by Jake Wengroff
The concept of shorting, as applied to publicly traded asset classes, is that the investor is bearish and believes that the price of that asset will fall. By shorting and betting that the price will drop, the investor hopes to make a profit. However, to make that profit, one would not sell assets that they currently hold, for if the price drops, they will be at a loss.
Instead, shorting usually involves borrowing securities from a firm and quickly selling them at a current higher price. Then, as the price drops, the investor buys them back at the lower price in order to return them to the firm. The price difference delivers a profit, and this can be done for cryptocurrencies.
This is the opposite of the classic securities trading strategy: buying low, selling high (This is called “going long”).
Here is a simple example to illustrate the concept of shorting Bitcoins (BTC) — profiting from what you believe will be a drop in the price of Bitcoin:
- You borrow 10 BTC from an exchange
- The price of 1 BTC is $40,000 each, but you believe the price will drop
- You immediately sell them and make 10 * $40,000 = $400,000
- The price of BTC does indeed drop to $38,000 each
- You now purchase 10 BTC at a cost of 10 * $38,000 = $380,000
- You return the 10 BTC to the exchange
- You have realized a profit of $400,000 – $380,000 = $20,000
This is obviously a simple example. There are a lot of risks involved — such as when the price does not drop as expected — in addition to fees that you must pay the exchange. To enter into a short sale, you also need to have a margin account with the exchange or broker, and you must pay interest on the margin account.
How to Short Bitcoin
While the example cited above is the most basic, there are several ways to short Bitcoin and other cryptocurrencies.
This is the example from above, and generally the easiest method of shorting crypto. Many crypto exchanges support margin trading, and for investors accustomed to shorting other types of securities, it should be familiar to them.
Trading with other people’s money can certainly increase your profits but it can also amplify your losses. There are limits in place, not just on transaction size but also for transaction dates. Normally after a given period of time, you will need to either execute the transaction — regardless of whether it is profitable for you or not — or return the funds or crypto you have borrowed.
Like stocks, currencies, commodities and other assets, Bitcoin has an options market. If you want to profit from a predicted drop in the price of Bitcoin, you can buy options contracts that give you the right (but not the obligation) to sell Bitcoin (a “put” option, giving you the right to sell, versus a “call” option that gives you the right to buy) at a particular price on or before a specified date.
To execute this strategy, you would need to purchase the number of options contracts that match the number of Bitcoin you intend to buy and sell.
Let’s say the price of Bitcoin keeps dropping, and after 60 days, you decide to exercise your options. At that point, you can buy Bitcoin on an exchange at the now-lower price you predicted, then immediately turn around and sell that Bitcoin at the higher price as agreed in the options contracts. You will now make a profit because the exchange must honor the higher price defined in the option contract despite the fact that the market price for Bitcoin has dropped.
Contract for Differences
A contract for difference (CFD) is a type of informal futures contract between a buyer and a seller in which the buyer must pay the seller the difference between the current value of an asset and its value at contract or settlement time.
The value of a CFD contract does not consider the asset’s underlying value, only the price change between the trade entry and exit. CFD contracts are generally reserved for advanced traders only.
Keep Trading and Investing While Your Assets Are Protected
As crypto investors seek opportunities via different trading strategies, they need peace of mind that their assets are safe. Shorting cryptocurrencies is fraught with risk — and investors don’t want to deal with the risk of a breach of their crypto exchange at the same time.
While the blockchain cannot be hacked, the applications, including the wallets, exchanges and platforms, built upon them can be vulnerable to misuse.
TransitNet is developing a solution that the market needs: a third-party title registry that serves as proof of ownership of crypto assets. It’s the industry’s first, and it will add a layer of protection for investors regardless of how they are investing their crypto.
Join the forefront of the new crypto infrastructure with TransitNet.
Jake Wengroff writes about technology and financial services. A former technology reporter for CBS Radio, he covers such topics as security, mobility, e-commerce and the Internet of Things.
Investopedia – Long Position
Nerdwallet – Margin Trading: What It Is And What To Know
Investopedia – An Introduction to Contract for Differences