Is Ripple (XRP) a perfect Hedge for Bitcoin?

For many who follow cryptocurrency closely, it is well known Ripple XRP has been coined a "centralized" or "bank friendly" currency. One of it's primary use cases is to provide quick cross-border payments across more than 25 countries. The source of such quick/liquid cross-border payments is XRP.

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Decentralization vs. Centralization

One of the main differences between Bitcoin and Ripple is that Bitcoin is decentralized while Ripple is intended to partner with banks.

Many banks have partnered with or are expected to partner with Ripple in the future.

Meanwhile, Bitcoin is a cause of much speculation as regulators all over the world try to find ways of re-gaining lack of control over Bitcoin; for example, with China imposing strict regulatory environment banning ICOs & exchanges, and the U.S. SEC cracking down on ICO's.

Note: Some argue the core miners of BTC are the "central authority", but we are talking government perspective here in defining centralized vs. decentralized.

What is a Hedge?

A hedge is effectively an offsetting position that is supposed to move in the opposite direction of the original position as to limit risk/loss. For example, if you transac in U.S. dollars have a loan payable in a foreign currency, if the cost of acquiring the foreign currency goes up, there is an economic loss in paying back the loan. Therefore, you may acquire foreign currency today (or an option to purchase the currency in the future at a fixed price) to lock in the price to be paid for the foreign currency used to pay off the loan.

Is Ripple (XRP) a perfect Hedge for Bitcoin?

Perfect Hedge eliminates all risk. This is not easy to achieve, it relies on what I consider to be four critical assumptions.

Critical Assumption #1: I have considered that an investment in 1 Bitcoin, I would like a hedge of the risk that Bitcoin is made illegal through the lobbying efforts of the central banks.

Critical Assumption #2: Another consideration in this is I would have to believe that Bitcoin becoming illegal would drive it's price down to a nominal amount.

Critical Assumption #3: I have considered Ripple XRP is a primary contender for bank adoption based on research (however those more educated on the topic than me, feel free to speak up).

Critical Assumption #4: In order to have a perfect hedge, I would have to assume the news of Bitcoin becoming illegal worldwide, and an endorsement of XRP, would cause the market capitalizations of the two currencies to Invert. To swap market caps, the $7.8 billion market cap of XRP would have to increase approximately 13-fold, and the opposite would have to occur for BTC's $98 Billion market cap.

Hypothetical Pictorial Scenario - The Perfect Hedge

Below is the scenario I am trying to hedge, on a hypothetical basis BTC and XRP market capitalizations invert:

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Takeaway - Risks in this Assumption

My initial conclusion was that I might consider to acquire 2300 XRP for every 1 Bitcoin, so that I can hedge against a complete inversion in the value of the two currencies.

It is possible that, if Bitcoin was made illegal worldwide and the price declined, XRP wouldn't move up to fully replace Bitcoin - this is known as Basis Risk, the risk that hedging asset does not move in the opposite direction as expected.

It is also possible Ethereum or some other Altcoin is favored over XRP by the central authorities, and I picked the totally wrong asset as a hedge.

I am not a financial/investing expert, so I could be totally calling this wrong. Still, it is fun to think about applying the academic concept to this new market.

Disclaimer: Author is not an investment professional. This is not an investment recommendation, do your own research, it is your sole responsibility to make your own financial decisions. This blog does not constitute, create or form a professional-client relationship of any kind, or in any manner, it places sole accountability and responsibility on the user or reader if they make any legal, financial or other decisions based on the information obtained. Author has holdings in both XRP and Bitcoin.

Cover Picture was obtained as a screenshot of https://coinmarketcap.com/

Sources

http://www.investopedia.com/terms/h/hedge.asp
https://ripple.com/use-cases/banks/

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