InvestZ Archives | Page 179 of 183

Aug

2021

Guide to Eco-Friendly Cryptocurrencies

By Laurel Tincher | Growing Wealth, invest, Investing | Comments Off

Although there are many benefits to Bitcoin, the cryptocurrency has come under scrutiny due to the significant electricity use involved in mining and keeping the blockchain network running. This issue is one of the reasons Bitcoin has not become more widely adopted than it has so far.

Bitcoin miners globally use thousands of computers to solve complex algorithms in order to mine new bitcoins and verify transactions. This computational work keeps Bitcoin decentralized, secure, and available for use 24/7, but it also has a relatively large carbon footprint. However, not all digital currencies use as much electricity as Bitcoin, and there are ways that Bitcoin can be made into a more eco-friendly cryptocurrency as well.

The crypto industry recognizes Bitcoin’s electricity use, and is taking steps to reduce it. Some crypto miners use renewable energy sources in an effort to keep their costs down. The Bitcoin Mining Council claims that more than half of Bitcoin mining uses sustainable electricity, but some scientists have found that the Bitcoin network could consume nearly as much electricity as all global data centers combined.

Still, leaders in the crypto industry signed the “Crypto Climate Accord ,” an agreement to power 100% of global blockchains by renewables by 2025.

Why Does Bitcoin Require So Much Energy?

Bitcoin requires so much electricity because it uses a “proof-of-work” system that requires “work” using computing power in order to keep it running. The proof-of-work system essentially uses the proof of work as a way of validating transactions, mining new bitcoins, and keeping the blockchain working.

In addition to using more renewable energy for Bitcoin mining, there are other ways that Bitcoin can reduce its energy use in the coming years, such as the introduction of the lightning network, cloud mining, and off-chain transactions. But for now, Bitcoin’s electricity use continues to be high.

Recommended: How Much Energy Does Bitcoin Use?

12 Most Sustainable Cryptocurrencies

Are any cryptocurrencies eco-friendly? Yes, there are other types of cryptocurrencies and proof systems that don’t use as much electricity. These include “proof-of-stake (PoS),” “proof-of-storage,” and “proof-of-space.” Rather than relying on energy-intensive work, these proof systems use other types of verification and incentive structures. Even among proof-of-work cryptocurrencies, some are more energy-efficient than others, depending on the type of devices used for mining and the way the algorithm works.

There are alternative cryptocurrencies, or altcoins, that use far less electricity than Bitcoin. Some coins simply have fewer transactions, while others are actually designed in ways that are more energy efficient. Some popular cryptocurrencies that may be more eco-friendly than Bitcoin include:

1. Ethereum (ETH)

Ethereum is in the process of switching over to a PoS model, which will drastically cut its electricity use.

2. Nano

Nano is very energy efficient because it doesn’t even use mining, it uses a different form of proof-of-work system. It offers instant transactions with zero fees.

3. Chia (XCH)

Touted as one of the most eco-friendly cryptocurrencies, Chia uses a unique “proof of space and time” model that utilizes storage space on users’ personal computers to keep its network running. It creates “plots” of numbers, which it “farms” over time. Bram Cohen, the creator of BitTorrent, created Chia. The coin’s only environmental downside is that it requires the use of solid-state drives, burning through them quickly and creating a lot of e-waste.

4. Stellar Lumens (XLM)

A popular cryptocurrency that uses a small amount of electricity, Steller has a unique consensus model that uses nodes instead of a proof algorithm. It is a network created to be a bridge between cryptocurrencies and traditional financial institutions, similar to PayPal. Users like Stellar because it is fast, simple, and cost-effective for sending large transactions all over the world across any currency.

5. Polkadot (DOT)

Another Ethereum co-founder, Gavin Wood, created Polkadot, which uses a multi-chain network to go between different blockchains. It uses a nominated proof-of-stake (NPoS) model that requires holding or staking coins in the network instead of a mining process that would use more electricity.

6. Hedera Hashgraph (HBAR)

Like Nano, HBAR doesn’t use mining, and has quick, low-fee transactions. Large corporations such as Google, Boeing, and IBM support this cryptocurrency, which is used for micropayments and transaction fees.

7. Holo (HOT)

Holochain doesn’t use mining or much electricity, and it is scalable and less expensive than many other cryptos. Instead of a proof system, the cryptocurrency enables users to earn “HoloFuel” in exchange for sharing computing power and space on their personal computers to host peer-to-peer (P2P) apps on the network. This creates a very large network that can scale over time without centralization or huge increases in energy use.

8. Ripple (XRP)

Another popular cryptocurrency designed to use less electricity than Bitcoin, Ripple has its own calculator which determines the environmental impact of events and assets on its blockchain network.

Recommended: What Is Ripple (XRP)? How Does It Work?

9. IOTA

Iota doesn’t use mining, but instead uses a network of smaller devices that use less electricity.

10. Solarcoin (SLR)

This unique eco-friendly cryptocurrency promotes the creation and use of solar energy. Users who create solar energy are rewarded with Solar coins.

11. Bitgreen (BITG)

Similar to Solarcoin, Bitgreen rewards users for eco-friendly activities such as volunteering or carpooling.

12. EOSIO (EOS)

Another eco-friendly cryptocurrency. EOS uses proof-of-stake along with pre-mined tokens, rather than energy-intensive mining. Users like this crypto because it is very easy for developers to use, is low cost and highly scalable.

The Takeaway

Crypto evangelists may appreciate the many benefits of investing in digital assets, but worry about the impact on the environment and question whether blockchain is environmentally friendly. However, there are many other cryptocurrencies besides Bitcoin, many of which have a much smaller carbon footprint, and may make sense as one type of investment in a diversified portfolio.

Photo credit: iStock/MicroStockHub

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

External Websites: The information and analysis provided through hyperlinks to third-party websites, while believed to be accurate, cannot be guaranteed by SoFi. Links are provided for informational purposes and should not be viewed as an endorsement.

SOIN0621256

Aug

2021

What is a Crypto Bear Market?

By Colin Dodds | Growing Wealth, invest, Investing | Comments Off

Since Bitcoin’s launch in 2009, several crypto crashes have occurred, including some that have completely wiped out specific altcoins. Since those crashes happened in lesser-known forms of crypto or without extensive media coverage, not all investors are aware of them.

Despite the crashes, however, there haven’t been any sustained bear markets in Bitcoin, which is the de facto benchmark for cryptocurrencies.

What Is a Crypto Bear Market?

A crypto bear market is one in which the value of major cryptocurrencies, such as Bitcoin, have fallen at least 20% from their recent highs, and are continuing to fall. By contrast, a crypto bull market is one in which the major cryptocurrencies are on the rise.

One of the most famous crypto crash occurred in December 2017, when Bitcoin fell from almost $20,000 per coin to just over $3,200 in a matter of days. After that, it rallied, reaching a price of nearly $65,000 per coin in April of 2021, before dropping again to below $32,000 in May.

Traders aiming to time the markets aim to purchase cryptocurrencies or other assets at the bottom of a bear market, but it’s often difficult to know when a bear market has actually ended.

Why Is It Called a Bear Market?

The terms bull and bear markets come from stock trading, and according to some accounts their origins come from the style of attack each animal uses – a bull will charge with its horns pointed upward. A bear, on the other hand, towers over its opponents and swipes down.

Similarities Between Crypto and Stock Bull & Bear Markets

Investors don’t have experience with the performance of cryptocurrency during a stock bear market. The last true, sustained stock bear market occurred in 2007-2009. At the time, Bitcoin had just launched, gaining attention, if not yet acceptance. While calling a bull or a bear market in stocks or in cryptocurrency requires technical analysis of values, there are several other that both markets have in common:

Volatility

The value of both stocks and cryptocurrencies fluctuate over time, but some cryptocurrencies tend to gyrate severely due to liquidity constraints within the market and a less established derivatives market.

Recommended: Why Is Bitcoin So Volatile?

Trader Sentiment

In both the stock market and cryptocurrency negative trader sentiment can portend a bear market. However, contrarian traders in both cases may see market dips as an opportunity to buy cryptocurrency at a discount. Outside Influences Bear markets, in both stocks and cryptocurrency, can reflect external factors that change the way that investors value a particular asset. Those factors can include overall economic strength, interest rates, or geopolitical factors.

What Are the Signs of a Crypto Bear Market?

One of the most famous maxims in all of investing is “buy low, sell high.” In four words, it’s how investors make money. And it’s why, for crypto investors, knowing when a bear market is coming, or when one is just about to end, can make all the difference.

This is where the relative youth of the crypto market makes things difficult. With the stock market, economists, analysts and traders have decades and even centuries of data to sift through to find the trends and triggers that occurred just before a bear market turned to a bull and vice versa. Bitcoin, on the other hand, was launched in 2009.

Some warning signs of a crypto bear market include:

• Lower trading volume: This could indicate that people have begun holding their coins amid market uncertainty.

• “Backwardation”: This occurs when the price of an asset in the futures market is lower than its current market price.

• Death cross: This is a technical indicator in which an asset’s 50-day moving average crosses its 200-day moving average.

Get up to $1,000 in stock when you fund a new Active Invest account.*

Access stock trading, options, auto investing, IRAs, and more. Get started in just a few minutes.

*Customer must fund their Active Invest account with at least $25 within 30 days of opening the account. Probability of customer receiving $1,000 is 0.028%. See full terms and conditions.

What Are Indicators of a Crypto Bull Market?

Even though crypto’s history has essentially been a very lengthy bull market followed by a short, terrifying market free-fall, and another market bull run, some trends have popped up for investors to watch.

• Liquidity. Crypto took a hit at the beginning of the lockdowns in spring of 2020, when investors needed cash. But so did everything else. Then it rose, as the crisis receded and the Fed pumped trillions into the economy, aiding in Bitcoin’s liquidity and other cryptos alike.

• Adoption: If more companies and financial institutions adopt crypto, then it should move more in step with the economy, and be subject to less violent fluctuations. It’s a sign that the Wild West is being tamed. But adoption is a double-edged sword. If it’s your cab driver and barber who are talking about crypto, then it could mean that the market is oversaturated.

Should I Invest in Crypto?

There is also a baseline level of uncertainty with crypto that doesn’t exist in many other asset classes. While nobody thinks that regulators will shut down or curtail the stock market or that hackers will breach a stock exchange, these are common concerns with Bitcoin and other forms of cryptocurrency.

In addition to concerns about cryptocurrency regulation and blockchain security, there is also a growing debate about the energy costs of Bitcoin and other cryptocurrencies, which adds to the question mark over the long-term viability of crypto as a whole, at least in its current form. Those existential doubts rear up whenever Bitcoin, or other major cryptos, take a steep decline, or fall for too long.

That existential doubt can also be a major plus for investors, however. The shadows over crypto means that their declines are often incredibly steep. That creates regularly occurring opportunities to buy the crypto of your choice at a very steep discount, if you believe in the long-term growth of crypto as a whole, and if you can wait for the dip. Proponents of cryptocurrencies, including Bitcoin, believe that its growing adoption and use make it a smart long-term investment.

The Takeaway

Like all assets, cryptocurrencies go through cycles in which their value rises and falls. For short-term investors, especially, knowing the signs of a bear market can help you create a portfolio strategy that makes sense for your risk appetite and financial goals.

Photo credit: iStock/Eva-Katalin

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Crypto: Bitcoin and other cryptocurrencies aren’t endorsed or guaranteed by any government, are volatile, and involve a high degree of risk. Consumer protection and securities laws don’t regulate cryptocurrencies to the same degree as traditional brokerage and investment products. Research and knowledge are essential prerequisites before engaging with any cryptocurrency. US regulators, including FINRA , the SEC , and the CFPB , have issued public advisories concerning digital asset risk. Cryptocurrency purchases should not be made with funds drawn from financial products including student loans, personal loans, mortgage refinancing, savings, retirement funds or traditional investments. Limitations apply to trading certain crypto assets and may not be available to residents of all states.

Investment Risk: Diversification can help reduce some investment risk. It cannot guarantee profit, or fully protect in a down market.

²Terms and conditions apply. Earn a bonus (as described below) when you open a new SoFi Digital Assets LLC account and buy at least $50 worth of any cryptocurrency within 7 days. The offer only applies to new crypto accounts, is limited to one per person, and expires on December 31, 2023. Once conditions are met and the account is opened, you will receive your bonus within 7 days. SoFi reserves the right to change or terminate the offer at any time without notice.

First Trade Amount		Bonus Payout
Low	High	Bonus Payout
$50	$99.99	$10
$100	$499.99	$15
$500	$4,999.99	$50
$5,000+		$100

SOIN0521234

Aug

2021

What is an Impermanent Loss?

By Brian O'Connell | Growing Wealth, invest, Investing | Comments Off

Impermanent loss can be a financial fact of life for cryptocurrency token holders – who may not even be aware it exists.

Impermanent loss involves a liquidity risk centered on the pricing algorithms used by so-called decentralized finance (DeFi) exchanges, which can impact portfolio asset values.

To define impermanent loss, cryptocurrency investors must first understand the difference between holding tokens in an automated market maker (AMM) and holding coins on your own, usually in a crypto wallet. (An AMM is a digitalized and decentralized cryptocurrency exchange protocol that uses its own statistical formula to set cryptocurrency prices.)

Liquidity providers act as a broker of sorts, by depositing an equal number of assets into the exchange, with two funded assets per liquidity pool. Liquidity providers stake their digital assets to earn trading fees made in the pool, with the size of the liquidity pool contribution. Impermanent loss is the opportunity cost that comes from staking crypto with an AMM.

Recommended: What Is DeFi (Decentralized Finance)?

As in-the-know crypto traders might say, impermanent loss could leave an investor rekt, meaning with a substantial loss.

What Is Impermanent Loss?

An impermanent loss is the money that a liquidity provider loses when the value of crypto deposited into an automated market maker, a type of DeFi exchange, differs from the value of that crypto if it were stored in a crypto wallet.

Pricing volatility can present an investment risk when liquidity-minded investors hold tokens in an AMM, and when those prices do diverge significantly, impermanent losses can mount up, impacting the value of an overall crypto portfolio.

However, the losses can be offset–completely or partially–by fees that the decentralized exchange pays for liquidity providers. Exchanges that have high volume tend to pay higher fees to liquidity providers, which can minimize the impermanent losses that leave investors at a net negative.

How Does Impermanent Loss Happen?

The key factor with impermanent loss is the way automated market makers work. As noted above, AMM’s enable investors to trade digital financial assets like cryptocurrencies without the permission of the token holder. AMMs allow for this type of trading by leveraging liquidity pools in lieu of the more stable and traditional form of asset trading, which relies on the “buyer-and-seller” stock exchange model.

AMMs allow any investor to fund a liquidity pool and act as a de facto market maker in pairing trades and charging trading fees. Impermanent risk is the downside risk in that scenario.

With volatile assets like cryptocurrency, over time the value of those assets may not equal the value they held when first deposited (i.e., their dollar value can shift downward or upward from the time of deposit to the time of withdrawal.) The more substantial the price change, the higher the chances the liquidity provider is exposed to impermanent loss.

How much can a liquidity pool funder lose? The science isn’t exact, but data indicates that an asset price change of just 1.25% can lead to a 0.6% deprecation in funded pool assets, relative to holding the assets in a digital wallet instead of using the assets to pair trades. A significantly higher price change of five times the initial price deposit could lead to a 25% decrease in asset value.

When pairing trades, liquidity pools may have one asset that’s relatively stable and one asset that is susceptible to higher pricing volatility. In that case, the odds of a significant loss impairment are higher than when the paired tokens are both stable and have a low exposure to impairment loss.

An Impermanent Loss Example

In an AMM scenario, the protocol’s decentralized structure digitalizes the cryptocurrency trading model, essentially setting a price between two different cryptocurrency assets. AMM uses an algorithm to set these prices on a constant basis, which can trigger volatility between the two assets.

Often, those assets can differ in structure. For instance, one cryptocurrency may be a stablecoin and the other can be a more volatile crypto asset, like Ethereum. In this scenario, the more volatile asset is Ethereum, which can change value quickly on trading markets, even as de-fi exchanges set prices on the cryptocurrency.

Ideally, exchanges want to offer equal liquidity levels when setting a price between two assets. Yet when one of the assets quickly rises or declines significantly in value, it changes the pricing structure. Now, the automated market’s trading price on stablecoin and Ethereum (using the above examples) is out of skew with the real value of the more volatile asset (Ethereum, in this case.) The markets will try to fix this pricing discrepancy, as traders wade in to the AMM to buy and invest in Ethereum at a discounted price. When enough traders do this, they drive the price up, and the AMM pricing structure once again is in balance.

Recommended: What Is a Stablecoin?

That scenario can have a major impact on the liquidity holder’s portfolio value. The liquidity provider, usually a cryptocurrency investor who leverages automated markets to find profit opportunities, may lose value based on the way AMM operates. When the provider trades on an AMM platform, they’re normally required to fund the two assets (as in the stablecoin and Ethereum example above) so traders can transition between the two assets by trading those assets in pairs.

When one of the paired asset prices is volatile, the investor can wind up with more of one of the cryptocurrency assets than expected, and less of the other. That hit to the current value of their portfolio assets compared to what the assets would be worth if left untraded, and kept stored in a digital wallet (that difference represents the impermanent loss).

It’s worth noting the loss in value may be temporary, if the value of the asset returns to the value at deposit, before the liquidity provider removes their crypto. Until then it’s an unrealized loss that only becomes permanent when the investor pulls their coins from the liquidity pool for good.

The Takeaway

Cryptocurrency investors are increasingly using liquidity pools to cull profits from automated market makers. In the process, liquidity-minded investors may be leaving themselves exposed to imperfect DeFi asset pricing, leading to impermanent loss that can reduce the value of their cryptocurrency portfolios.

Jul

2021

Blockchain in Finance: What Does it Mean for Fintech?

By Brian Nibley | Growing Wealth, invest, Investing | Comments Off

While investors and asset managers have mixed opinions on the future of cryptocurrencies, many agree that blockchain–the technology that enables crypto trading–holds the potential to transform many different industries.

Blockchain technology is the infrastructure that makes trading Bitcoin and thousands of other cryptocurrencies possible. Invented in 2009 by a person or group known as Satoshi Nakamoto, a blockchain is one example of what’s known as distributed ledger technology (DLT).

Distributed ledgers keep records of transactions spread across different servers in multiple locations. Blockchains are special types of distributed ledgers that are immutable (they can’t be changed) and decentralized (they’re outside the control of a single entity).

Understanding Blockchain Basics

Blockchain technology processes transactions into groups referred to as “blocks.” Each new block gets attached to the block that came before it, creating an ever-growing chain of blocks. This is where the term “blockchain” comes from. Altering the data inside any single block would require changing the entire chain, something which requires massive amounts of computing power and is almost impossible in most cases.

However, the data held in blocks can take many forms, not just financial transactions. The ability to create an immutable, transparent, decentralized ledger of data creates many new possibilities. In addition to altcoins, several other industries outside of cryptocurrency are looking at different blockchain applications, including Fintech.

Blockchain Applications in Fintech

There are myriad ways that financial services can make use of blockchain technology. Most of them currently exist in a proof-of-concept or pilot phase, meaning their real-world applications have yet to be consistently utilized or widely adopted.

Payments

Payment systems represent the most tried-and-true use case for blockchain in finance, since that’s essentially how crypto trading works. Sending money across national borders using the traditional financial system takes a long time, and can get costly as each intermediary that facilitates the transaction receives a fee. Blockchain has the potential to make this process faster and more affordable by enabling things like:

• Fast and secure cross border payments

• Multiple forms of payment – cryptocurrency, stablecoin cryptocurrency, etc.

• Reduced fraud risk through digital Know Your Customer (KYC) and Anti-Money Laundering (AML) data

• Smart contracts, digital agreements between two parties that get stored within the blockchain.

Insurance

Blockchain could allow insurers to more efficiently handle claims. IBM reports that it is already using blockchain technology to help clients automate underwriting, settle claims, and reduce fraud.

Asset Management

When it comes to asset management, blockchain financial services can help real estate funds, private equity firms, venture capital firms, and similar institutions. These groups often find themselves to remain compliant with changing regulations and improve risk management. Blockchain security could also offer an additional layer of protection for their assets.

Blockchain improve efficiency in asset management through:

• Tokenization of securities, leading to greater liquidity and market access

• Customizable privacy settings for confidential transactions

• Reduced human errors in shareholder voting

• Improved governance with greater transparency for investors

• Automation of other tasks

Regulatory Compliance

Keeping up with the pace of regulatory change can be challenging for some financial institutions. That’s especially true when an organization conducts business across national borders and exposes itself to regulatory frameworks in multiple jurisdictions. Blockchain can help in ways such as:

• Programming digital assets with specific governance attributes

• Eliminating human errors that occur in manual processes

• Improving network governance

Potential Drawbacks of Blockchain in Finance

As you can see, there are a variety of ways that fintech and blockchain could improve many cumbersome tasks that people and organizations deal with today. The main benefits have to do with increases in speed, automation of complex processes, and “trustless” processes, meaning a central entity doesn’t have to be trusted with information or transactions.

There are also a few potential drawbacks, though. They mostly have to do with the impracticality of creating and maintaining an independent, decentralized blockchain.

Maintaining Decentralization

Decentralization democratizes blockchain by making it resistant to central authority and makes things more secure by eliminating any single point of failure. But when a single organization creates its own blockchain for specific purposes, they might be the only ones with an ongoing incentive to maintain it. This could lead to the nodes becoming centralized, somewhat defeating the purpose of having a blockchain in the first place.

Trust Issues

With the Bitcoin blockchain, users trust the transaction data because Bitcoins are “born” on that blockchain. From the moment Bitcoin is mined into existence, everyone can see where coins go and what wallets they’re in. However, most of the potential use cases for blockchain finance involve assets that were not born on-chain (insurance claims, securities, loans, titles, etc.). For this reason, it’s possible that the data being put onto a blockchain in this manner could contain mistakes or inaccuracies.

Environmental Concerns

The blockchain requires massive computing power, which makes it an inefficient industry from an energy standpoint.

The Takeaway

Creating a blockchain in finance, while appealing in principle, might be hard to do in practice while still preserving the unique features that make a genuine blockchain desirable. Still, the technology holds significant promise for improving the way that many financial transactions occur.

Photo credit: iStock/Eoneren

Jun

2021

What Are Currency Hedged ETFs?

By Matthew Zeitlin | Financial Independence, Growing Wealth, invest, Investing | Comments Off

Currency-hedged ETFs are exchange-traded funds created to minimize the risks of fluctuating exchange rates in ETFs that have foreign holdings.

Many investment companies offer two versions of the same ETF with one version including a currency hedge. The latter ETF has the same holdings as the former, but it also includes derivatives purchased to protect–or hedge–against currency risk. The protections come at a cost, however, and hedged ETFs may have higher fees than non-hedged ETFs.

Why Do Investors Use Currency-Hedged ETFs?

Since currency values fluctuate, exchange rates can affect the total return on an asset. While ETFs provide investors with a significant diversification, they don’t offer any protection against the investment risk created by foreign exchange rates. So purchasing an ETF focused on overseas markets creates an additional layer of volatility within the investment.

Currency shifts can boost or diminish returns on international investments — but they almost always make them more uncertain. If the local currency loses value against the ETF’s currency (in this case the dollar), that can offset returns for the dollar-based investor, even if the assets that make up the security’s returns go up in their own currency.

Since many ETF investors are not interested in forex trading, they can minimize their currency risk by purchasing a currency-hedged ETF, which can smooth out volatility related to foreign exchange rates.

Currency-hedged ETFs may have a slightly higher expense ratio than non-hedged ETFs, due to the cost of the futures contracts as well as potential expenses associated with the tools and people who develop the hedged currency strategy.

Recommended: How to Invest in International Stocks

How Do Exchange Rates Impact Investment Returns?

While a strong dollar may be good when you’re buying assets in a foreign currency, it can hurt returns on assets denominated in a foreign currency. Over the past decade, the strong dollar has meant that hedged portfolios tend to outperform those that weren’t hedged.

Here’s an example: If the dollar-to-foreign-currency conversion rate is 1 to 2, as in one dollar buys you two units of the foreign currency, and you buy 100 shares of a stock at 5 foreign currency units per share, it will cost you $250, or 500 foreign currency units. Now, let’s say those shares double, so that 100 shares are worth 1,000 foreign currency units instead of 500 and your investment is now worth $500, compared to the $250 you spent initially.

But if the dollar strengthened so that the conversion rate went from 2 foreign currency units per dollar to 4 foreign currency units per dollar, those 100 shares are still worth 1,000 foreign currency units but for a US investor, their $250 investment would have shown no gain. While this is an extreme currency fluctuation, it illustrates the reason that some investors might purchase currency-hedged ETFs.

How Does Currency Hedging Work?

Investors use two methods to hedge against currency risk: static hedging and dynamic hedging.

Static Hedging

Static hedging is the most basic kind of hedging. An ETF that uses static hedging has one strategy that it executes, regardless of market conditions. An ETF using this strategy would buy contracts in the future market that lock in a currency’s value relative to the dollar or set parameters around it.

The contract is an agreement to buy a currency at a future price, which has the same effect of cancelling out currency gains or losses if they move from the currency’s current value against the dollar.

Dynamic Hedging

Dynamic hedging may incorporate multiple strategies or change strategies as market conditions change. Dynamic hedging is not always in effect, instead the hedge is “put on” based on the judgment of the ETF manager. Sometimes this judgment reflects an algorithm or series of rules that looks at market conditions for determining when to buy and sell financial instruments that hedge currency exposure.

For example, an ETF might have a rules-based system that looks at the trend of a currency’s value against the dollar, the interest rates in both countries, and the overall value of that currency (namely if it’s more expensive than the dollar). Those data points and, specifically, how they change over time, would determine whether and how much to hedge the ETF at any given time

The Takeaway

Currency-hedged ETFs are one way to get exposure to foreign markets and protection against the currency risks that come with that type of investment, but they may cost more than non-hedged ETFs. It’s important for investors to understand how they work, as they start to build their own investment strategy and learn how to pick ETFs to include (if any) in their portfolio.

If you’re ready to start putting that strategy into action, a great place to start is the SoFi Invest investing platform, which offers personalized investment advice, a range of ETFs, and automated investing.

Start investing today.

Photo credit: iStock/Delmaine Donson

SoFi Invest®
INVESTMENTS ARE NOT FDIC INSURED • ARE NOT BANK GUARANTEED • MAY LOSE VALUE
SoFi Invest encompasses two distinct companies, with various products and services offered to investors as described below: Individual customer accounts may be subject to the terms applicable to one or more of these platforms.
1) Automated Investing and advisory services are provided by SoFi Wealth LLC, an SEC-registered investment adviser (“SoFi Wealth“). Brokerage services are provided to SoFi Wealth LLC by SoFi Securities LLC.
2) Active Investing and brokerage services are provided by SoFi Securities LLC, Member FINRA (www.finra.org)/SIPC(www.sipc.org). Clearing and custody of all securities are provided by APEX Clearing Corporation.
For additional disclosures related to the SoFi Invest platforms described above please visit SoFi.com/legal.
Neither the Investment Advisor Representatives of SoFi Wealth, nor the Registered Representatives of SoFi Securities are compensated for the sale of any product or service sold through any SoFi Invest platform.

Fund Fees
If you invest in Exchange Traded Funds (ETFs) through SoFi Invest (either by buying them yourself or via investing in SoFi Invest’s automated investments, formerly SoFi Wealth), these funds will have their own management fees. These fees are not paid directly by you, but rather by the fund itself. these fees do reduce the fund’s returns. Check out each fund’s prospectus for details. SoFi Invest does not receive sales commissions, 12b-1 fees, or other fees from ETFs for investing such funds on behalf of advisory clients, though if SoFi Invest creates its own funds, it could earn management fees there.
SoFi Invest may waive all, or part of any of these fees, permanently or for a period of time, at its sole discretion for any reason. Fees are subject to change at any time. The current fee schedule will always be available in your Account Documents section of SoFi Invest.

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Guide to Eco-Friendly Cryptocurrencies

Why Does Bitcoin Require So Much Energy?

12 Most Sustainable Cryptocurrencies

1. Ethereum (ETH)

2. Nano

3. Chia (XCH)

4. Stellar Lumens (XLM)

5. Polkadot (DOT)

6. Hedera Hashgraph (HBAR)

7. Holo (HOT)

8. Ripple (XRP)

9. IOTA

10. Solarcoin (SLR)

11. Bitgreen (BITG)

12. EOSIO (EOS)

The Takeaway

What is a Crypto Bear Market?

What Is a Crypto Bear Market?

Why Is It Called a Bear Market?

Similarities Between Crypto and Stock Bull & Bear Markets

Volatility

Trader Sentiment

What Are the Signs of a Crypto Bear Market?

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What Are Indicators of a Crypto Bull Market?

Should I Invest in Crypto?

The Takeaway

What is an Impermanent Loss?

What Is Impermanent Loss?

How Does Impermanent Loss Happen?

An Impermanent Loss Example

The Takeaway

Blockchain in Finance: What Does it Mean for Fintech?

Understanding Blockchain Basics

Blockchain Applications in Fintech

Payments

Insurance

Asset Management

Regulatory Compliance

Potential Drawbacks of Blockchain in Finance

Maintaining Decentralization

Trust Issues

Environmental Concerns

The Takeaway

What Are Currency Hedged ETFs?

Why Do Investors Use Currency-Hedged ETFs?

How Do Exchange Rates Impact Investment Returns?

How Does Currency Hedging Work?

Static Hedging

Dynamic Hedging

The Takeaway

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