Hedging refers to the use of a virtual contract to hedge against the fluctuations of the spot price, and avoiding the risks arising from fluctuations in spot prices during this period. It is divided into going long hedge and selling short hedge, going long is in order to avoid the risk of spot price increase, while selling short is to avoid the risk of spot price decrease.
If the user currently holds some BTC, or if he or she wants to obtain BTC at a fixed cost in the future, then the fluctuations in BTC spot price will generate profits and losses. In order to avoid the risk of spot price fluctuations, the user needs to establish contracts positions of the opposite side of spot market. Therefore, the losses or profits will be covered, no matter how the price changes.
A bitcoin miner estimates that he could get 10BTC by mining after a month, based on his current productivity.
Current spot price of BTC = 500 USD/BTC
The income that the miner wants to stabilize = 10 BTC*500 USD/BTC=5000 USD,
Face value of a BTC contract = 100 USD
Quantities of sell short contracts= 5000USD/100USD=50
If the spot price of BTC declines to 400 USD/BTC a month later.
The profits generated by the contract = (100/400-100/500)*50=2.5 BTC,
The number of BTC the miner would be able to sell: 10+2.5=12.5 BTC,
Selling price = 400 USD/BTC,
The profits =12.5*400=5000USD.
Above all, by establishing the corresponding positions in advance, the miner can lock his final stable profits through hedging.
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