Hedging is the life blood of traders who hold big positions. When they hedge, their aim is to reduce their risk drastically and also to find arbitrage opportunities from their hedging. 

Where to go for hedging? 

Enter Derivatives. Derivatives are instruments that are derived from the value of an underlying.  

Basically derivatives are risk mitigation instruments. It exists to mitigate risk. 

Why do Futures markets exist? 

I’d like to give real-world examples to make readers understand the existence of future markets. 

 Let’s say there is an Aluminium Manufacturer. He would like to mitigate his risk on the prices of Aluminium. Why is he mitigating his risk? Simple, he doesn’t know what would happen to the prices of Aluminium over the future course of his business. 

How would he do that? 

Well, he goes to the “Futures Exchange” to sell his product. He could sell the forward contract of his product. In the forward contract, the probability of receiving a premium for his products is high and he’d sell contracts of Aluminum. Let me explain through a hypothetical case – let’s call him Manufacturer A. A sells 10000 contracts of Aluminium of 2 months forward assuming that we’re writing this on October 28 and he is selling futures of January contract. A is selling for 10000@ $200/ton. He’d be having $2,000,000 less trading fees in his ac. Say the spot prices are trading around $180. He is getting a premium of $20/Ton. Say at the time of January 28 Aluminium is selling at $180.

Hypothesis 1 – $180. He had made a profit of $20/ ton on hedging the contracts he sold. Anyhow he would be providing delivery of those contracts in physical goods. He’d continue his risk mitigation by doing the trade in forward contracts. He made his $20 on mitigating the risk. But in real terms, there is no change in prices. He would keep on continuing to manufacture Aluminium. He would continue to sell his current obligations in spot markets by delivering to his regular customers. This is what we call hedging. In this case, the manufacturer has mitigated the risk by selling in future markets. He would continue to sell his products as he has to do it to continue his business. In future markets, he wouldn’t have a substantial premium yet he would continue to do it simply to manage the risk.

Hypothesis 2 – $220. He had made a loss of $20/ ton on hedging the contracts he sold. Anyhow he would be providing delivery of those contracts in physical goods. He’d continue his risk mitigation by doing the trade in forward contracts. He lost $20 on mitigating the risk. But it wouldn’t affect him as he simply mitigated the risk by placing future contracts. Anyhow he is going to settle the contracts with his Aluminium. He sold the Aluminium at $200 when the spot was around $180. This is how a manufacturer mitigates the risk. In the forthcoming forward expiry contracts, he would probably fetch more premium for his products. It’s a win-win situation for him.

Now replicate this to crypto and we could understand the concept of derivatives and risk mitigation it plays on the underlying instrument.

Now let’s come to crypto perpetual. It’s futures without expiry. 

Biggest issue with this kind of mitigation is price disruption. What is price disruption? 

Have a look into this order book. Let’s say you hold 1000 BNB tokens. You’d like to do hedging of your BNB tokens. How do you sell 1000 tokens? It’d simply disrupt the prices. This screenshot is from Binance. Binance is No.1 in volumes for perpetuals. This issue would obviously create slippages and issues on liquidity depth of the order book. If and when bulk of selling is coming , it’s obvious that price disruptions are bound to happen. 

You’re bound to lose a few percentage points on your hedging. 

How to hedge without price disruption? 

Enter Swaps. Swaps are nothing but a type of derivative in which cash flows are exchanged based on price movements of underlying assets based on the Notional amount. 

To know more about Swaps 

Go here and here 

All you’ve to do is to choose the notional based on your funds and hedge the underlying without price disruptions. 

The main difference between single crypto swaps and multi-crypto swaps is the number of underlying assets involved. A single crypto swap involves the exchange of cash flows based on the performance of a single crypto or crypto index, while a multi-crypto swap involves the exchange of cash flows based on the performance of multiple cryptos or cryptoindices.

Single crypto swaps are typically used by investors who want to gain exposure to a specific crypto or crypto index without actually owning the underlying asset. For example, an investor who believes that the BTC will outperform the market in the coming months could enter into a single crypto swap that pays out based on the performance of the BTC.

Multi-crypto swaps are typically used by investors who want to gain exposure to a basket of cryptos or crypto indices without actually owning the underlying assets. For example, an investor who wants to gain exposure to the L1 protocols could enter into a multi-crypto swap that pays out based on the performance of a basket of L1 cryptocurrencies.

Single crypto swaps and multi-crypto swaps can be used for a variety of purposes, including hedging, speculation, and diversification. Investors should carefully consider their investment objectives and risk tolerance before entering into any type of swap agreement.

Here is a table that summarizes the key differences between single crypto swaps and multi-crypto swaps:

Feature	Single Crypto Swap	Multi-crypto Swap
Number of underlying assets	One	Multiple
Purpose	Gain exposure to a specific Crypto or crypto index	Gain exposure to a basket of cryptos or crypto indices
Risks	Market risk, counterparty risk, liquidity risk	Market risk, counterparty risk, liquidity risk, diversification risk
Potential benefits	Hedging, speculation, diversification	Hedging, speculation, diversification

Here are some additional things to consider when choosing between single crypto swaps and multi-crypto swaps:

Investment objectives: What are you trying to achieve with your investment? If you are looking to hedge against risk, a single crypto swap may be a good option. If you are looking to speculate on the future performance of a crypto or crypto index, a multi-crypto swap may be a better option.

Risk tolerance: How much risk are you comfortable with? Single crypto swaps are generally considered to be riskier than multi-crypto swaps. This is because the performance of a single crypto or crypto index is more volatile than the performance of a basket of cryptos or crypto indices.

Liquidity needs: How quickly do you need to be able to access your funds?

Ultimately, the best way to choose between single crypto swaps and multi-crypto swaps is to understand your investment objectives, risk tolerance, and liquidity needs.

1. Regulatory Compliance:

Regulatory risk is one of the most important risks involved in tokenization of RWA. So many regulatory authorities are there for trading finance products. From Europe to the US to Australia different regions have different authorities. Protocol that brings RWA in Blockchain needs to comply accordingly to different geographies. This is one of the toughest ask for a tech company.

2. Market Liquidity:

Have been hearing from so many quarters that tokenizing RWA in itself would bring customers whereas in reality it is not.

The demand for these products depends on so many factors viz., Understanding the product, nature of the products and right mix of the product to attract liquidity towards that specific product. This is easier said than done.

3. Smart Contract & Tech Risks:

The use of smart contracts introduces the risk of vulnerabilities and bugs. Blockchain products are totally dependent on code. In Blockchain, Code= Contract. If and when there are severe bugs then the entire product collapses. Blockchain technology is still in its nascent stage, and adopting it by common man is a tall ask. Apart from this there are scalability issues and interoperability challenges for a product.

4. Valuation Challenges:

Identifying pricing and valuation for tokenization is an herculean task. In most of the products it’s not possible to understand the market value of a product. The parameters to ascertain market value are simply not found with Tokenized products.

5. Market Perception:

Perception in acceptance of tokenized assets is still a tough challenge. This could have a tremendous impact on the value of tokenized products. How the market perceives plays a pivotal role in driving prices of a product. Creating perception is important for holding prices of a product to create value for stakeholders involved in the project.

6.Operational Risks:

Operations of an organization are important for the success of the product. Tokenization involves complexities in the operational aspect of a tokenized product. Operational issues viz., custody, security, and maintenance of tokenized products are highly complex in nature and would take a substantial amount of time and effort to produce better structure for the product.

7. Fraud & Security risks :

Due to permissionless and decentralized nature, there is a probability to commit fraud by stakeholders of tokenized products. The decentralized and pseudonymous nature of blockchain can attract fraudulent activities. Hack, theft, rug pull and other key issues are likely to get involved in a product that are tokenized by an organization.

8. Market Manipulation:

Due to liquidity issues, there is a probability that tokenized assets may be susceptible to market manipulation. This could include circular trading, wash trading, fake it till you make it type of schemes. This would drastically affect market players and traders that could permanently make them stay away from the markets.

These are the risks that are involved in tokenization of real world assets. An organization has to take care of these risks and would try to avoid or mitigate these risks to provide better products for the customers.