What Are the Different Types of Crypto Structured Notes Available for Hedging? ▴ Question

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Concept

The imperative to manage risk in digital asset portfolios is a direct consequence of the market’s inherent volatility. This volatility, while a source of significant opportunity, presents a complex challenge for investors seeking to protect capital and achieve consistent returns. Crypto structured notes have emerged as a sophisticated solution, offering a pathway to mitigate risk while retaining exposure to the potential upside of the crypto market. These instruments are not merely a repackaging of traditional financial products; they represent a bespoke approach to risk management, tailored to the unique characteristics of digital assets.

Crypto structured notes offer a tailored approach to risk management in the volatile digital asset market.

At their core, crypto structured notes are investment products that combine a traditional investment, such as a bond or a stablecoin, with a derivative component, typically options or futures. This combination allows for the creation of a wide range of risk-return profiles, from principal-protected notes that offer a guaranteed return of capital to yield-enhancement strategies that aim to generate income in sideways markets. The design of these products is a direct response to the need for more nuanced investment tools in the crypto space, moving beyond simple buy-and-hold strategies to a more active and strategic approach to portfolio management.

The development of crypto structured notes has been driven by the growing sophistication of the digital asset market and the increasing demand from institutional and retail investors for more advanced risk management tools. As the market matures, so too does the need for products that can address specific investment objectives, such as hedging against downside risk, generating income, or participating in market upside with limited capital commitment. Crypto structured notes provide a framework for achieving these objectives, offering a level of customization and flexibility that is not available through direct investment in cryptocurrencies alone.

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Strategy

The strategic application of crypto structured notes for hedging purposes is a multifaceted discipline, requiring a deep understanding of the underlying products and their mechanics. The choice of a particular structured note will depend on a variety of factors, including the investor’s risk tolerance, market outlook, and specific hedging needs. Each type of structured note offers a unique risk-return profile, making it suitable for different market conditions and investment objectives.

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Principal-Protected Notes

Principal-protected notes are designed for risk-averse investors who prioritize capital preservation. These products typically combine a zero-coupon bond or a stablecoin deposit with an options strategy, ensuring that the investor’s initial investment is returned at maturity, regardless of the performance of the underlying asset. The potential for upside is typically capped, but the downside is limited to the opportunity cost of not investing in a higher-return asset.

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Shark Fin Notes

Shark Fin notes are a popular type of principal-protected product that offers a guaranteed minimum return, with the potential for a higher payout if the price of the underlying asset stays within a predetermined range. The payout structure resembles a shark’s fin, hence the name. These notes are available in both bullish and bearish versions, making them suitable for a variety of market outlooks.

Bullish Shark Fin ▴ This note is designed for investors who expect the price of the underlying asset to rise moderately. The maximum payout is achieved if the price at expiration is within the specified range. If the price exceeds the upper bound of the range, the investor receives the principal back plus a small, guaranteed coupon.
Bearish Shark Fin ▴ This note is for investors who anticipate a moderate decline in the price of the underlying asset. The payout structure is the inverse of the bullish version, with the maximum return achieved if the price at expiration is within the specified range.

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Yield Enhancement Notes

Yield enhancement notes are designed to generate income in a variety of market conditions, particularly in sideways or range-bound markets. These products typically involve selling options to generate premium income, which is then passed on to the investor in the form of a higher yield. While these notes offer the potential for attractive returns, they also carry a higher level of risk than principal-protected notes.

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Dual Investment Notes

Dual Investment notes are a popular type of yield enhancement product that allows investors to earn a high yield on their crypto holdings while also setting a target price to either buy or sell a cryptocurrency in the future. These notes are available in two versions:

Buy Low ▴ This note is for investors who want to buy a cryptocurrency at a price lower than the current market price. The investor deposits a stablecoin and sets a target price. If the price of the cryptocurrency falls to or below the target price at expiration, the stablecoin is used to buy the cryptocurrency at the target price. If the price remains above the target price, the investor receives their stablecoin back plus a high yield.
Sell High ▴ This note is for investors who want to sell a cryptocurrency at a price higher than the current market price. The investor deposits a cryptocurrency and sets a target price. If the price of the cryptocurrency rises to or above the target price at expiration, the cryptocurrency is sold at the target price. If the price remains below the target price, the investor receives their cryptocurrency back plus a high yield.

The following table provides a comparison of the different types of crypto structured notes discussed:

Product Type	Primary Objective	Risk Profile	Ideal Market Condition
Shark Fin	Capital Preservation	Low	Moderately Bullish or Bearish
Dual Investment	Yield Enhancement	Medium	Sideways or Range-Bound
Convert Plus	Price Locking & Yield	Medium	Volatile
Future Plus	Leveraged Returns	High	Strongly Bullish or Bearish

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Execution

The execution of a hedging strategy using crypto structured notes requires a careful consideration of the product’s parameters and the underlying market conditions. The process begins with a thorough analysis of the investor’s risk tolerance and investment objectives. Once these have been established, the investor can select the appropriate structured note and customize its parameters to meet their specific needs.

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Product Selection and Customization

The selection of a crypto structured note will depend on the investor’s market outlook. For example, an investor who is bullish on a particular cryptocurrency but wants to protect against downside risk might choose a Bullish Shark Fin note. Conversely, an investor who is bearish on a cryptocurrency and wants to generate income from their holdings might choose a Sell High Dual Investment note.

Once a product has been selected, the investor can customize its parameters to suit their specific needs. These parameters may include:

Underlying Asset ▴ The cryptocurrency on which the structured note is based.
Tenor ▴ The duration of the investment, typically ranging from a few days to several months.
Target Price ▴ The price at which the investor wants to buy or sell the underlying asset (for Dual Investment notes).
Price Range ▴ The range within which the price of the underlying asset must stay for the investor to receive the maximum payout (for Shark Fin notes).

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Risk Management

While crypto structured notes can be effective tools for hedging, they are not without risk. It is important for investors to understand the risks associated with each product and to implement a robust risk management framework. Some of the key risks to consider include:

Market Risk ▴ The risk of losses due to adverse movements in the price of the underlying asset.
Counterparty Risk ▴ The risk that the issuer of the structured note will default on their obligations.
Liquidity Risk ▴ The risk that the investor will not be able to sell their structured note before maturity.

Effective risk management is paramount when utilizing crypto structured notes for hedging.

The following table provides a more detailed breakdown of the mechanics of a Bullish Shark Fin note:

Scenario	Condition	Payout
Price within Range	Settlement Price is between the lower and upper price bounds	Principal + (Principal (Guaranteed APR + (Settlement Price – Lower Price Bound) / (Upper Price Bound – Lower Price Bound) (Bonus APR – Guaranteed APR)))
Price above Range	Settlement Price is above the upper price bound	Principal + (Principal Guaranteed APR)
Price below Range	Settlement Price is below the lower price bound	Principal + (Principal Guaranteed APR)

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References

Darwinbit. “4 Ways to Hedge Against Volatility with Crypto Structured Products.” Darwinbit, 19 Nov. 2023.
Alpha Venture DAO. “Simplifying Crypto Structured Products.” Alpha Venture DAO, 4 Jan. 2023.
Yield App. “An introduction to crypto structured products ▴ Variable risk-return profiles.” Yield App, 26 Jan. 2023.
Medium. “An introduction to crypto structured products ▴ Variable risk-return profiles.” Medium, 2 Aug. 2023.
Darwinbit. “How to Choose a Crypto Structured Product.” Darwinbit, 19 Nov. 2023.

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Reflection

The emergence of crypto structured notes marks a significant step forward in the evolution of the digital asset market. These products offer a level of sophistication and customization that was previously unavailable, providing investors with the tools they need to navigate the complexities of the crypto landscape. As the market continues to mature, we can expect to see the development of even more innovative and advanced structured products, further expanding the range of options available to investors for hedging and risk management.

The ability to tailor risk-return profiles to specific investment objectives is a powerful tool, but it also requires a deep understanding of the underlying products and the risks involved. The successful implementation of a hedging strategy using crypto structured notes depends not only on the selection of the right product but also on the implementation of a robust risk management framework. As the digital asset market continues to evolve, so too will the tools and strategies available to investors for managing risk and achieving their financial goals.