Cryptocurrency exchange rate can change several times a day. Just like fiat exchanges, there are two main behaviors among cryptocurrency players: some of them buy coins at a low price (as most traders do), or purchase coins at their peak during the all-time high period. It is easier to buy a currency at a low price and wait for its growth. None of the coins has ever shown an increase without a fall, so a cryptocurrency trader needs to be able to short.
What Does Short Selling Mean
Short selling or short is a method of making a profit over an asset price drop. You need to borrow a Bitcoin, and sell it at the current price. Next, you buy BTC again to pay back your debt. If the price is lower than before, so you have a profit over a sale difference.
Imagine, you borrow 2 Bitcoins. Then you short sell your 2 Bitcoins at the price of $14 000, and when the price falls, let’s say to $6500 for 1 BTC, you buy 2 BTC again. Thus, you have 1000$ of profit in your pocket.
If you want to see a living example of how short works, watch the film The Big Shortdirected by Adam McKay.
Bitcoin Short Trading
One of the easiest ways to short BTC is by using an open digital assets market. Traders can directly short digital currency. A trader can sell tokens at an accessible price, wait until the price drops, and then buy the tokens again. If the price does not change as much as the trader wanted, he may also lose money. There are ways that make shorting Bitcoin profitable.
Many exchanges support short selling. For those who want to speculate on the Bitcoin price without actually owning it, Bitcoin futures provide a real and efficient way. Futures protect traders from the risk of volatile price fluctuations of Bitcoin.
Financial futures are contracts that determine the price and date of the underlying asset sale or purchase in advance. Contractors are required to fulfill the terms of the agreement upon its expiration.
There are two contract positions. A long position allows a party to buy an asset in the future at a certain price. A short position allows a party to sell the underlying asset at a certain price when the contract expires in the future.
Futures contracts are regulated by the Commodity Futures Trading Commission (CFTC).
Futures are slightly different from short selling. Futures contracts specify a price and an expiration date. According to futures contracts, time makes sense.
You want to short BTC. You buy futures that allow you to sell BTC at the price of $7000. Under this contract both parties agree on a specific date. Thus, if BTC is above $7000 when the contract time is running out, futures have no value.
Buying long-term futures is very risky since the time value of the contract decreases as it expires.
Bitcoin options are traded in the same way as a basic call or put options when the investor pays a bonus for the right to buy or sell a certain amount of Bitcoins on a certain date. This is a right, not an obligation.
A call option is a financial contract that gives its holder the right to buy an agreed number of securities at a certain price over a certain time. The call purchaser makes a profit when the underlying asset increases in price.
A put option is a contract that gives the right to sell a certain amount of the underlying security at a specified price for a specified time.
There are offshore exchanges that offer binary options. The idea is that you bet on a ‘yes’ or ‘no’ scenario. You can guess if Bitcoin price increases or decreases a certain price.
Bitcoin margin trading is an operation with assets when a trader uses the funds provided by a third party. So, traders borrow funds at high-interest rates to increase their leverage. After the transaction is closed, the borrowed money is returned to the exchange with a charge, and the user receives the rest.
Leverage is the amount a trader decided to borrow as a loan. Margin leverage can be 2x, 20x, or even higher.
A trader opens a $1000 long position with a 10x leverage. The total amount of the transaction is ten times higher than its position. If the price increases by 1 percent, the profit will be equal to $100. The trader decides to close the position, and his account is filled with the earned $100 subtracting a charge. If the trader makes the same transaction without leverage, they will earn only $10 subtracting a charge.
Margin trading might both increase and decrease your profit. If your trade is failed, you have to add funds to your account to avoid order liquidation. This process is known as the margin call.
Liquidation is a procedure when a bargain loses more funds than the trader has. Thus, the trading closes, and a trader loses all his money.
Shorting via Exchange
For more experienced traders, several crypto exchanges provide Bitcoin short selling, namely Poloniex, Kraken, Bitfinex, etc. Shorting via exchanges is usually compared with CFD (contract for difference). The only difference is that you gain your profit in BTC, not in dollars.
Investors short sell funds that do not belong to them on crypto exchanges. Investors borrow Bitcoins from margin lenders on the exchange as long as the position is opened. As soon as investors close their trading, they gain or lose the difference.
The main problem of shorting via exchanges is to find an exchange that can lend you money. Many exchanges provide this service under the ‘margin account’. If you borrow money, you will have interest charges as well as other fees.
Investors, who want to create a margin account for short selling, need to search for the best conditions. Some websites offer a review of various trading platforms, which can help you to begin.
How to Manage Risks
Bitcoin short is risky. When you invest in the asset, your losses are normally limited. For example, you decided to invest $1 in stock, and this stock eventually falls. So your loss is $1.
When shorting, your losses might be more dramatic. The crypto market is volatile and hardly predictable. If you borrow 1 BTC and sell it for $7000, you cannot be sure the price will not increase to $8000.
Be careful and invest only if you are sure that prices will fall, and if you have money to cover possible losses.
Brokers can also place a stop-loss order. Stop-loss order is a way to limit losses when managing an investment portfolio. In fact, this is an instruction to close a position (sell securities) in case of unfavorable price movement. Recently, we’ve posted an article about trading orders, where we explained all about stop-loss order.
A short selling Bitcoin is difficult. It is important to understand there are risks both for short-sellers and buyers. The potential loss is not limited, but the potential gain is limited by the current market price. Investors use strategies to short Bitcoins for a more important reason than just waiting for the price to fall.
Keep in mind that every strategy for short Bitcoins can be used to profit from price increase. Investors use margins or futures because these strategies use leverage. These strategies allow the investor to own the price difference with less investment than the current Bitcoin price. In addition to the price of the asset, the short position includes the cost of the transaction fee and the interest.
Bitcoin short is not usually recommended for crypto-beginners, as it has many risks. When short Bitcoin, make sure you invest an amount of money you are ready to lose. Check the current price and be aware of the crypto news to foresee possible events.