How To Short Crypto: A Comprehensive Guide

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Last updated Jun 07, 2024 | 04:21 PM UTC

Shorting crypto involves borrowing digital assets and selling them at the current market price, with the intention of buying them back at a lower price in the future. The difference between the selling price and the buying price is your profit. 

This strategy allows traders to profit from falling prices, making it a powerful tool in volatile markets like cryptocurrency.

To short crypto, you need access to a trading platform that supports this function, such as a centralized exchange (CEX).

Understanding the mechanics and risks involved is crucial before engaging in short selling.

Key takeaways

  • In crypto, shorting means borrowing and selling tokens to repurchase them at a lower price for profit. 
  • Crypto shorting is a common tactic traders use to earn short-term profits, leveraging rapid volatility in the market. 
  • Shorting can be highly risky due to the potential for unlimited losses, margin calls, and borrowing costs. 
  • Shorting traditional assets like stocks is less risky but also has lower scope for profitability. 
  • Traditional markets often don’t operate 24/7, unlike the crypto market, which makes them less suitable for shorting. 
  • To use the crypto shorting technique, traders should choose exchanges with high-leverage options and strong security measures.

How to long and short crypto

Going long means buying an asset with the expectation that its price will rise. Conversely, going short means selling an asset you don't own, anticipating that its price will fall, allowing you to buy it back at a lower price.

Steps to long crypto

  • Buy crypto assets: Purchase your chosen cryptocurrency on a trading platform.
  • Hold in a secure wallet: Transfer your assets to a secure digital wallet.
  • Sell when price increases: Monitor the market and sell your assets when their value appreciates.

Steps to short crypto

  • Borrow crypto: Use a broker or exchange to borrow the cryptocurrency you want to short.
  • Sell borrowed crypto: Immediately sell the borrowed assets at the current market price.
  • Repurchase crypto: Wait for the price to drop and buy back the same amount of cryptocurrency.
  • Return borrowed crypto: Return the borrowed assets to the lender.
  • Keep the difference: The difference between the selling and repurchase price is your profit.

How shorting works in general

Basic mechanism

Shorting involves borrowing an asset, selling it immediately, and then buying it back at a lower price. The profit is the difference between the selling price and the repurchase price.

Risks of shorting

Shorting carries significant risks, including unlimited potential losses. If the asset's price rises instead of falls, you could face substantial losses. Margin calls can force you to buy back the asset at a higher price, further increasing your losses.

Margin requirements

To short an asset, you need a margin account with sufficient collateral. This collateral acts as security for the borrowed assets and ensures you can cover potential losses.

Interest and fees

Borrowing assets for shorting incurs interest and fees. These costs can reduce your overall profit, making it essential to factor them into your trading strategy.

Differences between shorting crypto and shorting traditional assets

The main difference between shorting crypto and shorting traditional assets like stock comes down to the risk factor. Crypto prices can fluctuate extremely in a short period of time, which makes shorting crypto significantly risky, but all increases the profit opportunities. 

However, traditional assets tend to be less volatile in a short-term, so the risk factor and profit opportunities are much lower. In fact, shorting traditional assets often requires high volume trades to have suitable profit margin. Here are more detailed differences: 

Volatility

Cryptocurrencies are notoriously volatile. For instance, Bitcoin can experience swings of 10% or more in a single day. In contrast, traditional assets like stocks or commodities typically have less dramatic price movements. A blue-chip stock like Apple might fluctuate 1-2% in a day, reflecting more stability. This high volatility in crypto can lead to significant profit opportunities, but it also means higher risk. A sudden market movement against your position can lead to substantial losses.

Market hours

Crypto markets operate 24/7, unlike traditional markets which have set trading hours. For instance, the New York Stock Exchange (NYSE) operates from 9:30 AM to 4:00 PM EST, Monday through Friday. This continuous operation of crypto markets means that price changes can happen at any time, including weekends and holidays. For a trader, this can be both an opportunity and a challenge, as market-moving news can occur outside of traditional trading hours, requiring constant vigilance.

Regulations

Crypto markets are less regulated compared to traditional financial markets. Traditional assets like stocks and bonds are subject to strict regulatory oversight by bodies such as the Securities and Exchange Commission (SEC) in the United States. This regulation provides a level of investor protection and market stability. 

In contrast, the crypto market’s regulatory environment is still developing. For instance, exchanges like Binance and Coinbase must navigate varying regulations across different countries, which can lead to inconsistencies and potential risks for traders.

Liquidity

Liquidity refers to how easily an asset can be bought or sold without affecting its price. Major cryptocurrencies like Bitcoin and Ethereum generally have high liquidity due to their large market caps and widespread adoption. 

For example, Bitcoin's average daily trading volume often exceeds $10billion. In contrast, smaller altcoins may have low liquidity, making them more susceptible to price manipulation and harder to trade in large volumes. 

Traditional assets, particularly those of large companies, usually enjoy consistent liquidity. The daily trading volume for a stock like Microsoft can exceed 20 million shares, ensuring that trades can be executed quickly and with minimal impact on price.

Leverage

Leverage allows traders to borrow money to increase their position size. In crypto trading, leverage can be extremely high. Some exchanges offer leverage up to 100x, meaning a trader can control $10,000 worth of crypto with just $100 of their own money. This can amplify profits but also significantly increases risk. In traditional markets, leverage is typically more conservative. 

For instance, in the stock market, the typical leverage for a margin account might be 2x or 3x. This means a trader with $1,000 can trade up to $2,000 or $3,000 worth of stock. The lower leverage in traditional markets reduces the risk of catastrophic losses.

Security

Security is a critical factor in both crypto in traditional markets. However, the cryptocurrency market is extremely vulnerable to cyber threats and the impact of security incidents on market prices can be brutal. 

Incidents such as the Mt. Gox hack and the FTX collapse saw the market loose billions in seconds. Traditional markets face different security issues, such as fraud and insider trading. However, these markets benefit from established legal frameworks and regulatory oversight designed to protect investors.

Case example: Shorting Bitcoin vs. shorting Apple stock

Consider a trader who believes that the price of Bitcoin will fall. They borrow one Bitcoin and sell it at the current market price of $70,000. If the price drops to $60,000, they buy back one Bitcoin and return it to the lender, pocketing a $10,000 profit. Conversely, if the price rises to $80,000, they face a $10,000 loss.

In contrast, shorting Apple stock involves borrowing shares and selling them at the current price. Suppose the trader borrows 100 shares of Apple at $150 each and sells them for $15,000. If the price drops to $120, they can buy back the shares for $12,000, making a $3,000 profit. If the price rises to $180, they would incur a $3,000 loss. The more stable nature of Apple stock compared to Bitcoin means less dramatic price swings, but also fewer extreme profit opportunities.

Understanding these differences is crucial for anyone considering shorting cryptocurrencies. Each market presents unique challenges and opportunities, and traders must be prepared to navigate these with a clear strategy and thorough knowledge of the risks involved.

What a CEX needs to have to enable shorting

  • Lending mechanism: Robust infrastructure for borrowing and lending crypto assets. Secure management of loans and collateral.
  • Margin trading capabilities: Support for margin accounts, allowing traders to borrow funds. Clear and accessible information on margin requirements and collateral.
  • Security measures: Strong security protocols, including two-factor authentication and encryption. Regular security audits to protect users' funds.
  • Liquidity pools: High liquidity to ensure smooth and efficient trading operations. Sufficient depth in order books to handle large trades without significant price impact.
  • Regulatory compliance: Adherence to relevant laws and regulations, including AML (anti-money laundering) and KYC (know your customer) requirements. Transparency in regulatory practices to build trust with users.
  • User interface: Intuitive and user-friendly interface for executing short trades. Real-time data and efficient order execution features.
  • Customer support: Multiple support channels and knowledgeable staff.

These features are essential for a centralized exchange to effectively support shorting, ensuring a secure, efficient, and user-friendly trading experience.

Final thoughts

Shorting crypto can be a profitable strategy, but it requires a solid understanding of market mechanics and risks. By using reliable platforms and following informed strategies, traders can potentially capitalize on falling prices in the volatile crypto market. Always consider the unique aspects of crypto trading, such as 24/7 market hours and regulatory differences, to navigate this dynamic landscape effectively.

Disclaimer: Trading cryptocurrencies involves significant risk and can result in the loss of your invested capital. Always conduct thorough research and consult with a financial advisor before making any trading decisions. This article is for informational purposes only and does not constitute financial advice.

Frequently Asked Questions

What is shorting crypto and how does it work?

Shorting crypto involves borrowing a cryptocurrency and selling it at the current market price, with the aim of buying it back at a lower price in the future. The difference between the selling price and the repurchase price is your profit. This strategy allows traders to profit from falling prices.

What are the risks of shorting cryptocurrencies?

Shorting cryptocurrencies carries significant risks, including the potential for unlimited losses if the asset's price rises instead of falls. Other risks include margin calls, where you must provide additional collateral if the trade moves against you, and high volatility, which can lead to rapid and unpredictable price changes. Additionally, borrowing costs and fees can reduce overall profitability.

Can I short any cryptocurrency or only specific ones?

You can short many popular cryptocurrencies, but availability depends on the platform you use. Major cryptocurrencies like Bitcoin and Ethereum are widely supported for shorting on most exchanges. However, smaller or less liquid cryptocurrencies may not be available for shorting due to limited market depth and higher risk. Always check the specific offerings of your chosen trading platform.

Written by

Mohammad is an experienced crypto writer with a specialisation in cybersecurity. He covers a wide variety of topics spanning everything from blockchain and Web3 to the retail crypto space. He has also worked for several start-ups and ICOs, gaining insight into the mindset and motivation of the founders behind the projects.