Shorting is a trading strategy also used in the traditional financial markets and cryptocurrency markets.
Shorting cryptocurrency involves the process of selling crypto at a higher price with the intention of reacquiring it at a lesser price in the future, especially in situations where a cryptocurrency’s price is likely to drop.
Shorting in the crypto world implies borrowing a cryptocurrency and selling it at the present market price, anticipating its fall. When the price falls in the future, the user goes ahead to buy the cryptocurrency back, yielding a profit of the difference amid the user’s selling and buying prices.
Shorting provides a means for users to make money off the decline in an asset’s price. Investors can decide to short their cryptocurrency when they expect its market value to fall.
Due to the volatile and unpredictable nature of crypto markets, this could be considered a risky strategy as there are high chances of acquiring large losses, this does not mean that there are no potential gains too. It is very important that the investors understand the risks involved and how to manage it, study market trends, build up enough experience before proceeding to short their bitcoin or other cryptocurrencies.
When a trader shorts bitcoin or other cryptocurrencies, he/she is simply selling a digital asset or money that he borrowed from someone else on any of the exchange platforms and selling it off at the current price, with an expectation that the price will drop in the future, which would allow him buy back the asset at a lower price. The trader gets to pay back the lender and still have profit incurred from the strategy.
So, it’s more or less like a speculation on the potential decrease in value of a cryptocurrency or asset. Traders usually use derivatives like future contracts or contracts for difference to short crypto.
In the traditional market, the way shorting works is similar to that of cryptocurrency market. Shorting in the traditional market involves an investor identifying a security or stock that he believes will decline in value. He goes further to borrow the stock or security from a broker at a particular price and then sells it on the open market.
As soon as the price declines, the investor acquires it back at a lower price and returns it to the lender while keeping the topped profit.
Is it safe to short cryptocurrencies?
Shorting bitcoin or other cryptocurrencies can be considered a risky strategy given the unpredictable and volatile nature of crypto markets. It involves highly advanced and intricate trading strategies that could easily backfire. Shorting means anticipating a decline in value of a crypto traded asset while using several derivatives and products on the market to position yourself to benefit from that decline.
However, shorting bitcoin and other cryptocurrencies can be significantly volatile and large losses can be acquired. While shorting, the trader borrows assets from someone else, sells it and then buys it back to return the borrowed asset while keeping the profit. If a trader is not careful, he might encounter difficulties in paying back the borrowed asset.
In cases where there is an unfavorable sudden change in market trends, the exchange handling their investment may cash out their position to get their money back, resulting to the individual acquiring significant losses.
Price movements cannot be predicted correctly due to the volatile nature of the crypto market. This means that the investor or trader is more or less betting on his speculation about price movements. If he boldly anticipated a decline and it doesn’t turn out that way, he stands the chance of incurring huge losses.
Some crypto exchanges like Binance have put extra measures in place, like making traders take a certain test before trading in order to make sure that the investors understand the complicated financial products they are dealing with and its nature.
Regardless of this, most investors can find answers to the test online but inexperienced investors might be put off by all the extra measures and may not jump into short trading due to lack of proper understanding.
Experts’ advice against shorting selling due to the incredibly volatile, less regulated and advanced strategies it encompasses. To play safe while shorting or engaging in other trading activities, it is important that an investor makes adequate research so as to choose reliable and trustworthy exchange platforms or broker.
How to short Bitcoin and other cryptocurrencies
Investors are advised to carry out a thorough examination on the methods to see which would work for him.
However, before considering methods to use in short-selling, investors must first find a trend and study it. With the volatile nature of the crypto market, there is no certainty regarding outcomes.
For example, politics, hype culture, influencers etc. can disrupt the crypto market. There are several methods of shorting crypto and they include: Futures or options, trading on margin, contracts for difference and prediction markets. Let’s take a step further to briefly discover these methods.
Buying options or futures contracts
In futures contract, investors buy or sell a certain asset by a particular date, set at a particular price. Futures, entails that the agreed-upon transaction takes place when the contract expires.
This method requires sophisticated knowledge of derivatives and it’s not suitable for beginners. For opening a position in an option, fees, called a premium can be attached. In buying a futures contract, the investor basically bets on the price of an asset to rise. This allows him to make profits from that asset in the future.
Bitcoin futures, for instance, let’s investor to buy or sell BTC at a future date. This implies that if an investor sells a futures contract, they can lock in a price and anticipate to buy it back in the future at a lower price, thereby making profit from its decline in value. If peradventure the value of bitcoin rises, the investor may not benefit from this following this method, except there is a market turn.
The speculative nature of options makes it risky especially for beginners.
A call option offers the holder the right to buy a stock while a put option allows the holder to sell a stock. A call option can be seen as a payment made against future purchases, holders are allowed to buy a specified amount of underlying asset. A call option gives a buyer the option, but not the obligation, to go through with the transaction.
A put option guarantees that the investor will sell his currency or asset at its current prevailing price regardless of the decrease in value in the future within a specific period of time. A put option on the other hand, gives the holder the right, but not the obligation, to sell the underlying stock at the strike price on or before expiration.
Margin trading
Margin trading is another method of shorting cryptocurrencies. Shorting crypto using margin trading involves borrowing money from your preferred exchange platform or broker to purchase a certain amount of cryptocurrency, anticipating its increase in value, and then selling and acquiring a return.
After this, you return the money to the exchange, pay the applicable interest fees, and keep the profits gotten from the transaction. So basically, using margin trading to short cryptocurrency entails borrowing an asset or security from a chosen exchange platform in order to trade larger amounts and enjoy huge returns.
Contracts for differences (CFDs)
CFD is regarded as an advanced method of shorting cryptocurrency which uses derivatives and are unregulated but can still be used by traders given the extensively unregulated nature of crypto. This method is usually applicable for short-term trading.
Here, brokers or exchange platforms allow investors to bet on a decrease or increase in an asset’s price without having to essentially own the asset. The contract pays the difference between an open and closing price on an underlying security.
Depending on the holder’s position, a higher price on the close date could get you a profit, and vice versa. Using this method to short crypto means that you are betting on the decline of crypto prices.
CDFs usually require high fees and the chance for significant losses if the market turns against the investor should be noted.
The possibility of an investor earning profit depends on the decline of an asset’s price, he/she loses money if reverse is the case. Investors using CFDs do not necessarily need to hold or accumulate cryptocurrency, as it requires fiat currency instead for settlements and they have a more flexible settlement tenure.
By also offering leverages, CFDs allow holders to regulate a larger position with a small amount of money.
Prediction markets
Prediction markets or betting market are similar to mainstream conventional markets. They offer investors an opportunity to short cryptocurrency and at the same time interact with other investors.
Some popular prediction markets include: Polymarket, Augur, Predictlt, BetHash, Gnosis etc. A prediction market is an exchange-traded market where investors can trade contracts that pay based on the outcomes of unknown future events.
Contracts that are dependent on the occurrence of events in the future can be traded using the method of prediction market. Similarities can be drawn between prediction markets, futures markets and betting. Prediction markets enables investors to predict future events that don’t relate to an underlying asset’s price. Investors get to profit if their prediction comes true.
Some prediction markets like Argur, Gnosis, and Polymarket permit investors or holders to short crypto even without holding any securities, giving people who do not have interest to invest capital in buying cryptocurrencies an opportunity to still participate in the market.
Prediction methods also have potential risks as it involves betting on a future event, loses could be incurred if the predicted outcome doesn’t happen. Just like in the other methods, investors also need to acquire deep understanding and conduct thorough study of market trends in order to navigate through prediction markets and other methods properly.
Investors should be cautious and fully aware that in as much as they expect significant profits, there might be loses too while trading in crypto markets.
What are the rewards and risks of shorting crypto?
There are substantial benefits involved in shorting crypto. With margin trading, investors are able to leverage securities they already own to obtain extra assets, sell assets short, or access a line of credit.
Regardless, margin trading can magnify losses just as it can boost earnings. Prediction markets also offers potential profits only if your prediction is accurate. Short selling crypto also provides hedging risks. Investors can benefit from shorting if their portfolio feels exposed to a potential slump.
Experiencing both long and short positions can also reduce volatility. Short selling equips investors with two varying ways to profit which are: when the market is up and when it’s taking a descending slump.
However, shorting cryptocurrencies is embedded with risks too. When an investor predicts on the decline of a crypto’s value and it increases instead, such an investor might witness losses, the incurred losses could largely depend on the amount staked, the specific instruments or methods used.
Major losses can be incurred, take for example if an investor decides to short Bitcoin when the price is at $10,000. The price then climbed to $60,000. When the investor sold the cryptocurrency, he received the $10,000 in anticipation that he would buy it back at a lower price, only to now find it costing him $60,000. What this mean is that he would have acquired a $50,000 loss if he decides to purchase back at that time to return the asset from the lender. If an investor bets on a value’s decline, he risks making any profits if a cryptocurrency’s value starts to increase after selling.
Beginners are advised to properly research and gain adequate information before venturing into short-selling crypto or using any of the methods provided to short crypto.
