Key takeaways
- Crypto shorting is a trading strategy used to make profits by borrowing cryptocurrencies from an online broker, selling them at a higher price and buying them back at lower rates
- Markets can be unpredictable and volatile, and shorting can help hedge against losses in other trading positions.
What is crypto shorting?
Crypto shorting or short-selling as some traders might prefer, is a trading strategy in which traders borrow cryptocurrencies from an online broker, sell them at a higher price, and buy them back when they’re expected to depreciate. If the market moves in the trader’s favour and the crypto market depreciates, that trader can expect to make profits from the price movement.
That might sound a little confusing. OK, so what is it like to short a crypto?
Suppose that the current price of Bitcoin BTC is $61,000. After some research or even just by a hunch you believe that the price is going to decline. So you borrow some BTC from an exchange and sell it on the open market. Let’s say you’re rich and you borrow 1 BTC and sell it for around $61,000. Now you have $61,000 in your account, and you owe the exchange 1 BTC.
After a period of time, the BTC price moves as you predicted and falls by 10% to $54,900. You see the chance has come. You take the $61,000 you made from selling the borrowed bitcoin and buy back 1 BTC at this new price. You now have $6,100 and 1 BTC. You return the BTC back to the exchange. Your margin position is closed. You made a $6,100 profit from shorting 1 BTC.
Why would you short crypto?
- High profitability: The high-risk high-reward nature of the crypto market always attracts traders who dare to make amplified profits.
- Access to margin trading: When you choose margin trading (leverage trading), you can access the full value of the trade. In return, you will be asked for a deposit, which will be a percentage of the trade value.
- Hedge Existing Holdings: A ‘hedge’ is when an investor makes a bet that’s the opposite of what they expect to happen. For instance, if you believe ETH will go up by $10,000 over the next 6 months, you may buy a bunch of ETH and wait for it to appreciate, but you may also want to short some ETH in that time as a hedge in case you’re wrong. Just like an insurance policy you created.
6 Ways to Short Crypto
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Margin Trading
Margin Trading platforms allow investors to borrow money or crypto from a broker to make a trade. To short on margin, you will need to deposit some initial funds (called ‘posting margin’) to your account as a form of collateral. The collateral does not always have to cover the full amount of your trade. Margin trading can also be used to generate leverage in a position, which can magnify gains and losses.
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Futures Market
If margin requires you to actually purchase and hold the crypto asset, shorting through a furtures market allows you to just speculate on the price without holding the asset.
In a futures trade, a buyer agrees to purchase a security with a contract (a form that specifies when and at what price the security will be sold). When you buy a futures contract, you bet that the price of that security will rise. Conversely, selling a futures contract suggests that your prediction of a bearish trend. Given this context, you can short a crypto by purchasing contracts that bet on a lower price.
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Binary Options Trading
Traders can short a crypto using call and put options. A call is an option contract giving the owner the right, but not the obligation, to buy an underlying security at a specific price within a specified time. On the other hand, put options give holders the right, but not the obligation, to sell a particular amount of an underlying security at a specified price and time frame.
If you want to short a crypto, you will order a put option.
Traders may prefer using binary options over furtures is that you can limit your losses by choosing not to sell your put options. Consequently, your losses are limited to the price you paid for the put options.
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Prediction Markets
Prediction markets in crypto are akin to those in mainstream markets, where people trade contracts that pay based on the outcomes of unknown future events. Therefore, you could predict that a crypto price will decrease by a certain margin, and if anyone accepts your bet, you will benefit if it comes to pass.
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Short-Selling Assets
Simply, just sell off tokens at a price that you are comfortable with, wait until the price drops, and then buy in the tokens again.
This method incurs high costs and risks. You will need to pay custody or wallet fees to store the crypto until the trade happens. If the price does not move the way you expect, you could both lose money and your crypto.
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Using CFDs
A contract for differences (CFD) is a financial strategy where payout is based on the price difference between the opening and closing prices at settlement. This works similarly to futures but with more flexible settlement tenure.
You enter into an agreement with a counterparty that you will compare the price of a crypto asset in the future to its current price.
If you take the short side of a CFD, and the price of the crypto declines, the counterparty will owe you money, and vice versa. CFDs also require posting margin funds as a deposit. Keep in mind also that CFDs are banned in some countries so make sure to check your government’s regulations before choosing this method.
The cost of shorting cryptocurrencies
Similar to all kinds of transactions on an exchange, shorting cryptocurrencies comes with some particular costs and fees. You should also keep in mind that different platforms have different fees policies, so make sure to choose the one that meets your needs. Here are some kinds of fees that you may incur:
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- Trading Fees: Every transaction incurs trading fees. In most cases, these fees are separated into maker and taker fees. Maker and taker fees are usually different for spot markets (where you buy and sell crypto) and futures markets (where you trade on the price of the crypto without holding the asset)
- Margin Fees: Since you borrow crypto from a platform, you will have to pay margin fees. Margin fees may fluctuate because they are recalculated every day depending on the market.
- Additional Platform Fees: Some exchanges may charge a withdrawal fee whenever you transfer money or cash out of the platform. Additional fees can vary widely depending on exchanges’ policies.
- Taxes: You will have to pay taxes according to your country’s regulations.
How much money can you make shorting crypto?
Indeed, you can make as much money shorting crypto as you can make by going for a long position. If you short and the market goes down by X, you would make just as much as you would have made if you took a long position, and the market went up X.
Of course, you may incur some additional fees as mentioned above, but they are usually minimal, and price moves of more than a few percentage points can make up for the fees.
Shorting Crypto Risks
Just like other financial strategies, shorting crypto is dangerous due to market volatility. Therefore, due diligence is recommended for whatever shorting method you opt to choose. To help with, here are a few important points to look out for:
Unlimited Loss:
Presume that you buy 1 BTC in at $61,000 and hold till the price goes up. In the worst scenario, that 1 BTC decreases to $0 and you lose $61,000. But your loss is capped. This is not what happens with shorting. Now let’s say someone shorted the BTC back when it was at $100, and they still haven’t closed their margin position. So they borrowed 1 BTC and got $100 in return, but they still owe that 1 BTC even as the price of Bitcoin grows over $61,000.
In fact, the price can double, triple, 10x, or even 100x higher, and you will eventually be forced to pay whatever BTC is trading for to close your position.
Margin Risk:
Margin trading can be particularly risky when you use more than 1x leverage. For instance, with 5x leverage, a 20% increase in the crypto’s price would result in losing all your collateral. With 10x leverage, a mere 10% price rise would make you bankrupt. If you are not an experienced trader, it’s advisable to keep leverage as low as possible to minimise risk.
