The cryptocurrency market is highly volatile, and prices can move down as rapidly as they rise. Consider shorting them if you wish to profit even when the price drops. This guide describes the complexities of short selling and how to short cryptocurrencies in depth.
What Does Shorting Crypto Mean?
The goal of crypto short selling (or “shorting”) is to profit from a decline in the underlying asset’s price. Short selling is so-called because the seller is “short” of the coins. You do not own the cryptocurrency from which you intend to profit.
The initial step in short selling is to borrow the asset (in this instance, a coin or token) and sell it at the current market price. Then, if the price declines, the speculator can repurchase the asset at a lesser price and close the position. Profit is the difference between the selling price and the purchase price.
For example, you intend to short one Bitcoin at its current price of $30,000 as you anticipate a price decline in the coming days. You borrow one bitcoin from a broker and sell it for $30,000 (no leverage or margin is assumed). Now, with a single bitcoin plummeting to $25,000, you purchase a bitcoin for $25,000 and return it to your broker. You have now earned a $5,000 profit, minus any interest you must pay the broker for borrowing the bitcoin.
Reasons for Short-Selling Crypto
Traders short-sell cryptocurrency for various reasons, depending on how much they wish to gain or the type of analysis they have conducted. Listed below are some motivations for shorting cryptocurrencies.
Asset Valuation
Occasionally, a currency may experience price inflation or be overvalued at a particular time. Traders may observe this pattern and decide to short-sell their cryptocurrency for a profit. They short crypto and await its retracement. When short-selling crypto based on valuation metrics, use a fundamental trading style and compare a coin’s real value to its current market price to determine when you can buy back the crypto coins you sold.
Price Volatility
Considering Bitcoin’s history, its price can be greatly volatile. Numerous traders have a high-risk tolerance and are attracted to highly volatile assets that have the potential to yield enormous profits or losses. Some traders rely on sheer fate and speculation when shorting Bitcoin, while others use a systematic approach based on knowledge and experience.
Hedging Risk
While crypto’s volatility may facilitate short selling, it negatively impacts long positions. For example, if you already possess Bitcoin and believe its price will shortly decline, you can decide to short-sell it.
If your predictions are correct, the money you make from short-selling cryptocurrency can compensate for or even beat the money you lose from holding on to it. Having a hedging strategy in effect, reduces your losses during a bear market.
Objective Mindset
Some speculators are shorting crypto for the short term and have pessimistic market sentiments. They remain current on the most recent developments in cryptocurrencies and the blockchain.
These merchants maintain an objective perspective and do not allow their opinions to influence their decisions.
Risks of Short-Selling Crypto
Short-selling crypto can help you make extra money when the market is down, but you must also consider its hazards. The following are some notable disadvantages of shorting cryptocurrencies.
Limitless Losses
When you purchase and hold cryptocurrency in the hopes of selling it for a higher price in the future, you only run the risk of ending up with a currency whose price did not reach your desired level. You still possess your currency and can keep it for as long as you want.
Conversely, your potential losses are unlimited when shorting cryptocurrency, as they exceed your initial investment. If you wish to cover your position without accruing losses, you may need to borrow currency at a higher rate if its price rises.
Margin Interest
When you short-sell cryptocurrency, you do not own it. You are instead leasing it from a broker, who will charge you interest for as long as you hold the coins.
Suppose that the currency’s price does not decline as predicted. You may have to rest on it for an extended period. While this increase occurs, interest continues to accrue, cutting your profits.
How to Short Crypto
Given the highly volatile market, you must identify a trend before short-selling your cryptocurrency. Politics, fad culture, and the influence of notable figures can all affect the price of a coin. After you’ve looked at the market trend, you can open a margin trading account and check the rules in your country to ensure you’re not breaking any laws. Now, let’s discuss various methods for shorting your chosen cryptocurrency.
Direct Short Selling
This is the first method most people encounter when learning to short Bitcoin or any other cryptocurrency. As stated, you borrow and sell cryptocurrency at a specific price from an exchange.
Then, you wait for the price to decrease. When this occurs, you purchase the foreign currency and return the borrowed coins to the exchange. You earn the difference between the two prices in this manner.
Futures Markets
As with all other assets, there are futures markets for specific cryptocurrencies, in which you commit to purchasing security through a contract. The contract stipulates the price and time at which the security will be sold.
When you purchase a futures contract, you wager that the price of a security will increase. This enables you to profit from this security in the future. If you sell a futures contract, it means the market will go down in the near future.
Contracts for Difference
One of the most common methods to sell cryptocurrency is through contracts for difference. It involves betting on whether the asset’s price will rise or fall without possessing it.
You only need to transfer a portion of the margin account’s funds to guarantee you purchase the cryptocurrency at the specified price. Your deposit remains in your possession, with the exchange or broker holding it only as collateral.
So, only a small part of the total amount of the trade is needed to start a position. This allows you to increase your return on investment (ROI) if the cryptocurrency moves in the direction you bet on. Nonetheless, this strategy entails enormous dangers if the currency’s price moves contrary to your forecast.
Crypto Put Options
Can you short cryptocurrency without jeopardising your investment? Kind of. If you can manage complex derivatives in a bear market, you can add purchasing crypto put options to your list of crypto shorting strategies.
This option grants the right to sell a coin at a predetermined price and date. However, it is not required. In contrast, a put option allows you to sell the cryptocurrency.
For instance, if you believe that the price of a particular coin will decline in three months, you can purchase a put for three months at a predetermined price. You will earn a profit if the price of that coin falls below the price on the predetermined date. However, if it remains elevated, you will only forfeit the option’s maintenance charge.
Prediction Markets
Consider prediction markets to learn how to short crypto while interacting with other investors. These are comparable to conventional mainstream markets.
As an investor, you could speculate that the value of a particular cryptocurrency will diminish by a certain percentage or margin. Then, somebody else must accept your wager. If the price moves in that direction, you make a profit.
Tips for How to Short Crypto
Since there are many things to consider when shorting cryptocurrencies, you must ensure you take the proper steps. The last thing you want to do is short-sell cryptocurrency during a false retracement. The following are some helpful suggestions.
Use Technical Analysis
The technical analysis predicts the future behaviour of the crypto market by analysing past performance data based on the Dow Theory, which considers various factors such as regulations, demand, knowledge, and expectations. The analysis assumes that history repeats itself and market behaviour follows a trend. Any movement is not random and follows either a short-term or long-term trend.
Some indicators used in technical analysis to assist in predicting price collapses and retracements are:
- The average directional index (ADX) measures the strength of a trend.
- Bollinger Bands indicate whether an asset’s price is relatively low or high.
- The standard deviation is applied to the annual rate of ROI, showing the historical viability of cryptocurrency investments.
- The relative strength index (RSI) indicates momentum or the magnitude of any recent price change.
Stay Updated With the News
Yes, we did say “the news,” not just crypto news, because political and economic events can move markets in any direction. Government crackdowns and regulations can result in sudden market collapses.
If you believe something similar is about to occur, you can profit from the situation by shorting cryptocurrency in a bear market. But ensure you comply with any government rules, or it could lead to severe problems otherwise.
Use Fundamental Analysis
Due to the brief history of its markets, some experts may not believe that cryptocurrencies possess any “fundamentals.” Nevertheless, you can use fundamental analysis (FA) to improve your prospects of making sound investment decisions.
Determine the forces that influence the supply and demand of the cryptocurrency you want. Relevant variables include market sentiment, news, trading, adoption, and transaction activity.
Fundamental analysis is the study of a currency’s intrinsic value. External and internal factors are considered when determining whether an asset is undervalued or overvalued. Since the fundamental analysis of cryptocurrencies differs from that of conventional markets, three distinct metrics are commonly employed.
Short Crypto During Rallies
Can cryptocurrency be shorted during sharp rallies? Yes. This is one of the most advantageous moments to short a coin. Due to the fear of missing out (FOMO), assets are over-purchased during these rallies. After the clamour subsides, the coin returns to its original value or declines, allowing you to profit.
Transaction Count and Value
Transaction count gives you an idea of what is occurring so that you can use moving averages to determine how the activity surrounding a particular asset will change over time. However, use transaction count cautiously, as there is no assurance that a high transaction count is due to a specific cause instead of something else.
The transaction value indicates the number of transactions performed during a given period. It can be a very helpful predictor of how and when the price of specific coins will change.
Where to Short Crypto
Depending on the desired method, shorting cryptocurrencies is possible on various exchanges and platforms. Look for cryptocurrency exchanges with a high trading volume for optimal liquidity. Bybit, Binance, Kraken, and OKX are examples of exchange platforms that permit shorting. Other traditional brokerages, such as TD Ameritrade, also provide these services.
Create a margin account and search for the Bitcoin to USD trading pair interface to get started. You can also set up automatic borrowing so that the borrowed currency will be automatically returned if the price decreases. Alternatively, you must manually repay the borrowed cryptocurrency if the price increases.
Note that many larger platforms, like Robinhood, do not permit margin trading in cryptocurrencies. Therefore, you may need to research to locate a compatible platform or exchange with the shorting techniques you wish to employ.
Frequently Asked Questions
Why can crypto be shorted?
“Margin” is commonly used to short crypto, essentially borrowing crypto. Then, you sell the crypto you borrowed with the expectation that you can repay the margin by repurchasing the crypto at a lower price in the future.
When should traders go short?
When you anticipate the price of a particular crypto to decline for an extended period, you may short-sell it. However, support your decision with thorough market research. Short sellers usually start their positions when the market has reached an overbought level or when the price can’t break through a resistance level and starts to fall.
Are there any fees when shorting crypto?
When you short cryptocurrency, you may have to pay a transaction fee to the crypto trading platform you use. The fees may include commission, trading, spread, and overnight fees depending on the exchange platform. When using borrowed funds for margin trading, interest charges can accumulate daily.
Which is the best platform to short crypto?
Covo Finance, Bybit, Kraken, Binance, and Kucoin are a few well-known platforms for shorting cryptocurrencies. It ultimately depends on the requirements and preferences of the trader; traders should investigate and compare various platforms before selecting one for shorting cryptocurrencies.
Are gains from crypto shorting taxed?
Yes. You may need to pay taxes on gains or losses from crypto shorting. Depending on how a country taxes capital gains, profits and losses from shorting cryptocurrencies could be taxed. The tax rate varies depending on whether a person conducts business as an individual or a corporation.
Final Thoughts
In a nutshell, shorting is a sophisticated form of trading. It gives traders a chance to make huge profits but can also cause them to lose a lot of money. If you are inexperienced in trading and investing and unfamiliar with cryptocurrencies, you may quickly lose your position. To avoid this, one must study and master the mechanics of shorting to generate substantial profits.
