A currency that goes up today could suffer a decline tomorrow that you could not have imagined. Indeed, the prices of many coins change constantly throughout the day. Cryptocurrency volatility coupled with regulatory action could lead to fear-fueled blitzes and slight retracements after big rallies. You can avoid a loss in this situation by taking advantage of short selling, which allows you to make money when prices fall, even without cryptocurrency. In this article, we explain crypto shorting and the risks.
What does encryption shorting mean?
Crypto shorting is the process of selling cryptocurrency at a higher price with the aim of later buying it back at a lower price, ideally in situations where the price of the crypto asset is expected to fall.
The reason it’s called short selling is because you have a “shortage” of coins. You don’t actually own the cryptocurrency you want to profit from. To understand shorting, you need to understand long and short cryptocurrency positions. When you go long, it basically means you’re buying a cryptocurrency expecting its market value to rise. For example, you buy an altcoin for $10 and expect the price to rise to $12. You sell it when the price rises to make a profit.
On the other hand, going short means borrowing and selling cryptocurrency at the current market price, expecting it to go down. You then buy the coin when the price drops or falls slightly, making a profit, which is the difference between the selling price and the buying price.
- You plan to short a Bitcoin when it is worth $45,000 because you expect the price to drop in the next few days.
- You borrow Bitcoin from a broker and sell it for $45,000.
- A few days after borrowing Bitcoin, the price of BTC drops to $40,000.
- You buy Bitcoin for $40,000 and give it back to the broker.
- You have now made a profit of $5,000 minus the interest you have to pay the broker to borrow the Bitcoin.
Shorting is a way to profit from falling asset value. Therefore, traders may choose to go short when they expect the market value of the coin to fall. Shorting cryptocurrencies is a risky business because the market is often unpredictable. Of course, the potential for profit is there, but with market volatility, the possibility of big losses is just as likely.
When you have a long position, the price of the currency can go down, but rarely down to zero. Even if you don’t make any money, you still have your original investment. When you go short, the price of the coin can go up indefinitely, increasing your losses. That’s why you need to make sure you’ve done your research before taking the plunge. If you are confident in your search and are sure that the price will indeed come down, take a calculated risk as it can net you thousands of dollars.
Marketplaces like and Lending block are making it easier for lenders and borrowers to find and take advantage of the growing interest in cryptocurrency shorting. With this growing amount of assets, short selling of cryptocurrencies is becoming more and more accessible to traders.
Reasons for shorting crypto
Traders have different reasons for shorting cryptocurrencies, depending on how much profit they want to make or what kind of analysis they have done. Here are some reasons to short sell crypto.
Sometimes a certain currency can be in a price bubble or overvalued at a certain point in time. Investors can capitalize on this trend as they want to short sell their crypto to make a profit.
Therefore, they short the crypto and wait for it to start tracking. When shorting crypto based on valuation metrics, use a fundamental trading style and analyze the intrinsic value of the coin against the current market price to know when to buy back the borrowed cryptos.
Crypto volatility can be a concern for risk averse investors, but traders can take advantage of this feature to make money. Historically, it is clear that crypto prices can rise as quickly as they fall.
Risk averse traders are naturally drawn to these fluctuations as they offer potentially great rewards. Thus, traders who are aware of changing trends and have expertise in this area will benefit from currency volatility.
While crypto volatility can pave the way for short selling, it negatively impacts a long position. For example, if you already own Bitcoin and believe that the price will fall soon, you may decide to short sell the currency.
If your predictions are correct, your profit from selling crypto short may ultimately reduce or exceed the loss of your long position. Simply put, having a hedging strategy in place will minimize your losses in bear markets.
What are the risks of shorting crypto?
Short selling crypto is certainly a way to make extra money when the market is falling, but you also have to consider the risks. Below are some notable drawbacks of shorting cryptocurrency.
When you buy and hold cryptocurrency in the hope that you can sell it at a higher price in the future, you only risk ending up with a currency that didn’t reach the price you wanted.
At the end of the day, you still have your currency and can keep it for as long as you want.
On the other hand, your potential losses are unlimited when shorting crypto as they exceed your initial investment. If the price of the currency continues to rise, you may need to borrow it at a higher price to lower your average cost when you break even.
Remember, when you short sell crypto, you do not actually own the currency. Instead, you borrow it from a broker who charges you interest as long as you hold the coins.
Let’s say the price of the currency does not fall according to your prediction. As this increase takes place, the interest piles up and eats away at some of your profits.
How to shorten crypto
Before using any method to short sell crypto, you need to find a trend. Since the market is very volatile, many factors can swing it in either direction. For example, politics, hype culture and the influence of prominent people can disrupt the crypto market.
If you want to know how to short sell Bitcoin, you need to study the trends, such as the sudden interest of a high-value company or a billionaire. After that, you need to open your margin trading account. Most crypto brokers have short selling options. However, you should also check your country’s regulations to make sure you are not contesting legal guidelines.
Direct short sale
This is the first method most people come across when learning how to short Bitcoin or any other cryptocurrency. Simply put, you borrow crypto from an exchange at a certain price and sell it.
Then you wait for the price to go down. When that happens, you buy the currency and return the borrowed coins to the exchange. This is how you earn the difference between the two prices.
As with any other asset, some cryptocurrencies also have a futures market where you agree to buy a security through a contract. The contract specifies the selling price of the security and the time it takes place.
When you buy a futures contract, you are betting that the price of the security will rise. This allows you to make a profit on that security in the future. When you sell a futures contract, it indicates that you expect the price to fall in an upcoming bear market.
If you want to short Bitcoin futures, you can do so on the Chicago Mercantile Exchange, the world’s largest derivatives exchange, or with derivatives.