How to Take Advantage of Crypto Volatility?

  • By: Walter Dunphy ACCA
  • Date: March 28, 2022
  • Time to read: 4 min.

Crypto Investing is not for the faint-hearted, if you haven’t experienced a 50% drop in the price of one of your crypto assets then you may be in a very small group of people. Because the industry is so new the volatility levels that investors have to navigate are much higher than you would expect by investing in stocks. But can you take advantage of the huge spikes in volatility?

Just how much more volatile is crypto than investing in stocks

A good measure of the volatility of an asset is its Vega (Implied Volatility), at the time of writing Bitcoin has a 6 month implied volatility measure of 72%. Essentially what this means is the market expects the Bitcoin price to be within + or – 72% of its current share price over the next 6 months.

If we compare then compare this to a stock such as Proctor and Gamble (PG) which has an implied volatility measure of 20.3%. Volatility can be a nuisance for nuisance if you are a long term investor. You would much prefer to see your portfolio growing slowly but steadily.

But if you are a trader then volatility can be your friend, there are great opportunities to profit from the rise and fall in the volatility in markets. Up until recently, there were no ways for traders to trade in the crypto market to trade on its volatility. But one project set out to change this – Crypto Volatility Index (CVI) developed by COTI.

COTI set out to develop decentralised version of the VIX for the crypto world (The VIX is a measure of the stock market’s expectation of volatility based on S&P 500 index options).

How does it work?

The CVI protocol is built on Ethereum and Polygon and tracks the 30 day implied volatility of Bitcoin and Ethereum. The Index can range anywhere from 0-200 based on what the expected price volatility of the market is at that time.

The closer the index is to 200 the higher the implied volatility in the crypto market. As we can see from the below charge the CVI index recorded its highest levels in March 2020 and May 2021 when we experience some of the biggest crashes in crypto prices in recent times.

You two different indexes that you can chose from:

  • CVI Index – The index tracks the 30-day implied volatility of Bitcoin and Ethereum
  • ETHVI Index – The index tracks the 30-days implied volatility of Ethereum

To connect and use the CVI protocol you can use your MetaMask wallet. Traders can then open a position with ETH or USDC

The Crypto Volatility Index can be used to profit from volatility or also to hedge your other crypto investments against any spikes in market volatility.

If you hold an open position and there is a spike in volatility then you will make a profit. Conversely, if volatility decreases then you will have a loss. Traders will also earn $GOVI tokens that can be claimed as an added reward. GOVI tokens can be staked to earn a share of the fees collected by the platform.

On the other side of the transaction, we have liquidity providers who are hoping the volatility stays the same or decreases. If this is your strategy then you can also profit by providing liquidity to the platform. Liquidity providers earn 50% of the Purchase Fees and 100% of the funding fee traders pay, which we will go through in the next section.

The Fees

Once you open a CVI position you cannot sell it within the next 6 hours, if you decide to sell between 6 and 48 hours you will pay higher selling fees. These fees decrease over time and will be much lower if you wait until after 48 hours from the time you open your position. The fees remain at 0.3% after 48 hours.

Now let’s talk about the fees, the majority of these fees are variable and will be determined individually for each investor depending on the volatility present at the time of opening the position.

You will have to pay fees when opening and closing your position, there will also be ongoing funding fees to compensate liquidity providers for taking risks. The funding fee will be charged on an hourly basis until you liquidate your position.

The below graph show the funding fee rate at each different volatility level for the CVI:

Volatility Tokens

Alternatively, CVI have developed new volatility tokens.

  • CVOL – pegged to CVI index
  • ETHVOL – pegged to ETHVI Index

By buying and selling Volatility Tokens, traders can easily trade volatility on DEXs and even CEXs, making the Crypto Volatility Index (CVI) much more accessible to the greater DeFi ecosystem.

The new addition could help volatility trading go more mainstream in crypto.

In Summary

CVI Finance is the best place to start if you want to learn about hot you can hedge against or profit from volatility. They have plenty of docs, videos and explainer materials to help you get to grips with their platform.

As we have seen with crypto over the past number of years, there are constant news and other catalysts that send crypto into either a buying or selling frenzy which can cause a big spike in volatility. Learning how to use this to your advantage could help to increase your overall returns in the long run.

Disclaimer: This blog post is for informational and educational purposes only and should not be construed as financial advice.

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