If you’ve spent time on FinTwit or listened to finance podcasts, you might have heard of the term shorting or short selling. Short selling is an investment or trading strategy that speculates on the decline in a bitcoin price over a specific period. The trader uses this future expectation and then places a bet on its likelihood and takes market actions to try and steer the market towards terms that are favourable for the trade idea.
Short sellers are part of a healthy market; they are market participants looking to capital placed in certain assets where they feel it is overvalued, fraudulent or set to be affected by future events. They actively encourage capital to leave certain assets and provide a force for correcting an asset towards “fair” value over time.
What is bitcoin shorting?
Bitcoin shorting is a trading strategy where the investor sells bitcoin in the hope that it falls in value and you can buy it back at a lower price. Traders can then profit from the difference in market price. Short-selling takes the typical mantra of ‘buy low and sell high’ and flips it on its head – while you still buy low and sell high, the trader sells the asset first and buys it back later.
It is an advanced strategy that should only be undertaken by experienced traders and investors. However, as is the case with bitcoin, institutional-grade products are now marketed to retail in the hope that inexperienced traders will misuse these products.
Why do traders short-sell bitcoin?
Before you run out and start short-sell bitcoin, thinking you’re the next Michael Burry, it is important to note your motivations for doing so and the information you’re basing the idea on. Most traders who short bitcoin have a bearish view of the future of the market outcomes but also have information asymmetry to back up their claims. Many times it is often out of scepticism about the popularity of bitcoin, believing it is nothing more than a fad. Still, sometimes it could be due to issues with exchanges being insolvent, mining companies collapsing, or unfavourable regulation in countries coming to light.
If you take this view, it is extremely important to keep up to date with changes in the industry, as there is growing optimism around the future uses of bitcoin, and sentiment can quickly affect the price. There are plenty of people shorting bitcoin who still believe in its long-term potential but feel the prices of today might not represent fair value.
The reason traders consider short-selling bitcoin even when they believe in it would be to hedge a long exposure. If you already own bitcoin but believe it is due to fall in the short term, you might decide to reduce your risk by short-selling the digital coin simultaneously. This way, if the market falls, you can cover some of the loss to your initial investment with gains on your short position.
How to short bitcoin?
There are different ways of shorting Bitcoin or different types of short trading concepts. Some of the known ones are the following:
Margin trading is said to be the easiest option. Several cryptocurrency exchanges support margin trading or leverage trading. In this trading type, you borrow bitcoin from a broker to execute a trade. By borrowing money to increase your position, you can increase your profits but lead you to greater loss.
Usually, the broker offers you a certain percentage of the money you can borrow from the exchange and use for your trading. Also, after a given number of days, you will need to return the money you have borrowed and settle down the transaction.
Like any traditional asset, Bitcoin, too, has a future market. In a futures trade, you are buying security with a contract. The contract specifies when and at what price the security will be sold. If you buy a futures contract, you are betting that the price of bitcoin will go up. So you can get a good ROI.
On the other hand, if you believe that bitcoin’s value will drop in the coming future. Thereafter, you must purchase contracts that bet on a lower bitcoin price. When shorting futures, you agree to sell a contract at a lower price.
CFD stands for contract for differences. It is a financial strategy that pays out money based on the price difference between open and closing prices for settlement. The CFD option is a similar concept to bitcoin futures as they are betting on the bitcoin price. So when you purchase a CFD, you are betting that the price of bitcoin will fall. Hence, you are shorting Bitcoin.
There are also binary options for shorting bitcoin, too. There are two options to choose from, namely, call and put options. When using options, your goal is to sell the currency at today’s price, even if the market price drops later.
The final method of shorting bitcoin is through prediction markets. This is pretty similar to the mainstream markets. As a trader, you can create an event to make a wager based on the outcome. You must predict that the bitcoin price will drop by a certain margin or percentage. If someone takes up on the bet, you will earn a profit if your prediction comes true.
Risk and rewards of shorting bitcoin
Short selling may seem easy on the surface, and with these modern services, getting a short position is easier than ever, but that doesn’t mean you have any less risk. If the market doesn’t go as per your expectations, you will lose money, and if you’re not sizing your positions properly, you can get cleaned out rather quickly. If you want a quick overview of the risk and rewards of shorting bitcoin, they are as follows:
- Without proper market analysis, you can face infinite losses.
- You may need to have a margin account to start selling short.
- Margin interest incurs with short selling.
- Shorting brings you an excellent opportunity to earn high profits.
- It requires minimal initiation capital to start.
- With shorting, you can leverage investments to multiply returns
Stay humble, stack sats and hold
The mistake many new traders make is thinking they’re too bright for the market and finding out they’re not, by getting their accounts wrecked, get taken off the playing field, bruised, and battered quickly. Exchanges and trading platforms encourage you to take these risky bets and offer these complex financial products for a reason, because they are profitable for the house, not for most traders. You might think you have an edge, and you might win sometimes, but overconfidence can lead to you taking risks you don’t fully understand or leave you exposed to situations you never expected.
If you’re taking on more risk by trading bitcoin, by all means, go ahead, don’t let me stop you. But be warned and remember trading shouldn’t be your only strategy; it should be part of various trades to hedge your risk.
In most cases, you’ll be better off leaving the ape games to the fund managers and speculators and stack sats for the long run. Remember, they’re not making many more of these bitcoin, so you might not only lose your current bitcoin position today, but future purchasing power you could have tapped into had you only held on to that bitcoin.