How to hedge macro risk underlying cryptocurrencies?

Chih L. Chen, CFA, FRM
6 min readApr 18, 2022


In a prior post , I noted the increased correlation between Bitcoin and Ethereum with the NASDAQ 100 Technology Stock Index and mentioned that this may reduce diversification benefits of holding cryptocurrencies.

Historically, one generally sees correlations of risk assets increase during times of uncertainty and stress and this was what lead to the failure during the Great Recession of 2008 as many failed to recognize the increase in correlation of counterparties to default during times of stress. Some may argue that cryptocurrencies is not a risk asset, but if you define risk as uncertainly, then cryptocurrencies definitely meets that definition as the prices are highly volatile. Yes, there is great disruptive potential of the blockchain technology and therefore potential for cryptocurrencies to increase further, but that does not mean it is not susceptible to a broad selling of risk assets as investors become more risk averse and want to protect their capital during a possible economic downturn.

As I noted in my my earlier post about rate hike, inflation, and GDP expectations, the probability of inflation (according to Bloomberg composite of contributing economists) was around 25% for US and 35% for EUR. Given the high inflation, geopolitical environment, uncertain regulatory framework, and COVID still lingering, the risks of a severe recession could potentially be much higher and one will likely see more sell offs like today when Goldman raised the probability of recession to 35% over the next two years.

Note that I am a HODLer (long term holder) of a small cryptocurrency position, but have recently swapped most of my exposure to USDC stablecoins after the recent rout. Although, I believe in the long term economics of cryptocurrencies, I cannot handle a severe drawdown as I was not in crypto early and do not have any gains to risk.

However, I am curious and wondered how could I profit from a rally in ETH if the upcoming merge was successful and potential broader adoption of crypto while protecting oneself from a crash in the risk assets.

If anyone recalls, many were successful shorting CDS and mortgages prior to the Great Recession unfolding in 2008. However, I don’t want to be short the entire market, but rather take the bet that crypto outperforms broader technology stocks if one believes that broader adoption of crypto will create greater returns seen in the stock market.

As noted in my prior post, the correlation between ETH and NDX increased significantly in the past year as macroeconomic risks increased. I performed a simple linear regression between monthly returns of ETH vs NDX and found a slope of roughly 3 (i.e. the returns of ETH were roughly 3x that of NDX).

I then see if there was a way to short the NDX and found that the ProShares Ultra Pro Short QQQ (SQQQ ticker) is in fact 3x short the NASDAQ100 index.

A quick scatterplot and regression of 3x short NDX index vs SQQQ returns shows that this is roughly the case.

As a normal retail investor without access to futures or ways to short the NDX directly, I will consider shorting the NASDAQ100 as a hedge to ETH exposure so that I can potentially keep my idiosyncratic exposure of ETH while hedging my macroeconomic exposure.

Additionally, I consider a retail investor not willing to put funds directly into ETH at this time due to uncertainty in either centralized exchanges or willingness to take custody risk of digital assets, but would like some ETH exposure and gains it through an investment in the Grayscale Ethereum Trust (ETHE ticker).

However, I do note that when I plot a $10K investment directly in ETH vs ETHE over the past year, there is a big divergence in 2022 as ETHE clearly underperforms ETH.

Further, I do a simple regression of daily returns of ETH vs ETHE and find that the daily returns are not as closely related as 3x short NDX index vs SQQQ.

However, for the purpose of this post, I am interested in whether or not one can invest some capital in ETHE if they believe in ETH merge and broader adoption of cryptocurrencies over the next 2 years, but want to hedge some of the macroeconomic risks underlying the broad stock market.

The following is a scatterplot of daily returns of ETH vs SQQQ, which shows the slope of ETH/SQQQ is roughly 80%.

As a very rough estimate, I back-test this strategy and assume that I had $20K to invest and invested $11K in ETHE and $9K in SQQQ (note that I am not maintaining a 50% ETHE and 50% SQQQ portfolio as the slope is less than 100% so I assume the returns of ETHE is less than 3X NDX and thus do not want to over hedge and take a portfolio mix of 55% ETHE and 45%SQQQ).

If I had invested $20K in the above strategy at the end of March 2021, I would have done much better if I had just held ETHE and cash and more surprisingly, I did not hedge much of my ETHE exposure during the selloff in Q3 of 2021 (the hedge with NDX did not protect against a sell off in crypto).

Next, I run this same test but assume I invested at the end of 2021. Under this scenario, we can see that the SQQQ hedge did protect our capital as it help keep the overall investment around $20K while the ETHE + cash portfolio saw a draw down of $5K or 25%.

As a final note. Correlations are unstable and it is risky to assume they will be stable. However, one can use the historical observation that correlations between risky assets tend to increase during times of uncertainly and stress to potentially hedge macroeconomic risks if one has a specific risk or view they want to hold. For example, if one believes that cryptocurrencies have the potential to increase significantly and outperform other risk assets, then one can take a more specific view of this risk by offsetting the other risk factors (e.g. in the example above the broader technology stock index). That isn’t to say the above strategy isn’t risky. It is risky as the correlation between tech stocks and cryptocurrencies can change and if one is wrong about crypto and there are specific risk factors in crypto that cause it to lose value, you could lose even more. For example if you short NDX but NDX goes up while ETH crashes due to technological failure or regulatory burdens.

Disclaimer: This is not meant to be investment advice or recommendation by any means. I do hold some small positions in cryptocurrencies. This post is for informational purposes only. Please do your own research.



Chih L. Chen, CFA, FRM

Treasury, finance, and risk professional with curiosity and interest at applying quantitative and data analysis to discover economic insights and opportunities.