Understanding Hedging Strategies in Crypto: Asset Protection vs Liquidation Risk

In recent times, an interesting phenomenon has been occurring in the cryptocurrency market. Market manipulators intentionally drive up spot prices while watching short positions in the futures market get liquidated, profiting multiple times over. Ironically, the main victims are not retail traders betting on price directions, but institutional investors, airdrop holders, and even KOLs who are actually trying to protect their assets through hedging strategies. This proves that not all losses in the crypto market are due to incorrect predictions, but often stem from a misunderstanding of protection mechanisms.

What Exactly Is Hedging and How Does It Work?

Hedging comes from the term “hedge,” meaning a fence or barrier. In the context of crypto trading and investing, hedging refers to a strategy of using opposing positions to protect against price fluctuations, with the goal of locking in asset value rather than making a profit. It is a defensive activity, not speculative.

The basic mechanism of hedging is very simple: you own physical assets (for example, an airdrop worth $100,000 that will be distributed soon), but you are worried that prices will fluctuate before you can sell. To address this uncertainty, you open a short position of equal size in the futures market.

Scenario one: If the price jumps 50%, your physical assets become worth $150,000, but your futures contract loses $50,000, so the total value remains $100,000. Scenario two: If the price drops 50%, your physical assets are worth $50,000, while your futures contract gains $50,000, bringing the total value back to $100,000. In this way, hedging ensures your asset value remains stable regardless of market movements.

Sounds perfect, right? However, this seemingly safe hedging strategy contains two serious traps that can lead to liquidation at any time.

The Two Main Traps in Hedging: Funding Costs and Leverage

First Trap: Continuous Funding Costs Erode Profitability

Funding fee is the interest you pay when opening a short position in the futures market. The mechanism: when long positions dominate, futures buyers pay sellers to balance the market. If you are a seller (short), you receive this fee, but if the market is very bullish and funding costs are high, the gains from hedging can be eroded by these ongoing costs.

This is especially true for highly volatile tokens like $MMT, $SOON, and $AIA, where funding fees can reach very high levels—sometimes several percent per day. If you hold a hedge for weeks, accumulated funding costs can turn what should be a protective strategy into a net loss.

Second Trap: Leverage Exceeding Your Capacity

Leverage amplifies your capital. For example, if you want to open a $100,000 short position with 1x leverage, you need to provide $100,000 in margin, and you won’t be liquidated unless the price moves more than 100%. But with 10x leverage, you only need $10,000 margin, yet the risk of liquidation becomes very close—just a 9.5% price move can wipe out your entire margin.

Many investors find the capital required for 1x hedging too large, so they choose leverage of 5x, 10x, or higher to “increase efficiency.” The result: a sharp price spike can immediately trigger total liquidation, causing their hedge to fail completely.

Safe Hedging Strategy: Principles of 1x Leverage and Sufficient Margin

A truly effective hedge follows a simple principle: 1x leverage with enough margin, without risking your entire capital. With 1x leverage, you are less likely to be liquidated by normal market movements, and your hedge genuinely protects your assets.

Conversely, high-leverage hedging is high-pressure hedging—any unexpected price movement can lead to liquidation. The difference is clear: 1x hedging is real insurance, while high-leverage hedging is gambling with a different packaging.

Why do many fail to understand this? Because the fear of inefficient capital use pushes them to take unnecessary risks. They forget that the purpose of hedging is stability, not maximizing profit.

Key Lessons from the Recent Phenomenon

The massive liquidations affecting institutional investors and airdrop holders reveal one truth: misunderstanding financial tools is more dangerous than not using them at all. Futures contracts, leverage, hedging—all are neutral tools designed for protection. But those who use these tools with incorrect understanding put themselves at risk.

A professional trader does not rely on bets or luck but on a deep understanding of market mechanics. Before employing hedging, make sure you truly understand how it works. Don’t just listen to others claiming that “hedging is safe,” and then open high-leverage positions without proper calculations. If you get liquidated once, it might be bad luck; twice, it’s negligence; three times, it shows you haven’t truly grasped the principles.

Do your own research—DYOR—before making any financial decisions. The crypto market does not forgive ignorance.