Crypto Hedging Strategies: Fiat vs Commodities

One of the most volatile markets in the world, cryptocurrency investors need strong hands to hold on during price swings that can shake out all but the most committed.

To limit exposure to this volatility, investors can hedge against the market, using futures contracts, shorting, or one of the most simple methods—trading cryptocurrency for a stable asset, like a commodity, fiat currency, or stablecoin.

But while the best hedging solutions have a heritage that can be traced back thousands of years, the worst of them reflect the same flawed banking system to which bitcoin provides an alternative.

💲 Hedging with Fiat-backed Coins

The key advantage of hedging with fiat is accessibility. Stablecoins, which are blockchain tokens pegged to national currencies, can be traded on most popular exchanges, but this convenience comes at a cost.

There are several varieties of stablecoin that rely on different mechanisms to maintain stability—fiat-collateralized, which rely on a stockpile of assets theoretically backed 1:1 to the tokens; crypto-collateralized, like Maker’s Dai which relies on ethereum kept in storage, and algorithmic stablecoins, which rely on code to maintain the stability of the coin.

Tether, the original fiat-backed stablecoin, is by far the most popular option for traders to switch into when bitcoin starts to fall. But while it might have the most adoption, being second only to bitcoin in daily traded volume, it presents several risks over the short and long-term.

Pegged to the dollar, Tether and other similar stablecoins are subject to instability from the underlying currency. And, subject to more instability from local market forces that often wrench Tether away from its perch at $1 dollar. In fact, the leading stablecoin has fluctuated between $0.95 and $1.01 as traders move in and out of the asset during periods of high bitcoin volatility.

The range of Tether’s volatility

Also contributing to this volatility is lack of trust. During the few years of its short lifespan, the stablecoin has often been caught in controversy—sending the price plummeting as traders scramble to get rid of the token.

These controversies usually involve lack of transparency, with Tether being unable to prove that they hold the equivalent dollars in reserve, or even on one occasion admitting that some holdings have been invested in bitcoin.

Over the long-term, these crises of faith become insignificant, with the stablecoin eventually crawling back up to its 1:1 peg against the dollar once the news blows over. But, for investors with a long-term plan, fiat-backed stablecoins present another problem.

As it is pegged to the dollar, Tether and all other fiat-backed currencies steadily lose value all the time due to inflationary forces—a problem which goes right to the heart of the current banking system, and something that famous economist Maynard Keynes himself commented on:

“By this means (fractional reserve banking) government may secretly and unobserved, confiscate the wealth of the people, and not one man in a million will detect the theft.”

– John Maynard Keynes
Pros Cons
Available on most exchanges Unstable
Opaque operations
Loses value over long-term

👑 Hedging with Commodities

Traditionally, gold is used to hedge against the decline of currencies or equities, which often have an inverse correlation with the metal. But while gold doesn’t yet have any clear correlations with bitcoin, it has several advantages as a hedge in the cryptocurrency market.

Unlike national currencies which have a nasty tendency to eventually go to zero, the value of gold can be expected to rise over the long-term.

For example, over the last ten years gold has appreciated 37 percent in value, whereas the US dollar has lost 16 percent of its relative buying power.

Over twenty years, this is even more pronounced, with gold gaining 411 percent, and the greenback losing over 22 percent of its buying power.

This is because commodities are theoretically immune to the inflationary and political forces that gradually debase fiat currency, making them a good choice of hedge for the long term investor, who might wish to balance exposure between bitcoin and gold as a way of guarding against volatility in either asset class.

For residents of countries in economic turmoil where inflationary forces are in overdrive, like Venezuela, Argentina and Nigeria, commodities are even more appealing as a hedge.

The only downside is the potential cost and inconvenience of swapping bitcoin for an asset like gold—which can be a cumbersome process without the proper infrastructure in place.

But because metals are highly liquid, switching can be easy on the right exchange. Vaultoro provides the opportunity to instantly switch into gold from bitcoin, down to an accuracy of 10 cents for maximum inclusion. This gold is kept in secure Swiss vaults and regularly audited, and investors are able to check holdings via Vaultoro’s proprietary Glass Books Protocol.

William Rees-Mogg, co-author of the book The Sovereign Individual that almost predicted bitcoin thirty years before Satoshi Nakamoto arrived, had this to say about gold:

“To prefer paper to gold is to prefer high risk to lower risk, instability to stability, inflation to steady long term values, a system of very low grade performance to a system of higher, though not perfect, performance.”

— William Rees-Mogg
Pros Cons
Likely to gain value over time Higher storage costs than fiat
No KYC requirements below $5000 per member per day on Vaultoro
Immune to inflationary forces