crypto strategy

Shorting cryptocurrency is an advanced high-risk investment strategy. Here’s how it works

  • “Shorting” means anticipating a decline in the value of a traded asset.
  • Traders can short crypto, but market volatility and lack of regulation make it particularly risky.
  • There are several ways to short crypto, if you have the appetite and the ability to take risks.

When you think about investing, the idea is usually that you make profit when the price of an asset goes up and you lose money when it goes down.

Another more advanced approach is short selling or short selling. It involves betting against an asset because you expect its price to fall in the future.

Can you short crypto?

While short selling is most commonly associated with the stock market, it is possible to short sell Bitcoin and other cryptocurrencies, many of which can be extremely volatile with the potential for large gains or losses in short periods of time. . The process for shorting cryptocurrencies is similar to what you would use for stocks or other assets.

When you sell something short, you anticipate that its value will fall, and you use various derivatives and market products to position yourself to benefit from that decline.

“You’re basically borrowing the asset from someone and selling it,” says Pierre Eberle, president and chief investment officer of Castle Funds, a California-based investment firm. “You then buy it back in the future and return the borrowed assets. If the idea [in traditional trading] is to buy low and sell high, short selling only reverses the order – sell high and then buy low.”

But it is important to understand that shorting any asset, including crypto, is an advanced trading strategy that could easily backfire. While it’s possible to get a quick return, short selling also requires in-depth knowledge of the markets and derivatives.

How to Short Crypto

Shorting crypto can be done in a number of ways, including buying options or futures, trading on margin, or using a contract for difference. Here’s a bit more about each method.

Buy crypto on margin

Buying on margin means you borrow money from a brokerage or exchange. For example, let’s say you have $100 in your account, but you buy $1,000 in Bitcoin – the remaining $900 is on margin. You borrowed it from the stock market. This allows traders to trade larger amounts and earn greater returns, but it also comes with greater risks.

It is possible to trade cryptos on margin, depending on the exchange or brokerage you are using, and whether that exchange has offered you the option to trade on margin. But beware, there is usually are the interest charges (you are borrowing money, after all), and again, a risk of losing more money than you have in your account.

In practical terms, shorting crypto using margin involves borrowing money from your chosen exchange to buy a certain amount of cryptocurrency, waiting for it to appreciate, then selling and trading. earn a comeback. You then “return” the money to the exchange, pay any applicable interest charges, and have made a profit with money you didn’t even have.

Use a contract for difference

Using a contract for difference (CFD) is a more advanced method of short selling. The contract pays the difference between an opening and closing price on an underlying asset. Depending on your position, a higher price on the closing date could earn you a profit, and vice versa. So if you are using a CFD to short crypto, you are taking the position that crypto prices will go down.

Note that CFDs are derivative products and are not regulated. In fact they are illegal in the United States for retail investors to use in regulated markets. But the crypto market is unregulated, so it is possible for crypto traders to use them. There may also be costs, such as commission fees, to consider.

Here’s an example of how it might work: Bitcoin costs $10 and you think its value will go down. You open a CFD position to reflect this and watch the markets closely. Then the value of Bitcoin reaches $8, the contract expires and you have made the right bet, and therefore, profited according to the stipulations of the contract.

Use futures or options

Buying futures or options is another way to short crypto. Both methods allow investors to buy or sell an asset at a specific price on a specific date. Options give the buyer the option, but not the obligation, to proceed with the transaction. Futures contracts, however, require the agreed transaction to take place when the contract expires.

Using futures or options requires in-depth knowledge of derivatives and is not recommended for beginners. There may also be a charge, called a premium, for opening a position in an option.

“You would bet on crypto,” says Mark Fidelman, founder of DeFi marketing agency SmartBlocks and host of the Cryptonized podcast. A put option is, in essence, a bet that an underlying asset will lose value, which is why it could be used to short sell cryptocurrency.

“You hope it goes down in the short term – you really bet it goes down,” Fidelman said.

Here’s an example: Suppose you anticipate a drop in the value of Bitcoin over the course of a day. You have 10 BTC worth $100 and buy a put option that gives you the right to sell the 10 BTC at $100 in one day. As you expected, the price of BTC drops to $6 – you can either let the contract expire or sell the BTC for $100, which is $40 above its market value.

Using these types of contracts can allow you to open positions to effectively sell different cryptos at different times and at different prices.

Crypto Shorting Risks

The risks of shorting crypto are pretty obvious. If you bet that the value of a crypto will fall and instead rise, you stand to lose. The amount you could lose depends on the specific instruments or methods you use to open a short position and the amount you have at stake.

Consider this: if you use margin to buy $1,000 in Bitcoin and Bitcoin’s value drops 50% overnight, your investment is now worth $500 and you owe the exchange $500, plus interest.

Shorting any security, even stocks, carries similar risks. But the risks in crypto are even greater, given that it is a highly volatile and effectively unregulated market. That said, short selling can benefit financial markets, some experts say.

“For example, short selling can improve liquidity, increase stock price efficiency, minimize market bubbles, and can sometimes work to reduce market manipulation,” says Gabriella Kuz, CEO of the Global Digital Asset and Cryptocurrency Association. But while short selling may have a place in the market, that doesn’t necessarily mean it has a place in your investment plan.

Where to Short Crypto

It is possible to short crypto on a variety of exchanges or platforms, depending on how you want to do it. For example, major exchanges like Coinbase or Kraken allow users to buy Bitcoin futures. Other traditional brokerages, including TD Ameritrade, also offer them.

Eberle says that sometimes shorting crypto can be a complex process involving many exchanges.

“You can short real bitcoin by putting up collateral on platforms like AAVE or Compound, then you pay a variable interest rate to borrow WBTC, which is bitcoin wrapped on the Ethereum network, and l ‘bring it to a centralized exchange like FTX or Coinbase,’ he says. It’s a complex method, he adds, but one that traders could use.

Note that many larger platforms, like Robinhood, will not allow users to trade cryptos on margin. So, you may need to do some research to find a platform or exchange that works for the specific shorting techniques you want to use.

The bottom line

Shorting the crypto could potentially get you some quick returns, but that’s an advanced strategy. Crypto is an incredibly volatile asset, and experts warn that most people should probably avoid short selling.

“Unless you’re an absolute expert on that particular crypto you’re shorting, I would steer clear,” says Fidelman. “This is not a game for amateurs.”

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