Some investors put their money into cryptocurrencies expecting their holdings to increase in value, so they can sell them and make a profit. But a small group of traders is betting they can make money when the economy goes down.
To this end, short sellers are traders who profit financially when the value of a cryptocurrency drops. This is the reverse of speculating that an asset’s price will increase, which is known as going long on a crypto asset.
But how can these risk-takers profit by speculating on market downturns, and how can you short crypto? Here’s all you need to know.
What Does Shorting Crypto Mean?
Shorting, also known as short-selling crypto, is a type of trading strategy that enables investors to speculate against the cost of an asset, often with the objective of generating profits if and only if the asset’s value decreases.
Although it has been more common with traditional investments such as equities and commodities, shorting can also be implemented when trading cryptocurrency.
Long story short, to “go short on crypto” is to “borrow” cryptocurrency to sell it at a market discount. In order to make a profit when shorting cryptocurrency, investors will often sell their borrowed assets and repurchase them at a lower price.
Due to the unpredictability of the crypto market, shorting crypto can be a high-risk trading approach, but if executed properly, it can also yield enormous rewards.
Here’s the whole deal.
How Can You Short Crypto?
If you have reason to believe that the price of a specific financial instrument will decline in the near future, you should consider opening a short position in the order book. The standard practice for shorting cryptocurrencies entails borrowing a large quantity of the assets and then selling it to another party as quickly as possible.
Since you’ll need to recover these assets to pay back the loan at a later period, this creates a sizable financial gap in your budget. If you borrow assets from a broker with the intention of selling them, and the exchange rate for those securities falls as you have speculated, you can immediately redeem them and repay the loan at a lower value. Your revenue will increase as a result of selling certain digital assets and purchasing others.
Here’s what it looks like to short Bitcoin:
You anticipate that Bitcoin’s price will go down in the next several days or weeks, so you’ve decided to short five bitcoins. You take out a loan to purchase 5 BTC at the current price of $20,000 per coin, or a total of $100,000, and sell them immediately for the same price.
In the next two weeks, BTC loses 20% of its value and starts trading at around $16,000. At this point, you use those $100,000 to repurchase 5 BTC for $80,000 ($16,000 apiece). You pay back the loan with the initial five bitcoins plus interest and keep the profit. You have, in effect, made $20,000 by short-selling.
What Does Going Long on Crypto Mean?
When you open a long position, it indicates that you anticipate realizing a profit as a result of an increase in interest rates. The goal of this tactic is to make inexpensive initial purchases and then sell one’s assets when the market price has increased. Brokers generate revenue by capitalizing on the price disparity that exists between the buying and selling of shares.
It is important to keep in mind that for a trader to make a profit from outstanding offers, they need to be ready to put up a sizeable amount of cash at risk and think strategically about how the market will act over prolonged periods of time.
Ways to Short Crypto
Here are some of the most common strategies that traders employ when shorting cryptocurrencies.
These days, a significant number of cryptocurrency exchanges offer margin trading. If you engage in margin trading, your broker lends you cryptocurrency you then use to make a purchase or sale.
This indicates that margin trading can raise your profits while also increasing the amount you lose if your trade goes awry and you cannot pay back the loan.
In most cases, the broker will provide you with a set percentage of the total amount of funds that you are permitted to borrow from the marketplace and invest using that capital. In addition, after a specified period has passed, you will be required to repay the amount of money you borrowed and complete the transaction.
When you engage in futures trading, you are essentially purchasing security through a contract. The contract outlines the terms of the sale, including when it will take place and at what rate. Investors purchase futures contracts with the expectation that the value of the underlying security will increase.
The good side of these contracts is that you can lock in a price by entering into a futures contract to sell cryptocurrency at a future point in time. This allows you to sell the cryptocurrencies when the price is lower than what you originally agreed upon. If this scenario comes true, you can expect a satisfactory rate of return on your investment (ROI).
Contrarily, if you anticipate a decline in the value of the coin in the near future, you can hedge your investments by purchasing contracts tied to the sale of crypto at a lower price.
In a nutshell, shorting futures implies that you essentially agree to sell a contract at a price that is lower than the current market price. This is a potentially profitable but high-risk approach, given that the cryptocurrency market might continue rising.
Binary Options Trading
Additionally, shorting crypto can be done through binary options. The call and put contracts are a well-known technique in which you are required to execute a put order by making use of an escrow or other solutions. Your objective is to sell the cryptocurrency at the current price, regardless of whether or not the current value of the coin goes down later.
There are a plethora of possibilities for trading binary options on offshore marketplaces. However, both the cost and danger involved in using this trading method are substantial.
The most significant benefit, though, is that you can reduce the amount of money you lose if you decide against selling your put options. Therefore, the only money you will be out of pocket is the amount that you invested in the creation of a put order.
In general, a binary option is a form of contract trading that is short-term and involves minimal risk. Two different outcomes could occur. The first possible outcome is that you achieve the profit goal that you originally set, or you could lose the money you initially put in to begin the deal.
To sum, it’s easy to use the crypto binary options for shorting cryptocurrency; just speculate on a contract with a short expiration date. You will make money if the price of the coin drops during the allotted time span.
Contract for Differences (CFD)
Contracts for differences, often known as CFDs, are a less popular method that can be used to short cryptocurrency. When you trade CFDs, you are not taking physical possession of the underlying asset, which in this case, is cryptocurrency. Instead, you are speculating that there will be a decrease in the asset price. In the event that it works, you will gain money off of it, but if it doesn’t, you will incur losses.
CFDs are quite prominent because they provide leverage, enabling investors to manage a much greater position with the same initial capital investment. For instance, if the leverage ratio was 2:1, you would only need to put up $5 in order to “short” $10 worth of cryptocurrency.
Here’s a word of advice – whenever you short-sell cryptocurrency using CFDs, you must have a solid understanding of the dangers involved since leverage can obviously operate both for and against you.
Shorting cryptocurrency could also be done through prediction markets, where bets are placed on the outcomes of future market developments. Like their more traditional counterparts, prediction markets in the cryptocurrency world are a popular way to speculate on upcoming developments. Financial backers can now even stage their own events and make their predictions on the results.
In this way, you might place a bet that the value of your coin of choice would fall by a specified amount, and if anyone else accepted your wager, you would win if your prediction came true.
Where to Short Crypto?
To short cryptocurrency, the easiest route would be to open an account with a cryptocurrency exchange that supports this trading method. Users can effortlessly borrow cryptocurrency, sell it short, and then purchase it back at a reduced price while using these trading platforms.
Please be aware that not all exchanges support shorting cryptocurrency.
Is Shorting Crypto Safe?
Trading futures and options is already a complex endeavor, and the addition of leveraged trading makes it even riskier; the stakes are even higher when dealing with cryptocurrency. To this end, the U.S. brokerage Robinhood has received criticism for simplifying the trading of complex derivatives products, which were previously available only to highly experienced traders.
When you short cryptocurrency, you expose yourself to a significant amount of risk. In contrast to “long” trades, in which you speculate that the price of a particular asset will go up, “short” trades demand you to take on debt in order to participate. If you do not exercise caution, you may find it difficult to reimburse these loans.
Moreover, the exchange could liquidate your position to recover their funds if the market goes against you, thus leaving you with even less capital than before.
Because of this complexity, some exchanges, like Binance, require market participants who trade derivatives to pass a test before allowing them access to more complex and less transparent investment instruments. You can, of course, look up the solutions to these questionnaires on the Internet.
In a broad sense, there are not many obstacles that traders must overcome before they can enter the realm of short trading crypto. However, the following age-old maxims regarding any sort of investment are applicable at all times:
- Never invest more money than you can afford to lose, and
- Never put money into something you don’t fully understand.
Pros and Cons of Shorting Crypto
Generally speaking, there are both benefits and drawbacks associated with shorting cryptocurrency. Before deciding whether or not to embrace this type of trading position, it is essential to consider the following factors carefully.
Pros of Shorting Crypto
- Short selling is an opportunity to make money off a drop in an asset’s value.
- If you believe that the price of a particular cryptocurrency is going to fall in the near future, you can speculate on its value going down and make a profit when it happens.
- If you are concerned about the possibility of a market collapse, shorting some of your investment can help you compensate for losses in other sections of your investment portfolio.
Cons of Shorting Crypto
- Short selling is risky since the price might climb after you sell short. Sell-offs and bear traps might cost you a lot of money.
- Shorting crypto requires discipline and careful timing. To make money trading, you need to estimate the market’s future and when to join and leave deals. Because of this, shorting crypto is not a suitable strategy for everyone.
- Shorting crypto requires opening a margin account with the exchange. Not all platforms provide this trading product, thus making shorting crypto challenging for some investors.
When Is the Right Time to Short Cryptocurrency?
There is no simple answer to this question. The current state of the market and the trading technique you’re planning to use are some of the primary factors to affect your decision. Here are some additional tips you can follow:
- First and foremost, you must have a strong grasp of both the technical indicators and the dangers associated with shorting cryptocurrency to be successful.
- Before you establish a short position, you need to have a well-defined exit plan in place. This involves having a good understanding of when to cut your losses and walk away from the trade.
- Due to the volatile nature of cryptocurrency price movements, it is essential to maintain self-control and patience when shorting cryptocurrency.
In sum, you should never engage in short selling unless you are absolutely certain that the market is about to collapse when it comes to shorting crypto. Therefore, you must wait for the appropriate indications.
Also, when you first start trading, make sure to simply use a little margin so that you don’t end up losing a lot of money.