Using Crypto as a Hedge – A Viable Choice?

Even though cryptocurrencies continue to be highly speculative instruments, there are some investors who view them as reliable hedging tools. Is that a good way to use crypto in 2020? Several aspects must be discussed to provide a complete answer to this question. The good news is that Bitcoin and its peers had been able to perform above all expectations and this should raise the bar for the months ahead.

Crypto correlation with traditional asset classes

Something interesting happened during the past few months, which is not necessarily good news for those wanting to use crypto as a hedge. Cryptocurrencies, stocks, and gold had been rising all at once, negating some of the claims crypto is an uncorrelated asset class. Since crypto and stocks were rising together, it made hedging relatively difficult, since it would have been necessary to see a divergence in terms of performance. Still, periods of close correlation like the one we just witnessed are rare and already we see discrepancies between how crypto and other assets perform.

Short-term vs. long-term

It also comes down to the time frame an investor wants to use a cryptocurrency hedge. Especially now that we don’t know how cryptocurrencies might perform during an economic downturn, we must have a diversified portfolio. A short-term hedge will imply holding a crypto position as a protection against other exposure. Longer-term, crypto looks to be treated as a hedge against the devaluation of fiat currencies. Central banks around the world need to increase the monetary base, which diminishes the purchasing power of fiat. In the case of cryptocurrencies, though, that’s not possible, because they have a fixed supply and a lower number of tokens mined as time goes by.

Keeping portfolio stable

The main goal of a hedge is to keep a portfolio stable through a volatile period. To make cryptocurrencies act as a hedge one should analyze and spot a connection between the asset currently in the portfolio and any given cryptocurrency. At the same time, one could invest in a crypto-based portfolio and thus gain exposure to a wide range of tokens. Keeping the portfolio stable, though, comes with downsides. It will reduce the expected returns, in exchange for a lower risk. At the same time, it is possible to have the correlation between assets change, and thus require a portfolio adjustment, in case that happens. The market is very flexible and most of the time, what’s not expected to occur, it does eventually and takes everybody by surprise.