EA - It was probably hard to hedge financial risk to EA by Stan van Wingerden

Link to original articleWelcome to The Nonlinear Library, where we use Text-to-Speech software to convert the best writing from the Rationalist and EA communities into audio. This is: It was probably hard to hedge financial risk to EA, published by Stan van Wingerden on January 19, 2023 on The Effective Altruism Forum.SummaryHedging essentially means reducing the risk of your assets. [Link]Deciding whether or not to hedge (future) cashflow requires making a risk-reward tradeoff. [Link]Both the risks and the rewards of your hedges are uncertain & hard to guess for a variety of reasons. [Link]I think it was probably hard / expensive to safeguard EA crypto funds against the big crypto downswing, but this depends on the circumstances (which I know little about). [Link]IntroThe financial situation of EA has significantly worsened over the last few months. This is not only due to the FTX debacle, but also due to a broad downswing in cryptocurrency and tech stock prices. It’s worth investigating whether the financial risk of these events to EA organisations could have been mitigated somehow. This risk has many components, but the main financial risk issue to EA organisations I’m discussing here is the combination of multi-year $-denominated spending plans with future donations without fixed $ values. These cases show up all the time, be it from expected donations from companies or from broad financial exposure to different sectors, so one might wonder if EA organisations could have hedged some part of these future donations.This post deals with what it means to reduce risk through hedging (crypto) exposure, why one would want to, and why doing so might be undesirable or difficult in practice. I’ve tried to keep it non-technical, as it is intended to help a discussion on whether or not EA charities should have hedged their crypto exposure. I think most of this might still apply to stocks, but I’m no expert in that so I’m not discussing that. Definitely do not take any of this as financial or legal advice.What is hedging?Hedging essentially means reducing the risk of your assets. This can be done in a variety of ways, the most common of which use derivatives to place a bet that pays off if the price of the underlying crypto token goes down. For example, if you have 1 Bitcoin worth ~17000$ today but possibly less in 2024, you can agree with someone you trust to sell this bitcoin to them in 2024 for 17000$. This agreement to sell in the future functions as a hedge against price decreases of bitcoin: even if bitcoin drops in value, you’d still get 17k in 2024. (On the flip side, if bitcoin were to increase in price you would miss out on that as well.) One way to think about a hedge is as an insurance policy against bad market situations.You could also of course sell the bitcoin now in order to get rid of the risk in 2024. I’m going to ignore this possibility and focus instead on hedging future income, as I feel that those situations are most relevant to EA. In the above example, this would mean the bitcoin donation is made in 2024, you don’t have access to it beforehand, but you want to get rid of the bitcoin price risk in the meantime.A more uncertain but potentially more valuable hedge would use assets that are correlated with the amount you’re expected to be donated. If you both 1. expect to be donated large amounts of money by some company deeply involved in cryptocurrency and 2. expect the health of this company to be strongly related to the price of Bitcoin, then you can ‘hedge’ your expected future donations by taking on a bitcoin short. After all, if the company goes under, then you expect the price of bitcoin to drop, and therefore your hedge should pay off in that scenario, allowing you to still receive some money in the place of your missed donations. Compared to the above example of hedging a to-be-donated bitcoin, this example is not a strictly risk-lowering hedge, as your correlation assumptions can turn out to be wrong. Still, this ...