In a short summary, holding a 1x leverage sell short position on BYDFi allows traders to synthetically hedge their position's value in USD. The reason for doing this is mainly to maintain the USD value of your crypto coins in a highly volatile market environment. Before we begin addressing this common question raised by our traders, we will first need to understand what is Synthetic Hedging.
Synthetic Hedging = Synthetic hedging is the term given to the utilization of a given financial function to indirectly achieve the same hedging objective as described above. Hence, for BYDFi inverse perpetual, one method of achieving it is via placing a 1x leverage sell short position with 100% of your coin assets. Refer to the example below.
Example 1: Holding 1 BTC without placing a 1x leverage sell short position
Trader A purchases 1 BTC using our BYDFi Fiat Gateway function when BTCUSD was trading at approx $60,000. Trader A also did not open nor close any position and strictly kept the 1 BTC untouched inside his BitYard account.
- Trader A's 1 BTC maintains its value at $60,000 if he decides to withdraw from BYDFi to a spot exchange and convert it into USD (excluding any withdrawal fees)
Scenario 1 - BTCUSD plunged to $30,000.
- Trader A's 1 BTC is now only worth $30,000 if he decides to withdraw from BYDFi to a spot exchange and convert it into USD (excluding any withdrawal fees)
- Immediately Trader A will suffer an unrealized loss of $30,000 due to downward market movement in BTCUSD price.
Scenario 2 - BTCUSD pumped up to $120,000.
- Trader A's 1 BTC is worth $120,000 if he decides to withdraw from BYDFi or convert it into USD (excluding any withdrawal fees)
- Immediately Trader A will gain an unrealized profit of $60,000 due to upward market movement in BTCUSD price.
Summary: Even though Trader A did not perform any trades on BYDFi, the value of the 1 BTC crypto coin in USD will fluctuate greatly as a result of unpredictable volatile price movements.
Example 2: Holding 1 BTC and placing a 1x leverage sell short position
Trader A purchases 1 BTC using our BYDFi Fiat Gateway function when BTCUSD was trading at approx $60,000. Trader A immediately opened a 1x leverage sell short position with the entire 1 BTC balance inside his account.
- If the price of BTCUSD maintains at $60,000, Trader A's position will neither gain any profits nor suffer any losses (excluding any trading fees)
- Trader A's 1 BTC maintains its value at $60,000.
Scenario 1 - BTCUSD plunged to $30,000.
- Using the formula for calculating P&L for BYDFi Inverse Perpetual, Trader A's position would have gained an unrealized profit of 1 BTC
- Assuming Trader A decides to close his position, his total account balance would have 1 BTC (initial account balance) + 1 BTC (realized profit from closing sell short position) = 2 BTC (excluding any trading fees)
- Even though BTCUSD is now trading at half its value ($30,000), Trader A now has 2 BTC.
Total USD value of his coins inside his BYDFi account = 2 BTC x $30,000 = $60,000
Scenario 2 - BTCUSD pumped up to $120,000.
- Using the formula for calculating P&L for BYDFi Inverse Perpetual, Trader A's position would have suffered an unrealized loss of 0.5 BTC
- Assuming Trader A decides to close his position, his total account balance would have 1 BTC (initial account balance) - 0.5 BTC (realized loss from closing sell short position) = 0.5 BTC (excluding any trading fees)
- Even though BTCUSD is now trading at twice its value ($120,000), Trader A now has 0.5 BTC left inside his account.
Total USD value of his coins inside his BYDFi account = 0.5 BTC x $120,000 = $60,000
Summary: By placing a sell short position using 1x leverage using his entire BTC balance, Trader A can maintain its value at $60,000 despite the unpredictable price movements in a volatile market condition.