What Is It and How Does It Work?

When assessing investments, the typical notion is to gain from the rise in asset prices and incur losses as they decline. However, a more sophisticated approach is short-selling, or “shorting,” which revolves around speculating against an asset by anticipating its future price decrease.

Shorting is often linked with the stock market, but the practice extends to cryptocurrencies. Many digital assets exhibit high volatility, leading to substantial profits or losses within brief time frames. The prospect of huge profits allures many investors to short cryptocurrencies. 

This article examines cryptocurrency shorting, unraveling its nature and mechanics comprehensively. You can also visit Cryptocurrency Help to learn more about crypto investment. 

What Is Cryptocurrency Shorting?

Shorting cryptocurrency involves selling crypto at a higher price to repurchase it at a lower price later, usually when there’s an expectation of the cryptocurrency’s value decreasing. The term “short selling” comes from being “short” on the cryptocurrency, meaning you don’t actually own it. 

To understand this concept, you need to know what long and short positions are in cryptocurrency. Going long means buying cryptocurrency with the belief that its value will increase. For instance, you are buying Ethereum at $800 and selling it at $1,000 for a profit of $200. 

Conversely, shorting involves borrowing and selling a cryptocurrency at the current price, anticipating a value decline. Later, you repurchase it when the price drops, making a profit from the difference between your initial selling and buying prices.

Shorting allows profiting from an asset’s value reduction. Traders might short a cryptocurrency if they predict its value will drop. However, it’s risky due to market unpredictability.

How to Short Cryptocurrency?

Now that you know cryptocurrency shorting, let’s delve into the various approaches to shorting cryptocurrencies.

Direct Short Selling

When acquiring oneself with the process of shorting cryptocurrency, the initial method that many individuals learn first involves borrowing crypto from an exchange at a designated price and subsequently selling it. This is known as direct short selling. 

Following this step, you await a decline in the price. Once such a decline occurs, you repurchase the cryptocurrency and reimburse the borrowed amount to the exchange. This practice lets you realize a profit corresponding to the variance between the two prices.

Futures Markets

Similar to various other assets, certain cryptocurrencies also participate in futures markets, wherein you commit to purchasing a crypto token through a contractual agreement. This contract outlines the token’s stipulated selling price and the timeframe for this transaction.

Opting for a futures contract involves betting on the token’s price increase. This decision allows you to realize future profits from the price increase of that particular token. Conversely, when you sell the futures contract, it signifies your anticipation of a forthcoming decrease in price, particularly during a bearish market phase.

Contracts for Difference

Contracts for Difference (CFDs) are a standard method for shorting cryptocurrency. CFDs allow speculation on price changes without owning the actual asset. Brokers facilitate this by requiring a margin deposit, a fraction of the trade value, as collateral. This deposit guarantees your ability to buy the cryptocurrency at the predicted price. 

The structure offers the potential for higher ROI if your prediction is correct. Yet, risks are substantial; if the price deviates from your forecast, the collateral’s fraction can lead to position liquidation, especially if prices rise significantly.

Prediction Markets

If you aim to understand how to engage in cryptocurrency shorting within a community of fellow investors, prediction markets offer an avenue worth exploring. These markets operate in a manner akin to traditional mainstream markets.

In this system, you, as an investor, can anticipate a specific cryptocurrency’s decrease by a designated percentage or margin. Another individual must then accept your prediction. 

Should the price indeed move in the predicted direction, you stand to gain a profit. Notable prediction market platforms include Augur and Polymarket.

Cryptocurrency Put Options

Cryptocurrency put options offer a risk-free way to short cryptos. In a bear market, you can employ this complex derivative method. Buying put options allows you to short without risking your investments.

A put option grants the buyer the right to sell a cryptocurrency at a set price on a specific date. Importantly, this is a right, not an obligation, giving users discretion on exercising the option.

For example, if you anticipate Bitcoin’s decline, you can purchase a 3-month Bitcoin put at $20,000. If Bitcoin falls below this price on the set date, your put generates a trading profit. If prices remain high, you only lose the option premium, the fee for holding the option.

Risks Associated With Cryptocurrency Shorting

Cryptocurrency shorting offers profits during market downturns, but there are also potential risks. These risks include;

Unlimited Losses

Shorting cryptocurrency exposes you to the possibility of unlimited losses that surpass your initial investment. When the cryptocurrency’s price rises, you might need to borrow it at an even higher price to mitigate your average cost. If the trade eventually fails, you will run into a considerable loss.  

Margin Interest

During market fluctuation, you could hold onto the borrowed coins for an extended period. During this period of stagnation or ascent, the accrued interest accumulates, eroding a portion of your potential profits. If the cryptocurrency’s price keeps rising and you opt to cut your losses, you not only miss out on the price appreciation but also bear the burden of a substantial cost (in the form of interest) for shorting.

Exchanges That Support Cryptocurrency Shorting

Cryptocurrency shorting can be executed across numerous exchanges or platforms, offering different methods based on your preferences. For example, prominent exchanges such as Kraken, Binance, Bitfinex, Bybit, BitMEX, and Coinbase permit users to procure futures contracts. 

Moreover, established brokerage firms like TD Ameritrade also provide access to such options.