Hedging: Negating Bitcoin Volatility

Traditionally a hedge was an investment position intended to offset potential price volatility. In simple language, a hedge is used to reduce any substantial losses or gains, suffered by an individual or an organization.

Hedging reduces the exposure to price risk by shifting that risk to companies that have opposite risk profiles, or to investors who are willing to accept the risk in exchange for profit opportunity.

This is not to be confused with hedge funds. Hedge funds today do not necessarily hedge. Although the name refers to traditional hedging techniques, hedge funds invest in a diverse range of markets and use a wide variety of investment styles and financial instruments.

Many hedge fund investment strategies aim to achieve a positive return on investment regardless of whether markets are rising or falling. They generally avoid direct regulatory oversight and bypass licensing requirements applicable to investment companies.

A traditional hedge can be constructed from many types of financial instruments including stocks, exchange-traded funds, insurance, forward contracts, swaps, options, many types of over-the-counter and derivative products, and futures contracts.

A classic example is fuel hedging. This involves establishing a position in a financial instrument that is equal and opposite to a company’s exposure in the physical fuel market. The physical market is where a company procures the actual fuel that it consumes in its day-to-day operations. Southwest Airlines used fuel hedging to offset the risk of oil price increases between 1999 and 2008.

Southwest purchased futures contracts for oil at $51 a barrel, on public futures markets. During 2007-2008 the price of a barrel of oil skyrocketed to around $95 a barrel. The futures contracts Southwest purchased provided the company with a consistent price for fuel, for the durations of the contracts. This allowed them to compete for business against other airlines.

Southwest saved approximately $3.5 billion through fuel hedging on the futures market. A company that is not hedging its costs is saying one of two things. Our company has the ability to pass on any and all increases in prices to our customers. Or, our company is confident that prices are going to fall. We are comfortable paying a higher price if our analysis proves to be incorrect.

We can do the same with bitcoin. No need to ride the rollercoaster price wave if you do not wish, there are many products and services out there that are now willing to hedge that risk for you.

There are a few platforms that will do this, and as with traditional hedging, there are several options that may suit your needs. Each platform has its own methods, but all provide a very simple service for people to lock in a rate and reduce your risk. Three notable platforms include:

• BitReserve – BitReserve will allow you to hold your Bitcoin at a stable rate. You send your Bitcoin to a (USD, EUR, GBP, JPY, and CNY) money card operated by BitReserve. Proof of solvency is published in real time on their website. BitReserve has $9.6M USD in funding, raised through a crowdfund as well as traditional investors.
• Hedgy – Hedgy is providing the infrastructure needed for the use of smart contracts on the blockchain in terms of hedging. They use multi-signature wallets, and are currently running in a private beta. Hedgy has received $765,000 USD in funding, and just graduated from the Bitcoin accelerator, BoostVC.
• Coinapult – Coinapult allows you to lock in the value of your Bitcoin, in comparison to a range of assets including gold, silver, USD, EUR, and GBP. You can then unlock those Bitcoins in the future, avoiding market volatility. This Panama based solution has landed its own $775,000 USD in funding, and is open today for business.

You don’t need to be a millionaire or be sitting on a stockpile of thousands of coins to use a hedging service, most of these emerging startups want the average user to be able to stabilize their investment. Anybody can hedge their coins to reduce or eliminate the volatility risk. Whether its 1 BTC or 1,000 BTC the principles stay the same.

Byrne Reese, head of product at BitReserve, stated their common customer demographic as:

“BitReserve’s customer base is largely comprised of people who have fully jumped on the bitcoin bandwagon. They range from large holders to miners to hobbyists. Long-term, BitReserve is working to appeal to the everyday person with the ultimate goal of using technology to facilitate integration with wide-ranging financial services and infrastructure.”

More and more services are surfacing daily, providing different methods of hedging and protection against price volatility. Hedging isn’t black or white, there are no standards, and there are variable methods that have proven to be an efficient means of stabilizing your investment.

Matt Slader, CEO of Hedgy, simplifies the process as:

“Hedgy is a peer-to-peer marketplace for derivative contracts on the bitcoin block chain. We match merchants and miners looking to manage their bitcoin price risk, with speculative investors searching for unprecedented exposure to bitcoin volatility.”

An entire industry has been developed around bitcoin, including wallets, exchanges, storage hardware and much more. However, these newly emerged hedging solutions are some of the first to tackle a bigger issue: how to hold bitcoin without being exposed to the markets volatility.

Ira Miller, Coinapult CEO, describes this problem as:

"People can’t really afford to hold bitcoin for very long. You’ve got to pay rent at the end of the month in euros or dollars, you may even at this time convince your landlord to pay rent using the bitcoin network, but at at the same time, you may have market action that happens during those 15 days that means you can’t cover that anymore."

Currently, a lot of the infrastructure for this field is still in development. There are a few rolled out and useable today, with many more anticipating launch this year. There will be new, innovative methods of eliminating this risk, each service doing it in their own way.