How to Short Bitcoin – A Complete Guide

The incredible rise in the price of Bitcoin has led to innumerable predictions of its impending collapse. If accurate, this decline may create as much wealth as the rise did. Savvy investors who understand the mechanics of a short sale can profit from a decline as easily as buyers profited from the increase.
how to short bitcoin

Buy low.  Sell high.  Just not necessarily in that order.

A simple example will show why this is the case. An investor borrows a Bitcoin from a friend and sells it at a price of $15,000. After the price drops to $10,000 the investor buys a Bitcoin back and returns it to the friend. This is a classic short sale, and the investor in the example made $5,000.

The most the investor could have made is $15,000 which would happen if Bitcoin became worthless. Of course, the risk is that the price of Bitcoin goes up and the investor has to buy it at a higher price in order to return it to the friend. Given the increase in price, there seems to be no practical limit to the amount that the investor could lose in the transaction.

Shorting Bitcoin Via Exchange

The first problem with implementing this strategy is finding someone who is willing to lend you the Bitcoin. Many exchanges offer this service which falls under the category of a “margin account”. Because you are borrowing something, there is an interest charge on the loan in addition to other transaction fees.

The terms of borrowing – how much you can borrow and what rate you will be charged – varies by exchange. The terms and the qualifications for a margin account are changing very quickly as the market for Bitcoin and cryptocurrencies, in general, continues to develop. Kraken reports margin fees of .01% for every 4 hours the trade is open, a time frame that demonstrates how quickly active traders open and close margin positions.

Investors interested in establishing a margin account for short selling need to do some serious research to find the terms that best suit their intended trades.  Some websites offer an overview of the different trading platforms and are a great place to start. Keep in mind that many of the trading platforms are unregulated and so have a larger embedded risk.

Margin trading platforms are now available across a large number of Bitcoin brokers, including AvaTrade and Plus500.

Shorting Bitcoin through Contract for Differences(CFD’s)

One of the key points to understand about shorting is that it isolates the change in the price. This is easy to understand on the “long” side – where the investor buys Bitcoin with the expectation that the price will increase but can be a bit confusing on the short sale. This isolation of the change in price is the key to understanding a Contract for Difference (CFD).

A CFD is a derivative. This is a frightening word for newcomers, but it simply means that the value of the instrument is determined by the value of something else. In this case, the value of the CFD is determined by the change in the price of Bitcoin. Investors buying a CFD do not actually own Bitcoin. They only own the change in the price of Bitcoin.

Just like the terms of shorting, the terms of a CFD vary by broker. Again, investors need to do some homework and find a broker that meets their needs. This includes the financial requirements for trading. Among these brokers, you can find Plus 500, AvaTrade and FXTM. Investors who meet the definition of an accredited investor have access to investment products and strategies that are not available to the general public under US securities law.

Furthermore, there are various brokers that provide CFD’s which allow you to short other cryptocurrencies. See the list below:

Shorting Bitcoin via Futures Market (Cboe/CME)

One the easiest parts of a CFD to understand is that it measures the difference in the price of Bitcoin over a period of time. In this sense, a CFD “buys” the future price of Bitcoin. This can be done directly through the latest development in Bitcoin trading, futures contracts in Bitcoin.

Futures are easy to understand by beginning with their origins in the agricultural sector. A farmer who plants a corn crop cannot know what price it will bring when the crop is harvested. To eliminate this uncertainty he can buy a futures contract that will give him the right to sell his corn at a started price when it is harvested. The actual price at that time – the “spot” price – may be higher or lower, but his price is fixed by the futures contract.

Bitcoin futures contracts are available for as few as a single Bitcoin and have expiration dates ranging from one week to three months. One of the benefits of a future is that they can be traded before the contract expires. This means an investor can buy a futures contract and realize some of the value from that contract (presuming it has value) before the expiration date by selling the contract to another investor.


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Bitcoin Short – Pros and Cons

Shorting Bitcoin, or any financial asset for that matter, can get fairly complicated. However, the most important point to remember is that the most basic risk remains the same for the futures buyer as the straight short-seller. The potential loss has no cap, but the potential gain is limited to the current market price.

Investors use the strategies to short Bitcoin for a more important reason than just an expectation that the price will drop. Keep in mind that every strategy to short Bitcoin can be used to profit from a price increase. The most basic reason investors use margin, derivatives and futures is that these strategies employ leverage in one way or another.

These strategies allow the investor to own the change in price with a smaller investment than the current price of Bitcoin. In the case of a short, the price is the total transaction fees and interest. Leverage is a powerful financial tool used by every homeowner with a mortgage. Leverage multiplies the return on an investment that performs as expected, but also multiples the loss when it does not pan out.

Conclusion

Investors who have managed to grasp the relationship between blockchain and cryptocurrencies and then built on that to learn how to trade Bitcoin on exchanges have still only scratched the surface of how to profit from their knowledge. Understanding technical analysis –reading the patterns in the ups and downs of the market – is also only a step on the path to becoming a fully-equipped Bitcoin investor.

Gaining an understanding of how to profit from any movement in the price of Bitcoin could be the most important task the serious, savvy investor can undertake. Working through the math of how leverage increases Return on Investment (ROI) is part of understanding why margins, derivatives, and futures are so powerful. Working through the math of these instruments when they move in a bad direction is just as important to understanding the risk of leverage.

These building blocks are not always easy to acquire, but they are always worthwhile to have, even if the investor chooses not to use them. Understanding and tracking the futures market, for example, gives the investor insight into what other, perhaps more sophisticated investors, think will happen in the future.  That knowledge can be power.

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