position rather than replacing it, increasing total invested capital. This is because PAXG tracks the price of gold, and gold usually holds its value or goes up when markets get nervous, while Bitcoin tends to fall more sharply during the same periods.
| Scenario | BTC Allocation | PAXG Allocation | BTC Value After 20% Drop | PAXG Value | Total Portfolio Value | Total Loss |
| No Hedge | ₹5,000 | ₹0 | ₹4,000 | ₹0 | ₹4,000 | ₹1,000 |
| Spot Hedge | ₹5,000 | ₹2,000 | ₹4,000 | ₹2,100 | ₹6,100 | ₹900 |
You can see that with this hedging strategy Priya is able to offset her losses by ₹100, reducing the drawdown from ₹1,000 without a hedge to ₹900 with the PAXG hedge.
What Hedging Is Not
Many traders misuse hedging by treating it as a profit strategy or as a way to eliminate risk entirely, which leads to overtrading, unnecessary costs, and false confidence during volatile markets.
- Hedging is not profit maximization
- Hedging is not long term diversification
- Hedging is not speculation
- Hedging does not eliminate risk completely
Remember, Hedging reduces the impact of adverse price movement; it does not eliminate risk, guarantee profit, or improve long term returns on its own.
Strategic Rationale for Hedging: Why don’t traders sell instead?
When market risk increases, traders face a decision: exit the position entirely or manage the risk while remaining invested. Hedging represents the second approach. The preference for hedging over selling can be understood across three dimensions.
1. Functional Objective: Risk Control Without Liquidation
Hedging reduces downside exposure while preserving the underlying position. It acts as a volatility management tool rather than a directional bet. Selling eliminates risk but also eliminates participation. Hedging adjusts risk without dismantling the portfolio structure.
2. Conviction in Long Term Value
If the fundamental thesis remains intact, short term price movements may not justify full liquidation. Hedging allows traders to separate short term uncertainty from long term conviction, maintaining exposure to anticipated structural growth while mitigating interim risk.
3. Managing Loss Aversion and Regret
Behavioral finance research shows that investors are highly sensitive to regret. Selling during volatility creates the possibility of missing a rapid rebound, which is common in crypto markets. Hedging reduces emotional pressure by protecting capital while avoiding the fear of being completely out of the market.
So if Priya chooses to hedge instead of sell:
- She reduces potential losses if Bitcoin falls, because the hedge offsets part or all of the downside.
- She stays invested in Bitcoin, so she can benefit if the market quickly rebounds.
- She avoids the stress and timing risk of selling low and buying back higher.
Spot Hedging Explained
Spot hedging in crypto involves reducing risk by reallocating capital within the spot market itself. Instead of using crypto derivatives, like crypto futures or crypto options, the investor shifts part of their exposure into a relatively stable asset such as a stablecoin or a lower volatility crypto asset.
This reduces portfolio sensitivity to sharp price swings. Spot hedging does not create inverse exposure, but it lowers overall risk by decreasing concentration in a single volatile asset.
Crypto Spot Hedging Example
Priya holds ₹5,000 worth of Bitcoin after prices have risen steadily for several weeks. She still believes in Bitcoin’s long term growth, but she notices that prices have started moving sideways and recent rallies are getting weaker. News headlines are also turning cautious.
Instead of selling everything, she moves ₹2,000 into a stablecoin and keeps ₹3,000 in Bitcoin.
- If Bitcoin falls 20%, only ₹3,000 is affected, reducing her total loss.
- If Bitcoin rises again, she still benefits because most of her money remains invested.
Crypto Futures Hedging Explained
Crypto futures hedging involves opening a derivative position that moves in the opposite direction of the original holding.
Much like in the case of spot hedging, a futures hedge is used when a trader wants temporary downside protection without selling the underlying asset.
Crypto Futures Hedging Example
Example: Priya holds ₹5,000 in Bitcoin and wants protection without selling. She opens a ₹5,000 short Bitcoin futures position using 2x leverage, which requires only ₹2,500 as margin. This example assumes a full hedge where the futures position matches the spot value.
- If Bitcoin falls 20%, her spot loses ₹1,000 but the futures gains ₹1,000, keeping her portfolio stable.
- If Bitcoin rises 20%, the futures loses ₹1,000 while spot gains ₹1,000.
The hedge offsets price movement while she remains invested.
Practical Considerations When Hedging with Futures
Margin Maintenance: Because futures use margin, the position must be maintained above liquidation levels for the hedge to remain active.
Impact of Funding Rate while hedging Crypto Futures: In perpetual futures, funding payments may slightly increase or reduce the hedge’s cost depending on market conditions.
When Should You Hedge in Crypto?
The common advice around this is to “hedge based on risk imbalance, not price prediction”.
In simple terms, you should hedge when a normal market drop would hurt you more than you are comfortable with.
- Not when you “feel bearish.”
- Not when someone on Twitter says a crash is coming.
| Risk imbalance is a condition where the potential downside exposure of a position becomes disproportionately large relative to an investor’s capital, time horizon, or emotional tolerance, even if their long term thesis remains unchanged. |
Here’s an example:
Priya is holding ₹5,000 in Bitcoin for long term growth. She has observed that
- Bitcoin rose gradually about 8% in 3 months, Daily price swings averaged 1 to 2%
- No major macro triggers like US Fed rate decisions, ETF approval deadlines, or regulatory shocks
- Funding rate has also stayed neutral.
Historically during such low volatility, Bitcoin price drop can be around 10%.
Her exposure and her risk tolerance are aligned. There is no risk imbalance for Priya in this scenario.
Now take the scenario where the market is highly volatile. Priya observes the market and finds that:
- Bitcoin rallied 30% in 4 weeks
- Daily swings expand to 4 to 6%
- Funding rates spike sharply
- A US Fed policy decision and ETF flow data are due this week
Now a 20 to 25% pullback becomes plausible: In this scenario If Bitcoin drops 25%, her ₹5,000 becomes ₹3,750.
- Priya is not comfortable with this level of loss. I.e, The downside impact relative to her tolerance has increased.
That mismatch is risk imbalance.
In this scenario, Priya may decide to hedge instead of selling. To reduce downside risk during this volatile phase, she opens a ₹2,500 short Bitcoin futures position, so that If Bitcoin drops 25%:
- Spot falls from ₹5,000 to ₹3,750, a loss of ₹1,250
- Her ₹2,500 short futures gains 25%, earning ₹625
- Net portfolio value becomes ₹4,375 instead of ₹3,750
In effect Priya’s loss is reduced.
The hedge restores balance between potential loss and her comfort level, without forcing her to exit her long term position.
This also implies that:
Hedging May Not Be Necessary when…
- Market volatility is low and stable
- Position size is small relative to capital
- The investor is comfortable with short-term losses.
Cost of Hedging: Are there Any Downsides to Hedging Your Crypto Portfolio
Hedging is not free protection. When you hedge, you are deliberately giving up something so that losses hurt less if the market moves against you.
That trade-off is the cost.
Spot hedging costs upside
When you spot hedge, you move some money out of Bitcoin into a safer asset. If Bitcoin goes up strongly after that, only the remaining Bitcoin benefits. So you make less profit than if you stayed fully invested. You pay for safety by giving up part of the upside.
For example, if Priya moves ₹2,000 out of her ₹5,000 Bitcoin holding to reduce risk and Bitcoin later rises sharply, only the remaining ₹3,000 benefits from the price increase, so her gains are smaller than if she had stayed fully invested.
Costs of Futures Hedging
| Cost Type | What It Means | Outcome for the Portfolio |
| Missed upside opportunity | Futures losses offset spot gains when price rises | Total profit is reduced even if Bitcoin goes up |
| Funding payments | Periodic payments to maintain the futures position | Portfolio value slowly declines over time |
| Margin lock up | Capital must remain reserved as collateral | Less capital is available for other opportunities |
| Liquidation risk | Sudden price spikes can close the hedge | Hedge may fail when protection is most needed |
So if Priya hedges her ₹5,000 Bitcoin holding with a ₹5,000 short Bitcoin perpetual futures contract and Bitcoin rises 20%,
- her spot gains ₹1,000
- but the futures position loses ₹1,000,
- she also pays around ₹40 to ₹50 in funding over a month
- keeps roughly ₹2,500 locked as margin
Overall reducing both her net profit and available capital despite the market moving in her favor.
Priya accepts this cost because her goal during that period is to limit how much her portfolio could fall, not to capture every possible gain.
Full vs Partial Hedging
Traders can choose how much risk they want to reduce based on their comfort level and market conditions.
- A full hedge aims to offset most or all potential losses, offering maximum protection but limiting upside almost completely.
- A partial hedge reduces losses without fully cancelling exposure, allowing the investor to stay partly exposed to market gains while still lowering risk.
Example :Priya holds ₹5,000 worth of Bitcoin.
- With a full hedge, she opens a ₹5,000 short Bitcoin futures position.
If Bitcoin falls 20%, the loss on spot is fully offset by gains on futures. - With a partial hedge, she opens a ₹2,500 short Bitcoin futures position.
If Bitcoin falls 20%, only part of the loss is offset, but she still retains more upside if the price rises.
| Hedge Type | Futures Position Size | Protection Level | Impact if Bitcoin Falls 20% | Impact if Bitcoin Rises 20% |
| No Hedge | ₹0 | None | Loss of ₹1,000 | Gain of ₹1,000 |
| Partial Hedge | ₹2,500 short | Moderate | Loss reduced to ₹500 | Gain reduced to ₹500 |
| Full Hedge | ₹5,000 short | High | Loss largely offset | Gain largely offset |
A full hedge prioritizes protection, while a partial hedge balances protection with continued participation in potential upside.
Final Thoughts
Selling removes risk, but it also removes exposure to future gains. Spot hedging reduces how much you can lose by lowering exposure, while still keeping you invested.
Futures hedging offsets losses more directly, but comes with added costs and operational complexity. In practice, hedging is not about predicting prices, it is about staying invested while keeping potential losses within limits you are comfortable with during periods of higher uncertainty.
For traders who choose to hedge instead of selling, having access to spot markets and futures on the same platform makes it easier to adjust risk as conditions change. Platforms like WazirX allow traders to manage spot holdings and futures positions together, making hedging a practical risk management tool rather than a theoretical concept.
If you want to explore these hedging tools in practice, you can download the WazirX app to access both spot and futures markets in one place and see how risk management works with real trades.
Frequently Asked Questions
Traders often consider hedging when short-term uncertainty increases but their long-term view on the asset has not changed. In these situations, hedging is used to manage temporary risk while remaining invested.
The size of a hedge is usually linked to how much risk a trader wants to reduce rather than eliminating exposure entirely. Some hedge a small portion to soften losses, while others hedge more aggressively during high-risk periods.
A partial hedge reduces only part of the potential loss and leaves room for gains if prices rise. A full hedge aims to offset most or all losses, placing a stronger emphasis on protection over returns.
Long-term investors sometimes use hedging during periods of elevated volatility or uncertainty. It allows them to stay invested while managing short-term price fluctuations without changing their core view.
Hedging can limit gains when prices rise, because the hedge offsets some of the upside. This is generally understood as the trade-off for having protection during uncertain market conditions.
Belief in an asset’s long-term value does not remove short-term volatility. Hedging is often used to manage temporary risk while maintaining exposure to a long-term position.
Hedging is typically framed as a risk management approach rather than a prediction tool. The focus is on controlling potential losses rather than forecasting price movements.
Traders often look at whether potential losses would feel uncomfortable or disruptive relative to their capital or time horizon. When risk feels disproportionate, some consider hedging as a way to manage exposure.
Hedging is not usually applied to every price decline. It is more commonly associated with periods of unusually high volatility or uncertainty rather than routine market movements.
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