When you want to trade in an asset, digital or traditional, you have two options to trade- going long or short. When you decide to go long, you expect the price of an asset to appreciate over time, hence the saying “buy low and sell high.” However, shorting is the exact opposite. In this case, you are betting that the price of the coin will decline and will profit if it does.
The Bitcoin market has shown extreme volatility in the past 15 months. Its value has gone up to all-time highs of $20,000 in a parabolic rise, only for the bubble to burst and the prices to fall down by over 70 percent in the past 12 months. Knowing how and when to short Bitcoin can help you in making money from the crypto market, even if it swings in the bear’s direction. Note that shorting isn’t a strategy employed by naïve investors as it could be high-risk compared to the good old Buy and HODL policy.
While Bitcoin ETFs failed to make a debut in the US markets last year, Bitcoin futures have been available since January 2018 allowing users to short the coin. In a futures contract, a buyer agrees that he will buy a security at a specific date and price. When you sell the futures contracts, you are essentially betting against the price rise of the coin, giving you an excellent shorting opportunity.
In this case, the seller gets a legal contract from the buyer that he will buy a particular number of Bitcoins from you after a specific period of time. Let’s say the price of BTC is $10,000 today. The buyer is optimistic about the market and believes the price will go up to $12,000 in one month, giving him an opportunity to buy the coin for $2,000 discount.
The seller expects the price to drop after a month to $7,000. He wants to be able to sell his coins at $10,000 only, i.e., today’s rate giving him a $3,000 profit.
Another exchange called Bitmex has a unique futures contract called XBT/USD perpetual inverse swap contracts. These lower priced contracts are valued at $1 where funding is paid and received every 8 hours. This perpetual contract never settles on the market.
Binary options are another interesting way to short Bitcoin. In an options trade, you purchase rights to sell or buy an underlying asset at a specific price by a specific date. The users can use ‘call’ options to buy the assets and ‘put’ options to sell the assets. Just like futures contracts, the seller or someone who chooses the ‘put’ option is betting against the price rise and wants to be able to sell the underlying asset at a price he chooses, instead of the ongoing market price.
Binary options give you a middle path to escaping risk, which is not available in futures. If you think that the price of the coin is rising instead of falling, you can simply let the contract expire instead of executing it. If you think that executing the contract could open the doors of long opportunities for you, then go ahead and execute it.
Contracts for Difference (CFD)
The contract for Difference (CFD) is a type of futures contract which allows you to trade in fiat currency instead of trading in real BTC. The buyers and sellers agree that they will settle the contract in fiat currency on the date of the contract expiry. These contracts are always traded over the counter (OTC).
In the case of CFDs, the investor may intend to sell the contract after a week for a $10,000. Now, if the price of the BTC went up to $12,000, the seller owes the buyer only $2,000 rupees. If the price goes to $8,000, then the buyer would pay the seller $2,000. In some cases, CFDs allow parties to execute the contract earlier than the pre-specified date.
Bitcoin Investment Trust
Established in 2013, the Bitcoin Investment Trust allows users to trade in Bitcoin without actually holding the asset. It is traded publicly and mimics the price movement of actual BTC, though it is prone to underperforming or overperforming during periods of high volatility. The fund charges a 2% management fee from the users who are 4x as high as the fee of an average annual fund in 2017, according to Morningstar.
Though we would advise average traders to stay away from shorting due to the huge risk potential (prices can rise indefinately, so losses are unlimited in size theoretically) , it is nonetheless a powerful and useful tool to help reduce risk and diversify positions in an asset market. As we always recommend the readers- never invest money in crypto markets that you aren’t ready to lose. Cryptocurrencies are still a highly volatile market, and price fluctuations could lead to extreme losses for the users.
The Classic Short Sell
In this method of short selling Bitcoin, you will borrow a certain number of coins from an entity and sell them immediately. You are expecting the price of the coin to fall, and when it does, you buy at a smaller price and return the assets to the lender. In this way, you hope to be able to make a profit, which covers the lender’s rate of interest as well.
Let’s understand this with an example. Suppose you borrowed 10 BTC when the prices were $10,000. You are expecting the prices to fall and reach $8,000. In this case, as soon as you borrow the coins, you sell them on an exchange for $10,000. With this cash in hand, you simply wait for the price to fall. Once it goes to your target, i.e., $8,000, you will buy 10 BTC from the market and return to the lender.
In this way, you make a profit of $2,000 on each coin. However, the risk level of this kind of trading is very high. First, as you are borrowing coins, the interest charged could eat away your profits, if any. If you don’t have a profit, your losses will increase simply because of the interest.
Second, there is a limit to what one can make while shorting, but his losses could be infinite (at least theoretically). For instance, the price of any coin can only go to zero but not beyond that. This means that if you are shorting BTC at $10,000, your profit window is limited from $0 to $9,999. However, the price of any asset can go up infinitely, at least in theory, which means that your losses could go from $10,001 to infinity.
Therefore, if things don’t go your way, you will either have to book a loss or simply wait until the prices are in your favor while paying interest on your borrowings which you don’t hold anymore. This is a reason why only advanced traders prefer to engage with shorting strategies. It works like a double-edged sword for the unenlightened which could easily wreak havoc in your finances.