Last updated on January 2nd, 2018 at 12:00 am
Short-selling is an investment method that allows investors to benefit from drops in prices and value of a particular asset, in this case, Bitcoins.
What is Short Selling Bitcoin All About?
Short selling allows you to basically borrow an asset, such as Bitcoins, and sell it at current prices. Later on, you can purchase the Bitcoins to pay back the person or organization you borrowed them from when selling the first time around. Hopefully, when you go to repurchase the Bitcoins, prices will have dropped, so it will be cheaper to purchase the assets that need to be paid back.
Let’s illustrate this with a short example:
- You short sale (borrow and sell) 10 Bitcoins when the price is $4,000
- This means you get $40,000
- Price of Bitcoin drops to $3,500
- You repurchase 10 Bitcoins to give back to the agency you borrowed from at 10*$3,500 = $35,000
- Your total profit is $40,000-$35,000 = $5,000
How to Short Sell Bitcoin?
If you want to short sell Bitcoins, you will contact a trading agency or platform and place a short sell order. The agency will then sell the Bitcoins from their own supply, based on the assumption that in the future you will repay them with an equal number of Bitcoins. If you sell 10 Bitcoins, for example, you will eventually have to “cover” those 10 Bitcoins, whether prices rise or drop. If prices drop, it will be cheaper to rebuy these 10 Bitcoins. If prices rise, it will be more expensive.
When short-selling, the firm or individual who loaned Bitcoins to you can generally recall the assets at any given time and are required to give you only a short notice. So make sure you read any rules, regulations, or guidelines for “covering” any assets you short sell. With markets fluctuating at such a rapid rate, costs can swing wildly, putting you at risk. Short selling can be especially risky if the lender calls in the assets before prices have a chance to drop.
There are a variety of ways to short Bitcoin:
Short Sell CFDs
Short selling is actually very common with stocks and most major trading platforms allow you to short stocks. Some Bitcoin CFD trading platforms now allow you to short-sell Bitcoins (e.g. AvaTrade or Plus500), when trading CFDs your capital is at risk. Also, Keep in mind that these platforms don’t actually hold Bitcoins and are using a method called Contract for Difference.
Shorting via a Bitcoin Exchange
Exchanges geared towards crypto traders offer short support as a matter of course, and some allow for leveraged shorting too. These exchanges include:
… and many more. Ensure that the exchange you pick is reputable and remember; any bitcoins kept on an exchange are only yours in theory.
Certain specialized exchanges, such as BitMEX, offer Bitcoin options trading. Purchase of an option grant the ability, but not the obligation, to trade at a specific price by a certain expiry date. If you have experience with options trading this method might suit you, otherwise it’s not recommended for beginners. Options are complex but do allow for greater flexibility and higher leverage.
Timing a Bitcoin Short Sell
IF you time it right… Shorting Bitcoin is trading against the long-term uptrend; the longer you hold your trade the riskier this becomes. Of course, this is only true provided Bitcoin markets remain bullish (i.e. price go up) – but in July 2017 this appears to be the expectation of amateur and professional traders alike.
Another thing to remember – the maximum profit potential of a short is limited to a Bitcoin price of 0, whereas buyers have an unlimited upside of [infinity].
If you examine Bitcoin price charts, you’ll soon realize the truth of the old trading aphorism, “price takes the stairs up but the elevator down.” Whereas bullish moves take time to build and develop, bearish moves tend to be relatively short and sharp.
Trying to short the top of a big bull run is tough; you’re likely to stop out multiple times as Bitcoin keeps rising like a stubborn zombie. The smarter play is to short when price reaches resistance; such as the top of an established downtrend line, channel, or previous major high. If price persistently pushes through any of these structures, you’ll soon know that your short was wrong and can exit (“close”) it at only a minor loss.
Keep in mind that if many traders are positioned similarly, a price surge may result as fearful traders compete to close their shorts. This is known as a short squeeze. A perfect example may be seen at the right edge of the above chart.
Analyzing the market for Short Sell Opportunities
Beyond technical analysis, it helps to know the Bitcoin space well. Certain past events have triggered major sell-offs:
- Failure of major exchanges, eg. Gox collapse.
- Hostile regulatory action in major countries, eg. “China bans Bitcoin” fake news.
- Well-known developers throwing a quit fit, eg. Mike Hearn.
- Heightened hard fork risks, eg. the recent anxieties over UASF before BIP 91 locked in (review the last couple of weeks on the above chart).
- Delays or setbacks in widely-desired upgrades, eg. SegWit.
Events expected to have a very negative impact on price, should they ever occur, include:
- Any contentious hard fork.
- Breach of the cryptographic primitives used in Bitcoin (SHA256, secp256k1).
- Discovery of Bitcoin code exploits which threaten wallet security or network operation.
- Hostile actions against Bitcoin mining companies by the Chinese government.
- Movement in the first million or so bitcoins mined by Satoshi Nakomoto.
Events which, thus far, have had surprisingly little negative impact on price include:
- The failure (through fraud or seizure) of darknet markets, eg. Silk Road or Alpha Bay.
- Full blocks and correspondingly high transaction fees.
- Claims of having unmasked the identity of Satoshi Nakomoto, eg. Dorian Nakomoto fake news or Craig Wright hoax.
- Hostile pronouncements from journalists, economists, politicians, bankers, etc.
None of the above lists should be considered exhaustive. Remember that bullish markets tend to shrug off bad news and that markets may ignore, misinterpret or overreact to negative events.
The risks of Bitcoin Short Trading
We should warn you, however, that short-selling any asset is a high-risk venture. Normally, when you invest in an asset your losses are limited to the amount of money you have invested in that asset. For example, if you invest $10,000 dollars in a stock, and that stock suddenly collapses and become worthless, your losses will be limited to the $10,000 dollars you invested.
When short selling, however, your losses could extend far beyond your initial investment, something that is very important to consider, especially with Bitcoin. The easiest way to explain this is to use an example:
Let’s say you short-sold $100 dollars worth of Bitcoin back when prices were only $10 dollars per coin. That means you short-sold 10 coins. Let’s assume that you have yet to repurchase the coins, meaning that you still have to pay the owner back with 10 Bitcoins. At current prices that would cost more than $40,000 dollars!
As you can see, short-selling any asset can be very risky. If you want to short sell Bitcoins or anything else, you need to be very careful. Only invest if you are very confident that prices will drop, and if you have money to cover your losses if investments rise. Make sure you watch prices closely and cut your losses if prices start to rise too quickly. That being said, if your intuition turns out to be correct and prices do drop, you could make a lot of money. If you short-sold a single Bitcoin that’s currently selling for $1,200 dollars, for example, and prices collapsed back to $100 dollars, you’d make approximately $1,100 bucks, and that’s not a bad pay day at all!
That being said, if your intuition turns out to be correct and prices do drop, you could make a lot of money. If you short-sold a single Bitcoin that’s currently selling for $4,000 dollars, for example, and prices collapsed back to $2,500 dollars, you’d make approximately $1,500 bucks, and that’s not a bad pay day at all!
If you have any experiece with short selling Bitcoin I’d love to hear about it in the comment section below.