The phrase “shorting Bitcoin” gets used a lot by traders, and just from the context, it is easy to discern that it means betting that the BTC market will go down. What is less obvious is how traders can make money from a drop in an asset’s value and where the average person gets involved. Here’s a handy guide to what shorting really is and how it applies to cryptocurrency.
How does shorting crypto work?
The basic logic behind shorting is that you want to make a financial gain off of a drop in the value of an asset. While this seems counter-intuitive, there are actually several different ways to do this, and we’ll cover the most common here. Often the term shorting refers to a form of margin trading, but investors can also use futures and prediction markets to reach the same goal. Let’s go over each of these now.
Popular ways to short crypto
1. Margin trading
Margin trading refers to the practice of borrowing money from an exchange to set your position. Often, this is used to trade at leverage, but it can also apply to shorting an asset. How it works is that an exchange will basically let you borrow some commodity with an agreement to return it later. While you have the asset, you are free to do with it as you please, so long as it is returned by the agreed-upon time.
How this can make a trader money is simple:
Imagine a scenario where Jim believes that Bitcoin’s value will decrease shortly. In response, he borrows 5 BTC (or any other chosen amount) from an exchange and sells them under an agreement to return the same quantity of 5 BTC in a month. If Jim’s prediction proves accurate, he will buy back the 5 BTC later in the month at a lower price than he initially sold them for. After returning the borrowed BTC to the exchange, Jim keeps the profit from this price difference.
While this is great if Jim is correct, it can get pretty troublesome if he is wrong.
In regular trading, where an asset is bought low and sold high without leverage, the maximum risk is the initial investment. For instance, if you buy Bitcoin and its value drops by 50%, you can hold it until its value rises again, avoiding realized losses. However, in short selling, you must return the borrowed asset within a set time. So, if you short Bitcoin and its value increases by 50%, you must buy back and return it at this higher price, resulting in a loss. Unlike regular trading, this approach can lead to losses without asset retention.
2. Futures
Another popular way to short an asset is to deal in futures contracts. Essentially, futures are agreements to buy or sell an asset at a fixed price and on an agreed-upon date. In many ways, this can work just like margin trading, but the details are a little different.
In this case, say again that Jim thinks BTC will go down. He can then enter into a futures contract that agrees that Jim will sell his Bitcoin in one month but at today’s price. If Jim is correct and Bitcoin tanks, he still sells at the price that the contract outlined. Of course, again, if Jim is wrong, he could miss out on potentially far greater returns.
Now, Jim doesn’t have to create this contract directly. Futures can be traded much like the underlying assets they represent. Their value will be based on the contract details, current market conditions, and the time remaining before expiration. Therefore, if Jim is predicting a bad time for Bitcoin, he can purchase a contract that delivers BTC at current prices, and even before the contract ends, he could flip it to another investor, locking in his profit at virtually any time. In this way, in the future, investors can earn from the value of these contracts without being obligated to fulfill them, so long as they aren’t holding them when they expire.
One benefit for futures is that it protects from the intense risk of margin trading. The following example is a bit extreme but highlights the difference.
If Jim made a margin trade and Bitcoin went parabolic to the upside, say 200% growth when Jim had anticipated a drop, then he is still responsible for paying back that BTC, no matter how high the price goes. This can be financially ruinous in some cases. However, if Jim had used a futures contract, he would definitely have missed out on massive gains but still sell his Bitcoin at the agreed-upon price.
3. Prediction markets
A prediction market is basically a fancy term for gambling on the outcome of events. Users take “long” or “short” positions on various events like political elections or movements in financial markets. It could be almost anything, but of course, betting on the price movements of cryptocurrency is a common practice, and multiple markets already exist running on blockchains like Ethereum’s. In this way, you can short Bitcoin (or any asset) by literally just placing a bet in the price drop. While these markets can indeed be risky, they can also provide important insight into what the public honestly thinks about future events, as users have little incentive to bet for anything they don’t really believe in with a high degree of confidence.
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One downside currently with cryptocurrency-powered prediction markets is that they are still somewhat small. This can mean that there can be a limited amount of pools being run at any time, and starting a new pool doesn’t guarantee takers.
On the positive side, and much like with futures, this type of shorting also limits exposure to the basically infinite risk that margin trading poses. While the wager may not go your way, there should be a clearly defined agreement for what that will cost you. This also opens up a variety of options for betting on how much Bitcoin may fall and on longer timescales.
Where can I short cryptocurrency?
1. Kraken
Kraken, leveraging blockchain technology, offers diverse services catering to a broad spectrum of traders, from beginners to advanced professionals. Known for its extensive selection of cryptocurrencies and competitive fee structure, particularly in its Kraken Pro service, the platform is acclaimed for balancing user accessibility with sophisticated trading features in the blockchain and cryptocurrency world.
Pros:
- Caters to both beginners and advanced traders
- Offers over 230 cryptocurrencies and 130+ trading pairs
- Low fees on Kraken Pro-service
- 24-hour live phone and chat support
Cons:
- Limited funding options for U.S. customers
2. Bitfinex
Bitfinex, as of 2024, is a popular global cryptocurrency exchange known for its low fees and extensive crypto support. Its advanced trading tools and options cater to a wide range of users.
Pros:
- Offers low trading fees
- Provides staking and lending options for passive income generation
- Allows margin trading and caters to advanced traders
Cons:
- A steep learning curve for new users
3. Poloniex
Poloniex is a cryptocurrency exchange with its competitive fees and extensive cryptocurrency support. Poloniex provides a versatile and efficient platform for trading in digital assets.
Pros:
- Advanced trading features like stop loss, take profit, and auto-deposit margin for leveraged positions.
- Enables withdrawal of crypto holdings to an external wallet or funding of an account with crypto from an external wallet
Cons:
- Does not support selling crypto on the platform or withdrawing fiat currency and lacks fiat currency trading pairs
4. Binance
Binance has become one of the world’s leading cryptocurrency exchanges, known for its vast array of digital assets, advanced trading features, and high liquidity.
Pros
- Offers a wide selection of cryptocurrencies for trading with relatively low trading fees
- Known for high liquidity, ensuring ease of trading with minimal price slippage.
- The platform caters to both beginners and experienced traders with user-friendly and advanced trading options.
Cons
- Regulatory scrutiny in various countries
Things to consider when choosing an exchange to short crypto
On any of these sites, users should know that they will be required to go through various levels of KYC verification to be approved for a margin account. Furthermore, it should be expected that you will need to fund your account with collateral before you can trade with a multiplier or short an asset. The amount needed can vary by exchange and how big of a position you are looking to take.
Often, you will need at least 1/5 to 1/3 of your desired trade value. For example, say you want to trade $3000 worth of BTC, you will probably need to have at least $1000 worth in your margin wallet before the exchange will lend you funds.
Where can I trade futures?
Here again, there are a variety of options. Bitfinex and Binance still are some of the top offerings, and Kraken continues to be the best choice for U.S. customers. Users should be aware that in many places, cryptocurrency futures trading is still unregulated, meaning that local laws could change without much notice, and this is an inherent risk in the practice, at least for now.
To avoid these concerns, customers can turn to some options available from the institutional world. CME Group and Bakkt both offer products for Bitcoin futures, though admittedly, the minimum deposit needed to open a trading account with one of these firms may be a bit higher than many retail investors are prepared for. Still, these venues are much safer as they come from government-approved and regulated companies, meaning there shouldn’t be any surprises coming down the line regarding regulations.
Where can I bet on prediction markets?
There are a few notable prediction markets you can get involved with today. Augur is one of the most popular and well-known, but there are many other options available, such as Predictious and GNOSIS. These markets are generally somewhat small and still experimental but can offer a great alternative for those uncomfortable with some of the complexities of margin trading and futures.
Be aware that much like some of these other topics, local regulations around predictions markets may vary wildly. Since these are generally run on a blockchain and powered by smart contracts, they could remain difficult to oversee, but this is another area of cryptocurrency where the final word has not yet been written.
Should you short crypto in 2024?
While shorting an asset can be risky, the same applies to all investing. Shorting can be a powerful tool to hedge against surprise downturns and generally add diversity to a portfolio. As a general rule, users should start small or better yet, begin on a demo account. Many exchanges offer “dummy” trading accounts with fake assets so that newcomers can get their feet wet and learn with no actual risk involved. This can be a great way to decide if shorting is a strategy you might be interested in.
It certainly isn’t for everyone, but with the help of this guide, you should be ready to explore one or more of these shorting options. Even if you decide you aren’t interested, understanding it can make the entire cryptocurrency market, and in fact, the global economy, make a little more sense.
Frequently asked questions
What is shorting bitcoin?
What are the risks of shorting bitcoin?
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