Hedging cryptos (or money in general)

Question

I'm thinking about moving funds between various currencies. Right now I have USD ($) and Euros (€).

My goal is to buy some Ripple (XRP), a cryptocurrency.

Ripple can be traded against the €, the USD, and the Bitcoin (BTC).

I tried to do the math myself but it's getting confusing to a point where I'm really unsure if my logic is flawed or not. Here it is.

Solution 1:

I could simply buy XRP with my EUR and get a simple exchange. No hedging here, simple enough.

Solution 2:

I could buy BTC with either EUR or USD, because the BTC is currently way stronger than XRP, and is also in a serious uptrend (about 5500-5700 at the time of writing, from 4800 about 15 hours ago).

So, because BTC rises (and XRP actually went down about 5% last night), the current BTC/XRP is, if I understand correctly, really favorable.

24 hours ago, I could get some XRP for 1 BTC, but today, i can get more.

But, because I need to exchange my fiat for BTC first, and because BTC is stronger than yesterday, I'll get less BTC.

Although, BTC/XRP varied just as much as BTC/USD, because it is BTC that moved, so XRP and USD moved in the other direction by the same amount (is this really correct ?)

So even if I got less BTC for my fiat, it doesn't matter, because what matters is now the bigger gap in BTC/XRP.

That only matters if I believe that XRP is going to go up again. Let's assume that I'm right (otherwise this question is pointless) and that it wil eventually go up, while btc will either go up or stay the same (in the long run).

My qestion is

If I exchange EUR -> BTC -> XRP now, I would indeed benefit of the gap, right?

Or am I getting this reversed ?

Here's a website that allows you to see the various pairs I'm talking about : https://www.bitstamp.net/market/tradeview/

PLEASE NOTE I'm not asking for financial advice "should I buy now?!", I'm asking about hedging and if the current gap would work in the way I think it works, or not.

Please ask for clarifications if I wasn't clear enough.

Answer 1

I don't think that you understand hedging properly; to hedge one instrument, no matter the security type, with another the hedging instrument must be negatively correlated with the instrument that you are hedging. In layman's terms there must be an expectation that if Bitcoin rises then Ripple will fall and vice-versa. This is so that the loss from one is offset by the gains in the other. The following graph suggests that, up until the last few weeks BTC and XRP were generally correlated in USD terms over the long term and that the recent divergence may be a blip.

Of course there is only so much money available to the cryptocurrencies markets so you may consider that there is reason to presume that if one currency rises (against USD) then another must fall since the money has to come from somewhere. Conversely you may suggest that both cryptos will go up in a correlated fashion in general as more people start investing or trading in these instruments so new money is being injected into the markets. Other than the graph presented showing a correlation in general I have no reason to believe either positive or negative correlation will be seen so I would not use one to hedge against the other.

If you are intending to trade the "gap" that has opened up between them because you believe that the previous trend will return that is a form of arbitrage and clearly not a way of controlling risk.