How to Hedge Your NFT Collection With Ethereum Derivatives
Therefore, NFT collectors who are concerned about a potential market downturn could hedge the value of their collection using Ethereum derivatives.
Hedge your NFT portfolio with futures
If you are concerned about the NFT hype dying down, which would likely result in a drop in the value of your NFT collection, you could hedge your portfolio by selling Ethereum futures.
Futures are financial derivative contracts where two parties agree to exchange an asset at a pre-agreed price at a specific date. The original idea behind futures contracts is that you can lock in a price to buy or sell an asset in the future. That way, you will know how much you will pay or receive regardless of where the market for the asset is at the time.
You can trade ETH futures on numerous leading crypto exchanges or, if you prefer regulated derivatives, on the Chicago Mercantile Exchange (CME).
If you are expecting the NFT market to correct in the coming six months, but you don’t want to sell any of your NFTs, you could hedge your Ethereum-based NFT portfolio by selling ETH futures with a six-month maturity.
You can decide how much of your portfolio you want to hedge by calculating the hedge ratio of your portfolio. That way, you will know how many futures contracts to hedge a part of or your entire NFT portfolio.
Hedge your NFT portfolio with options
Alternatively, you could also hedge your NFT collection using Ethereum options.
Options are derivatives contracts that give the holder the right but not the obligation to buy or sell an asset at a predefined price at a specific time in the future. That way, you can protect yourself against a drop in the value of your portfolio but, unlike with futures contracts, you are only required to pay for the option (and not buy or sell the underlying asset) at the expiry date.
To hedge your JPEG collection from a decline in value in the coming six months, you could buy Ethereum put options on crypto derivatives exchange like Deribit.
By purchasing Ethereum put option contracts, you can buy/sell ETH at a predefined price at an agreed date. If the market price of Ethereum’s token drops below the options’ strike price, your contracts will be “in the money” and you will be able to purchase ETH cheaper in the market and sell them for the higher pre-agreed value (at the strike price).
That way, you make a profit on your put options hedge, which will offset a loss on your NFT collection.
Before you go out and start hedging your beloved NFT collection with ETH derivatives, keep in mind that the NFT market and Ethereum aren’t perfectly correlated. In fact, according to a Coin Metrics report, they aren’t that correlated at all.
The report states:
“[...] There does not appear to be a consistent correlation between OpenSea sales volume and ETH price - at times they are highly correlated, like August 2021, but at other times they’re negatively correlated, like November 2021. Although it’s still early, it appears that NFTs are a relatively independent market and may, for the most part, move separately from the rest of the crypto market.”
That means you can hedge against a drop in the value of your NFTs to a certain degree but the chances are that Ethereum derivatives - even with a 1-1 hedge ratio - will not offset a drop in NFT portfolio value entirely.
Moreover, before you attempt to hedge your NFT collection, make sure you fully understand how futures and options work to make sure you don’t end up inadvertently losing money.