Instability is an inherent characteristic of the crypto market. A crypto asset running smoothly today may well experience an unexpected drop tomorrow. This would explain why the value of many cryptocurrencies constantly changes throughout the day. Such volatility, along with regulatory actions, may well lead to flash crashes caused by market fear, followed by minor retracements after large rallies. To keep from showing a loss when this occurs, traders can leverage a concept known as “short selling,” which allows the trader to make money when prices are declining – perhaps even without actually owning crypto. In this article, we explain crypto shorting and the accompanying risks.
What Is the Meaning of Shorting Crypto?
In simple terms, shorting crypto is the practice of selling cryptos at a high price with the intention of repurchasing it at a lower price later, ideally in situations where the crypto asset is predicted to fall.
The approach is called short selling because the trader is “short” on the coins, i.e., doesn’t yet own the crypto from which the trader intends to profit. To help with understanding, you need to be familiar with crypto short and long positions. When going long, the trader purchases cryptos with the expectation that its market value will increase. As an example, the trader will buys a specific coin at $15 and expect its price to reach $18. Once that price is reached, the trader sells and reaps the profit.
By contrast, short selling is borrowing a crypto, selling it at the current market value, and then expecting the value to fall, at which time the trader buys a coin and profits, the difference between the selling and buying prices.
Shorting is an approach to making money from the decline in an asset's value. Traders, therefore, are able to opt for shorting when the expectation is that a coin’s market is about to decrease. Shorting cryptos is risky because markets are often unpredictable. While there is certainly the potential for gains, a market’s volatility means there is the likelihood of significant losses.
When a trader holds a long position, the crypto’s price may well drop, but rarely to zero. So, even though the trader didn’t make any money on that trade, he still has the original investment. When shorting, the price of a coin may rise indefinitely, increasing the losses; thus, it is advisable to be certain there is sufficient solid research before jumping in. If the trader is confident about the research and positive the price will fall, he then takes the calculated risk because it could result in significant profit.
Marketplaces, like Lendingblock and Tybit, are simplifying the ability of borrowers and lenders to find each other and take advantage of the soaring interest in crypto shorting. The increasing number of resources is making short-selling crypto much more accessible to traders.
Risks of Short-Selling Cryptos
There is no question that short-selling crypto can lead to profits when the market is down; but the trader must also consider the associated risks. The following are some noteworthy drawbacks to shorting cryptos:
When buying and holding cryptos with the hope of selling at a higher price, the trader is only exposed to the possibility of ending up with a crypto that did not reach the envisaged price. So, the trader still has the crypto and may choose to continue to hold it for as long as desired.
However, the potential losses are limitless when shorting crypto, since the price can rise beyond the original investment. If the cryptos continue to rise, the trader may need to borrow it at a higher price to lessen the average cost if he or she is still intent on covering the position without incurring losses.
When a trader short-sells crypto, he does not own the crypto. Rather, the trader is borrowing it from a broker, who charges interest for as long as the trader holds the coins. Thus, if the crypto’s price does not decrease per predictions, the trader may need to hold the borrowed coin for a long time. As this is taking place, the interest continues to build, eating into potential profits.
How to Short Crypto?
Before using any method to short-sell crypto, a trader must first determine a trend. Because the market is extremely volatile, there are many aspects that can direct it in either direction, i.e., hype culture, politics, and/or the influence of noteworthy people who are able to disrupt the crypto market.
For a trader to know how to short-sell crypto, first there must be a study of trends. Among such trends are a sudden interest by an extremely wealthy individual or capital-rich company. Then, the trader must open a margin trading account. Most cryptocurrency brokers have provisions for short selling. Further, the trader must check his country’s regulations to be certain such short selling does not violate any legal guidelines.
Now that you understand just what shorting crypto entails, here is more information on how to short crypto via various methods:
Direct Short Selling
This is the initial approach traders take after learning how to short Ethereum or any other crypto. In short, the trader borrows crypto from an exchange for a specific price. Next, the trader awaits a decrease in the price. When there is a decrease, the trader purchases the currency and returns the borrowed crypto to the exchange. The trader then has earned the difference between the buy and sell prices.
It is said that the easiest crypto shorting approach is margin trading, which is supported by many crypto exchanges: FEX, Phemex and Binance Futures, to mention just a few. In this approach, the trader borrows crypto from a broker to get in the game. You need to know that “margin” refers to not simply “borrowing” coin from the broker, but borrowing at heavily leveraged rates, which means increasing your profits is not the only possible outcome; there is also the possibility of greater loss because you have borrowed so heavily. Normally, the broker offers a certain percentage of money you are able to borrow from the exchange to use for trading. Then, after a stated number of days, you must return the money you have borrowed to settle the debt.
As with all other assets, some cryptos also have a futures market where the trader agrees to purchase a security by way of a contract. The contract spells out both the price at which the crypto will be sold and when that sale will take place.
By purchasing a futures contract, the trader bets on the crypto’s price. This approach allows the trader to earn a profit on that crypto in the future. When the trader sells the futures contract, it indicates the trader expects the price to decline in a forthcoming bear market. Crypto futures may be traded on the Chicago Mercantile Exchange, the world's largest trading platform for derivatives, or with ByBit derivatives.
Contracts for Difference
Contracts for differences (CFD) are among the most popular approaches to short crypto. Brokers will allow traders who use CFDs to bet on an increase or decrease in a crypto’s price without actually owning the crypto. The trader only must deposit a part of the margin account’s fund to ensure he will be able to purchase the crypto at the specific price on which he is betting. The deposit remains in the trader’s possession and the broker or exchange only holds it as collateral.
Therefore, the trader only needs to supply a specific fraction of the total trade amount to open his position. Because of this, the trader is able to amplify his return on investment if the crypto moves in the direction of the bet. Having said that, CFDs carry enormous risks if the crypto’s price moves in the opposite direction to the trader’s prediction.
Crypto Put Options
Is it possible to short cryptos without risking your investment? There is an “almost” answer. If a trader deals with complex derivatives in a bear market, the trader is able to add a buying crypto put option to his list of methods on how to short crypto. The option gives the trader the right to buy crypto at a predefined price on a predetermined date. This, however, is not an obligation.
For example, if a trader believes that Ethereum’s price will drop in the autumn of 2022, he can purchase the crypto for three months with a price of, say, $25,000. If the price drops below this strike price on the predetermined date, the put will earn a trading profit. However, if the price remains high, the trader will not lose anything other than the option premium, which is the fee paid for holding the option.
Also available are binary options for shorting cryptocurrency. Well-known concepts are put and call options where you must execute a put order using an escrow or other services. The goal here is to sell the crypto at today’s price, even if, later, the market price drops. Many offshore crypto exchanges offer binary options. Remember, however, this approach involves high cost and risk.
The principal advantage here is the ability to limit losses by not electing to sell the put options. Therefore, you only are taking a loss on the funds spent in the creation of the order. Generally, it is a limited-risk and short-term contract trading approach, with two possible outcomes. First, you may make a profit, which you have defined beforehand. Second, you lose the money you put forth to open the trade.
To learn how to short cryptos while interacting with others, consider this approach, which is similar to mainstream conventional markets.
A trader may predict that a specific crypto will decrease by a particular percentage or margin. Following the prediction, someone else has to agree to the bet. If the price really goes the way you want, you earn a profit. Among the popular prediction markets are Augur and Polymarket.
As there are several factors that serve as the base for shorting cryptos, the trader must be certain he is taking the correct approach at the time. The worst situation is to short sell a crypto during a false retracement. Here are some tips to help make the proper decision.
Use Technical Analysis
Technical analysis (TA) is using real-world data to predict how the crypto market will perform in the future. This requires viewing past performance of the crypto in which you are interested, such as its volume and movement. Thus, if a trader wants to know how to short Ethereum, the trader will view its trading volume today compared to that of recent months.
TA is based somewhat on Dow Theory, which asserts that pricing in a market is dependent on everything from current and past demand and regulations to a trader’s knowledge of the crypto itself and the trader’s expectations and future demand for that crypto. TA’s root is that history will repeat itself relative to pricing and trends. All this information then is used to predict future market sentiment.
Furthermore, TA is based on the concept that any movement in the crypto market is not random, but rather is based on a trend – either long-term or short-term. Generally, if a currency has followed a trend, eventually it will follow the opposing trend.
The following are some indicators that are used in TA to assist with predicting price crashes and retracements:
• Average directional index (ADX) assists with determining the strength of the trend.
• Standard deviation is applied to the annual rate of return on investment and shows the historical validity of investments in a crypto.
• Bollinger Bands demonstrate whether the crypto’s price is low or high on a relative basis.
• Relative strength index (RSI) signifies momentum in TA. For any recent price change, this indicator determines the magnitude.
These indicators allow a trader to determine the profit opportunity with an investment. The trader also is able to use some statistical tools, such as time-weighted averages price (TWAP), Fibonacci ratios and extensions, moving averages (MA), and volume-weighted average price (VWAP).
When learning how to short a crypto, there is a need to understand MAs. Simply, MA refers to a crypto’s price over a certain period. The MA typically depends on the crypto’s trading price over the previous 20 days. It is possible to make predictions more accurate by connection of the moving averages.
All of these approaches are complex statistical concepts and require some learning. A novice trader who is still learning how to short cryptos may be cautious about jumping into complex economics. Remember that factoring in these indicators will allow making more intelligent investments.
Stay Current with the News
This is not just crypto news, because politico-economic events can propel a market in any direction. Indeed, it is possible for government regulations and crackdowns to lead to flash crashes in the crypto market.
Therefore, if you suspect that something along these lines is about to take place, capitalize on the situation by shorting cryptos in the bear market. At the same time, be alert to not going against any government guidelines in the process because that could lead you into significant trouble.
Use Fundamental Analysis
There are those who do not believe cryptos come with any fundamentals at all, given that their markets have only been around for such a short time. It is still possible, however, to use fundamental analysis (FA) to help the chances of making the right investment decisions. When using FA, you uncover the forces that drive supply and demand of cryptos in which you are interested. Examples of relevant variables are news, trading, market sentiment, adoption and transaction activity.
Using FA, the trader studies the intrinsic value of a crypto. Then the trader views both internal and external factors to decide if a crypto is overvalued or undervalued. Because cryptos’ FA is not the same as that of more traditional markets, three different metrics commonly are used:
These metrics may be observed by viewing the data on a blockchain. In fact, the trader does not have to do very much because there are Websites that already have generated this data. For example, data charges for various cryptos may be viewed when spot trading on Bybit.
Transaction count also provides a reasonable idea of the activity occurring on a network. The trader is able to use moving averages, and even plot a specific time period, to determine how activity surrounding a crypto changes over time.
Use this metric with caution! The information comes with no guarantee, for example, as to whether a high transaction count is because of unique active addresses or the same people transferring funds among their different wallets.
Transaction value shows the number of completed transactions in a certain time period. Thus, if 10 people transfer Ethereum in a single day, the transaction count would be 10. If each Ethereum were worth $1,000, the total transaction value for the day would be $10,000
The Bottom Line
After reading this guide, you should be able to short cryptos. Shorting crypto means selling it at a high price because you expect the price to decline due to fear in the market or retrace following a price rally. This allows you to purchase it later at a lower price. We hope our handy guide assisted you to know what shorting crypto is about and where to do it legally.
Shorting crypto means borrowing an amount of digital currency from a broker and selling it at market value. Then, when the value of the crypto has fallen, the trader purchases it and returns the borrowed amount, plus interest, to the broker. The trader’s profit is the difference between the buy price and the sell price, less the interest.
Is shorting crypto a good thing?
Is shorting crypto halal?
Shorting cryptos normally is considered Haram because it involves selling something that is borrowed. It may, however, be worth consulting your religious leader for guidance.
Where am I able to short crypto?
Several crypto platforms exist on which futures, margin and options contracts can be traded. Among the best known are Coinbase, Binance, Robinhood, Webull, Kraken, eToro, Interactive Brokers, Bitfinex, Cryptohopper and Kucoin.
Is shorting crypto illegal?
Short selling is highly regulated in traditional financial institutions. Crypto is unregulated in many jurisdictions, however, such as the US, Australia, India, Canada, and Europe. Traders, therefore, need to be wary of cryptos being hyped on social media because this could be a deceptive pump-and-dump scheme. As well, note that trading cryptos with CFDs or other derivatives in the UK is no longer possible.
Adrian Ashley is a seasoned business and finance writer. With a corporate career spanning over 20years, he has developed deep experience in such diverse areas as investing, business, finance,technology and macroeconomics. He is passionate about captu...