Volatility is an intrinsic characteristic of the cryptocurrency market. A currency that’s on a hike today might experience a dip tomorrow that you couldn’t have imagined. In fact, many coins’ rates constantly change throughout the day. Crypto volatility coupled with regulatory actions can lead to fear-driven flash crashes and slight retracements after big rallies.
To avoid experiencing loss when this happens, you can leverage a concept called short selling that allows you to make money when prices are falling – even without owning crypto. In this article, we’ll explain crypto shorting and how to short crypto.
What Does Shorting Crypto Mean?
Shorting crypto is the process of selling cryptocurrency at a higher price, with the aim of repurchasing it at a lower price later on, ideally in situations where a crypto asset’s price is expected to fall.
The reason it’s called short selling is that you’re “short” of the coins. You don’t actually own the crypto that you intend to profit from. To understand shorting, you need to be familiar with crypto long and short positions. When you go long, it basically means that you’re buying cryptocurrency, expecting its market value to go higher. For instance, you buy an altcoin at $10 and expect its price to hit $12. You sell it once the price increases in order to make a profit.
On the other hand, shorting means you borrow a cryptocurrency and sell it at the current market price, expecting it to fall. Then, you buy the coin when its price falls or retraces slightly, making a profit which is the difference between your selling and buying prices.
Here’s an example:
- You intend to short one Bitcoin when its value is $45,000 since you expect its price to fall in the next few days.
- You borrow a Bitcoin from a broker and sell it for $45,000.
- A few days after you borrow the Bitcoin, BTC’s price falls to $40,000.
- You buy a Bitcoin for $40,000 and return it to the broker.
- Now you’ve made a profit of $5,000, minus any interest that you have to pay the broker for borrowing the Bitcoin.
Shorting is a way to make money off the decline in an asset’s value. Thus, traders can opt for shorting when they expect a coin’s market value to decrease. However, shorting crypto is a risky business, since markets are often unpredictable. Of course, there’s the potential for gains, but with the market’s volatility, the likelihood of large losses is equally probable.
When you hold a long position, the currency’s price might drop, but rarely to zero. Even though you don’t make any money, you still have your original investment. When you’re shorting, a coin’s price can rise indefinitely, increasing your losses. That’s why you need to make sure you’ve done your research before you take the leap.
Reasons to Short Crypto
Traders have different reasons for short-selling cryptocurrency, depending on how much they want to gain or the kind of analysis they’ve conducted. Following are some reasons for short-selling crypto.
Valuation
Sometimes, a particular currency might be in a price bubble, or be overvalued at a specific point in time. Traders may pick up on this trend, wanting to short sell their crypto for profit.
Therefore, they short crypto and wait for its retracement to begin. When short selling crypto according to valuation metrics, use a fundamental trading style and analyze the intrinsic value of a coin against its current market price so you’re aware of when you can buy back the borrowed crypto coins.
Volatility
Crypto’s volatility might be a matter of concern for risk-averse investors, but traders can leverage this characteristic in order to make money. Historically, it’s evident that crypto pricing can rise just as quickly as it can fall.
Traders who have an appetite for risk are naturally drawn to these fluctuations, since they offer potentially large rewards. Thus, traders who are knowledgeable about changing trends and have expertise in the field use the currency’s volatility to their advantage.
Hedging Risk
While crypto’s volatility might pave the way for short selling, it affects the long position negatively. For instance, if you already have Bitcoin and you believe its price will soon fall, you can decide to short sell the currency.
If your predictions are correct, the profit you get from short-selling crypto can end up reducing or exceeding your long position’s loss. Simply put, having a hedging strategy in place minimizes your losses in a bear market.
How to Short Crypto
Before you use any mETHod to short sell crypto, you have to find a trend. Since the market is highly volatile, many factors can send it in either direction. For instance, politics, hype culture and the influence of notable people can disrupt the crypto market.
If you want to know how to short sell Bitcoin, make sure you study its trends, such as sudden interest on the part of a high-end company or billionaire. After that, you have to open your margin trading account. Most crypto brokers have the accommodations for short selling. However, you also have to check your country’s regulations to ensure you’re not challenging any legal guidelines.
Now you know what shorting in crypto is. Let’s discuss how to short the crypto of your choice using different mETHods.
Direct Short Selling
When learning how to short crypto, this is the first mETHod most people come across. Simply put, you borrow crypto from an exchange at a specific price and sell it.
Then, you wait for the price to go down. When it does, you buy the currency and return the borrowed coins to the exchange. In this way, you earn the difference between the two prices.
Futures Markets
Like all other assets, some cryptocurrencies also have futures markets, in which you agree to buy a security in a contract. The contract specifies the price at which the security will be sold and the time when this will happen.
In buying a futures contract, you bet on the price of a security to rise. Doing this allows you to earn a profit on that security in the future. When you sell the futures contract, it indicates that you expect the price to decline in an upcoming bear market.
Contracts for Difference
These are one of the most popular ways to short crypto. With contracts for difference, brokers allow you to bet on a decrease or increase in an asset’s price without having to actually own the asset.
You just have to deposit a part of the margin account’s fund to guarantee that you’ll be able to buy the crypto at the particular price you’re betting on. The deposit remains in your possession, and the exchange or broker only holds it as collateral.
Thus, you only need to supply a certain fraction of the total trade amount to open your position. Because of this, you can amplify your return on investment (ROI) if the crypto moves in the direction you’ve bet on. However, this mETHod obviously carries enormous risks if the currency’s price moves in the opposite direction to that of your prediction.
Crypto Put Options
Can you short crypto without putting your investment at risk? Sort of. If you can deal with complex derivatives in a bear market, you can add buying crypto put options to your list of mETHods on how to short crypto.
This option gives you the right to purchase a coin at a predefined price on a predetermined date. However, it’s not an obligation. Meanwhile, a put option gives you the right to sell the cryptocurrency.
For instance, if you think that Bitcoin’s price will drop in summer 2022, you can buy a Bitcoin put for three months with a price of $30,000. If the price of Bitcoin declines below this strike price on the predetermined date, your put will earn you a trading profit. On the other hand, if the price remains high, you won’t lose anything except the option premium, which is the fee you paid for holding the option.
Prediction Markets
If you want to learn how to short crypto while interacting with other investors, then consider prediction markets. These are similar to mainstream conventional markets.
As an investor, you could predict that a specific cryptocurrency will decrease by a particular percentage or margin. Then, someone else has to take you up on that bet. If the price really does go that way, you earn a profit. Some popular prediction markets include Polymarket and Augur.
Where to Short Crypto
Now that you know what shorting crypto is about, it’s time to learn where to short sell crypto. Ideally, look for crypto exchanges that offer high trading volume for maximum liquidity. Some crypto exchanges that allow shorting include:
- BitKan
- Bybit
- Binance
- Kraken
- OKX
- Bitfinex
Closing Thoughts
Can you short crypto after reading this guide? Well, you should be able to at least get started. In a nutshell, shorting crypto means selling it at a higher price because you expect its price to decline due to fear in the market or retrace after a price rally. This lets you buy it back later at a lower price. Hopefully, with our handy guide, you now know what shorting crypto is all about, how to short crypto, and where to do it legally.
