Understanding Shorting in Crypto: A Comprehensive Guide | CoinSwitch (2024)

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If you are into investing or trading, two common terms you might hear are “going short” and “going long.” Shorting has to do with the “going short” part. Essentially, shorting is the earning of profit from an asset’s falling price, sometimes with borrowing involved.

Being clear about these terms and the ideas behind them opens up options and helps you assess the risks involved. This article will help you to understand them and the concept of shorting in particular.

What is shorting?

To grapple with the meaning of the concept of shorting, it is important that we understand the term “going short.” If someone is going short on a cryptocurrency, it means that the person has a negative view of the market’s future and intends to profit from the falling price.

Imagine that the evolving global macros are suggesting that the price of BTC can drop further. Sensing an opportunity to make profits, you sell your BTC at the ₹15,50,000 level and buy it back a few hours later at ₹15,00,000. That gives you a clean profit of ₹50,000. The word shorting is sometimes used to refer to this practice most traders follow.

But more commonly, it is used to refer to something more specific. Shorting is an investment strategy you can use when you don’t have BTC in your wallet but still want to take a short position. It involves borrowing crypto in order to sell it based on speculation, in order to profit from the falling price trend. In the end, the borrower buys the crypto back again and returns it to the party that lent it out. In this article, we focus on this type of shorting and stick to this meaning when we say “shorting.”

Because shorting in this case is like taking a careful guess, even if it is a well-informed one, things can go either way. If the price moves against the direction you are expecting it to go, there will be losses that you will have to pay for from your pocket. That’s why we wouldn’t recommend that beginners get involved in shorting.

Can you short crypto?

Over the years, as crypto exchanges have evolved, they began to enable shorting crypto options for traders with a long order book. Because those traders are assumed to have some street cred.

So yes, you can still short crypto. However, it may be advisable to short crypto pairs that have been known to have high liquidity or consistently high trading volume throughout the year. Because cryptos with high trading volumes are far less likely to fall prey to price manipulation.

The process, of course, is taken care of entirely by the broker/exchange.

How to short crypto

Here are five steps you can follow to short crypto.

1. Start by creating an account with an established and reputed exchange. Ensure that the exchange has the shorting feature because not all of them do. The exchange should also have different types of order options like spot, limit, and stop-loss. You also should check the policy of the exchange and the fees charged on the platform.
2. To short crypto, you need to first be confident about the continuation of the bearish trend. And you can only be sure if you learn to analyze price charts. Here is one way to do it.
3. Once the borrowing is done, you can place a “sell” order in the open market. After the order is executed, your trade is confirmed.
4. Then, you close the trade or complete a “buy” order again.
5. Finally, you need to repay the amount borrowers plus interest and commissions.

Different methods of shorting crypto

There are many different methods that can be used to short cryptos, but every method comes with some risks. It’s important to understand the differences in order to figure out what kinds of risks you are comfortable taking. Listed below are some of the options for shorting cryptos.

Futures

Futures trading involves an agreement that allows you to buy or sell crypto at a price specified in the contract, in the future. It allows traders like you to seal the price of the asset they are interested in purchasing. You can either sell or buy this type of contract. When the contract expires, the contract holder has to buy/sell the number of tokens specified and at the price mentioned in the contract, to/from the other trader holding the futures contract.

In crypto shorting, when the contract expires, if the market price of Bitcoin is lower than the price in the futures contract, you are in for a profit. Because you can buy BTC at a lower price from the spot market and sell it to the holder of the contract at a higher price. Conversely, if the market price is higher than the agreed price, you could be in for a loss.

Let’s work with an example to clarify things further. The premium for a BTC futures contract, with a 30 October 2022 expiry, is ₹100. You are expecting the price to fall by 10% during the next 1 month, so you initiate a short position with the BTC futures contract by paying the premium. Suppose BTC’s price does indeed fall by 15% (well over 10%). If this happens, the premium for the contract goes up by 50%. So you can either square off your position and pocket the premium gain or buy the lower-priced BTC from the spot market and sell it to the holder of the contract for a profit.

Margin trading

Also known as leverage trading, this type of trading involves borrowing crypto against some deposited collateral and initiating a “sell” order at market price. The difference in the buy and sell price is the profit.

And what happens if the market price of the crypto concerned drops lower than the purchase price? It’s simple. You can just buy the crypto back and return the borrowed sum.

The catch, however, is that until the trade is closed, you will have to keep paying margin interest on the borrowed tokens. This interest is deducted from the profit or added to the loss. The longer the trade span, the higher the interest amount.

Conclusion

In a market as volatile as crypto, shorting gives traders an opportunity to profit from the falling price. But, as easy as it may sound, the risks are pretty high.

Therefore, before shorting cryptos, just be sure you are aware of all the risks involved. Learn about the different trading strategies. Also, do your research while choosing a trading platform too. The platform’s trade execution speed and volume will make a difference.

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