A new startup named Hedgy is looking to tackle one of bitcoin’s biggest problems – volatility.

While an entire industry including payment processors, wallets and data-driven tools has been built around bitcoin, the thorny issue of how to reduce its volatility against more familiar fiat currencies still remains.

The team at Hedgy thinks that the ability to use multi-signature addresses to execute derivative contracts might be a way for bitcoin companies to “hedge,” or mitigate, the risk inherent in bitcoin’s fluctuating value.

Matt Slater, CEO of Hedgy, told CoinDesk he believes his startup is important to the industry because it tries to solve bitcoin’s biggest problem for merchants and others interested in bitcoin:

 “Bitcoin is a very new market. Volatility is the number one barrier to entry for a lot of businesses.”

Hedgy’s beginnings

Websites like btcvol.info track the ongoing volatility of bitcoin, but it doesn’t take a market analyst to look at a historic price chart and recognize that the digital currency doesn’t exactly behave like a stable currency.

Bitcoin has seen highs and lows in price the past year.

Hedgy first began attacking the problem in April, when Slater and his early team competed in Boost VC’s bitcoin hackathon and took second place under the project name Coindash.

One of the judges in the competition was Coinbase’s Brian Armstrong, who seemed impressed by the team’s approach to reduce volatility risk.

Slater recalls:

“We came out of the hackathon with guns blazing and some early validation from Brian Armstrong.”

Hedgy has spent the past several months working on its backend as part of the most recent batch of Boost VC startups, and has solidified its technology and product offering for potential customers.

A simple agreement

Minimizing currency volatility is nothing new to many businesses, which need to hedge accounts receivable for multiple currencies. But, bringing the concept to cryptocurrencies is a more recent idea.

Hedgy uses a derivative called an over the counter non-deliverable forward contract to accomplish this.

It sounds complicated, but essentially, it’s an agreement between two parties to buy or sell something in the future. The novel aspect of this agreement is that it puts in place a stipulation to exchange only price variation.

“All it means is that instead of exchanging bitcoin at the end you just exchange the price difference,” said Slater.

It works like this: to lock into this type of agreement, one party would sell, for example, bitcoin for the price of $500 in three month’s time to another party.

Both parties would put up a percentage of the agreed-upon amount in bitcoin, indicated in the contract. The value at the end of the three months will be based on the price movement of bitcoin to date.

Slater described a scenario that highlights why this is important for bitcoin-accepting merchants, since it retains the value of the digital currency:

“Imagine I have 1,000 BTC and want to enter into a forward contract to sell 1,000 BTC in three months for $500. At the end of that three months, my 1,000 BTC at $500, or $500,000, will still be worth $500,000.”

A smart contract

What might be most interesting about Hedgy is how they plan to enforce these forward contracts in a programmable way.

By building its own smart contracts powered by multi-signature, Hedgy takes the third party risk directly out of its derivative offerings.

Slater explained the smart contract multi-signature technology:

“When two people enter into a contract, the collateral is always held in a multi-signature wallet. And the only authorization we have is to determine which party gets what with our signing key at the end of the contract. We don’t hold any of the funds.”

Essentially, the agreement between the two parties is executed programmatically at the predetermined date; a product offering Hedgy says is the first of its kind in the bitcoin industry.

“We feel like we’re really the first ones to apply this to derivatives,” Slater said.

Hedgy’s Matt Slater answering questions at the Silicon Valley bitcoin meetup.

Slater said that these types of automated executable contracts – rather than the current available solutions – are what’s needed to propel bitcoin forward.

“If you look at the current derivative marketplaces, you have to send them your bitcoin. We just think that is a very bitcoin 1.0 solution,” he said.

With Hedgy, the funds are kept client side in a locked multi-signature wallet until the execution date. By utilizing the block chain, the process is safer for everyone involved.

Slater added:

“We’re not holding the funds, we’re not taking custody. Our vision and what we’re building here is a smart contract that executes itself. Once it’s released, it’s released into the block chain.“

Customers need hedging

Hedgy sees a number of use cases for limiting volatility risk in digital currencies such as bitcoin, and as a result, the company is building several products.

The first one is a merchant product for organizations that need to hold on to bitcoin for a period of time but don’t want to bite their nails watching the price bounce up and down.

Slater described the offering: 

“[The] merchant product is called the BitLock. Enter in an amount of bitcoin you want to hedge, and we take care of everything else.”

Another product is called BitForward and is focused more on investors. BitForward will likely be linked up with existing companies in the bitcoin ecosystem.

“Our distribution strategy is that we’re building a Coinbase app, as well as plugging into different exchanges. Sort of like how E*Trade plugs in to an OTC market,” Slater said.

Hedgy has four full-time employees on its team: two full stack engineers, a designer and Slater, who is the self-described “finance guy”.

By focusing on technology that diminishes the issues related to bitcoin volatility, the company expects to develop other products and services along the way.

Commercial ideas for Hedgy’s smart contract multi-signature technology have probably not yet been imagined, according to Slater:

“We’re not limiting the use cases. We’re planning a suite of different products down the road.”

Hedgy is currently in private beta, accepting users on a case-by-case basis, according to the company. Prospective users can sign up for updates on the company’s offerings on its website.

Market volatility image via Shutterstock