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- 'Shorting' means anticipating a decline in value of a traded asset.
- Traders can short crypto, but the market's volatility and lack of regulation make it particularly risky.
- There are a few ways to short crypto, if you have the appetite and capacity for risk.
While short-selling is most commonly associated with the stock market, you can also short cryptocurrencies like Bitcoin and Ethereum using the best cryptocurrency exchanges. Cryptocurrencies are extremely volatile assets, offering the potential for large gains or losses.
The process of shorting cryptocurrencies is similar to the one you would use for shorting stocks or other assets. In traditional investing, you aim to buy low and sell high. Shorting is when you sell high and then buy it back lower.
"You essentially borrow the asset from someone and sell it," says Peter Eberle, president and chief investment officer of Castle Funds. "You then buy it back sometime in the future and return the borrowed assets."
Shorting crypto is an advanced trading strategy that could easily backfire. While it's possible to make a quick return, shorting also requires deep knowledge of the markets and derivatives.
"Unless you're an absolute expert on that particular crypto that you're shorting, I would steer clear of it," says Mark Fidelman, founder of SmartBlocks. "It's not a game for amateurs."
Here's what you need to know about shorting cryptocurrencies.
Methods for shorting crypto
Shorting crypto can be done in a few different ways.
Crypto margin trading
It is possible to trade crypto on margin, depending on the exchange or brokerage you use and whether that exchange has offered you the ability to trade on margin. But be warned that there are often interest charges (you're borrowing money, after all).
In practical terms, shorting crypto using margin entails borrowing money from your chosen exchange to purchase a certain amount of cryptocurrency, waiting for it to appreciate in value, and then selling to earn a return. You then "return" the money to the exchange, pay any applicable interest fees, and you've made a profit trading with money that you didn't even have.
Future contracts
Another way to short cryptocurrencies is with futures trading. With futures, you buy or sell an asset at a specific price by a particular date. You must either buy or sell that asset when the contract expires.
Only experienced crypto traders with high-risk tolerances should consider shorting crypto with futures contracts, as this strategy requires advanced knowledge of derivatives.
Options trading
Options contracts can also be used to short crypto. The process is similar to futures, but with options investors have the option, not the obligation, to go through with the transaction.
"You'd do a put on the crypto," says Fidelman. A put option is, in essence, a bet that an underlying asset will lose value, which is why it could be used to short a cryptocurrency.
Here's an example: Say you anticipate Bitcoin's value going down over one day. You have 10 BTC valued at $100, and buy a put that gives you the right to sell the 10 BTC at $100 in one day. As you anticipated, the price of BTC falls to $6 — you can let the contract expire or sell the BTC at the $100 price mark, $40 more than its market value.
Prediction markets
Prediction markets are platforms where people can wager on the outcome of certain events. Although not technically shorting, you can still earn a profit by betting that cryptocurrencies like Bitcoin will decline by a certain percentage. However, you won't make a profit unless someone else takes you up on that bet.
Prediction markets are risky and rely on investors to speculate on outcomes, which may lead to poor decision-making. These high-risk platforms resemble gambling sites rather than investment platforms, as the only way to generate capital gains is by "winning" a bet.
Risks of shorting crypto
The risks of shorting crypto are fairly obvious. If you're betting that a crypto's value will fall and it rises instead, you stand to lose. How much you could lose depends on the instruments or methods you use to open a short position and how much you have at stake.
- Unlimited loss potential: Shorting can lead to unlimited losses if the asset price rises significantly, as you aren't limited to your initial investment. Shorting stocks is already risky, but shorting crypto is even more so since decentralized digital currencies are so volatile.
- Margin calls: Since margin is essentially borrowing, you may have to deposit more money into your shorting asset to avoid liquidation. This can lead to significant loss.
- Volatility: Cryptocurrencies like Bitcoin are notoriously volatile with no guarantee of return. Shorting is a high-level trading activity. Although it can offer the chance of greater returns, it can also lead to outsized losses.
- Regulatory uncertainty: Although the crypto industry has steadily improved its regulatory front over the last few years — with the SEC cracking down on unethical trading practices and more exchanges enforcing proper security measures and more protection technology — the crypto market is still rife with scams and fraudulent activity.
That said, shorting can benefit financial markets, some experts say.
"For example, shorting can enhance liquidity, increase the efficiency of stock prices, minimize market bubbles, and may function at times to reduce market manipulations," says Gabriella Kusz, head of strategy at Blockfills. But while shorting may have a place in the market, that doesn't mean it necessarily has a place in your investing plan.
Choosing a shorting method
How you choose to short crypto depends on factors like experience and access to capital. Regardless of the shorting method you select, only experienced investors with knowledge of both cryptocurrencies and shorting strategies should consider this method.
You should also have the capital to recover from the loss if you're shorting position doesn't pan out. Beginners should not attempt shorting cryptocurrencies.
Depending on your preferred method, shorting crypto on various exchanges or platforms is possible. For example, large exchanges like Coinbase or Kraken allow users to buy Bitcoin futures contracts. Other traditional brokerages, including TD Ameritrade, offer them too.
Not all platforms offering margin trading and cryptocurrencies will allow users to trade crypto on margin. So, do your homework to find a platform for your specific shorting techniques.
Tips for shorting crypto
- Research and analysis: Conduct thorough research before attempting to short cryptocurrencies. Make sure you are getting your information from a trusted and reputable source. Luckily, many exchanges provide users with technical and fundamental analysis tools so they can identify potential price declines.
- Risk management: It is crucial to manage your portfolio's risk. Although shorting crypto is an extremely risky move, you should take precautionary measures to prevent losing more than you can afford. One method is a stop-limit order, which helps limit potential losses.
- Stay informed: Keep up-to-date on market news and events that may impact your cryptocurrency value.
Shorting crypto FAQs
Yes, shorting crypto is legal. Shorting cryptocurrencies like Bitcoin and Ethereum is considered a useful strategy for correcting overvalued priced assets. This can help the overall market health, but it's risky for investors.
The best platforms for shorting crypto are large exchanges like Binance.US and Kraken. These exchanges offer access to educational content and various security measures to protect investors against fraudulent activity and scams. Keep in mind that not all crypto exchanges allow shorting, so do your homework on the available features before opening an account.
You can manage risks of shorting crypto by thoroughly researching the cryptocurrency market and how advanced trading strategies like futures works. You can also limit potential loss with stop-loss orders and limited position sizes. Only experienced traders with advanced market knowledge should consider crypto shorting.
