How to Short Bitcoin: Everything to Know

By  Beluga Research September 29, 2023

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Summary

  • Shorting bitcoin is done to profit from price decreases by borrowing and selling it, then buying it back at a lower price
  • This involves betting on a bitcoin price decline and profiting from it, which can be a risky proposition in volatile crypto markets
  • Traders can short Bitcoin on reputable cryptocurrency exchanges through margin trading, where they borrow funds to amplify positions
  • Shorting bitcoin has advantages such as profit from market downturns and hedging against long positions, but it also comes with high risk and volatility

Overview

Shorting bitcoin is done to profit from price decreases by borrowing and selling it, then buying it back at a lower price. As the cryptocurrency market grows, more exchanges offer shorting options, providing traders with various platforms. Today several exchanges and trading platforms support shorting bitcoin, each with different mechanisms and features.

A Brief History

Short selling has been present in traditional financial markets for decades. However, it became accessible to retail investors with the emergence of cryptocurrency. Bitfinex, a cryptocurrency exchange founded in 2012, introduced bitcoin shorting. Holders could lend bitcoin to others who wanted to short it. Traders could borrow bitcoin, sell it at the current market price, buy it back later at a potentially lower price, and return it to the lender, keeping the price difference.

How to Short Bitcoin: Everything to Know

Choose a Reliable Exchange. Select a reputable cryptocurrency exchange that supports short selling. Research its track record, security measures and user-friendly interface. Remember, not all exchanges are equal, as they each operate with different business practices.

  • Account Setup. Create an account on the chosen exchange by providing necessary information and completing the verification process, including identity verification and submitting identification documents and proof of address.
  • Deposit Funds. Deposit funds into an exchange account. Most exchanges accept fiat currency deposits (like USD or EUR) or other cryptocurrencies that can be exchanged for bitcoin.
  • Understand Margin Trading. Shorting bitcoin often involves margin trading, where traders borrow funds to amplify their positions. It allows controlling a larger position with less capital. Understand the risks and use proper risk management strategies.
  • Locate the Shorting Option. Find the shorting option on the exchange, which could be a dedicated "short" button or a margin trading section where you can open a short position.
  • Open a Short Position. Specify the amount of bitcoin to sell. This creates a sell order on the exchange, effectively borrowing and selling the bitcoin at the current market price.
  • Monitor and Manage the Position. Closely monitor the market after opening a short position. Bitcoin's price is volatile, so have a plan to manage positions effectively. Use stop-loss orders to limit losses and take-profit orders to secure profits if the price moves favorably.
  • Closing the Short Position. Buy back the bitcoin borrowed and sold to close a short position. Ideally, buy it back at a lower price than the initial selling price to profit. The bought bitcoin is returned to the lender, and a short position is closed.
  • Calculate Profits and Losses. Understand how profits and losses are calculated when shorting bitcoin. They depend on the difference between the selling price and the buying price when closing the short position. Consider any fees or interest charges associated with borrowing and trading.

Getting Started

1. Choose a reliable and reputable cryptocurrency exchange that supports short selling.

2. Create an account by providing personal information and completing necessary verification processes.

3. Deposit funds into your account, considering factors such as transaction fees and processing times.

4. Familiarize yourself with the trading interface and order types offered by the exchange, such as market orders and limit orders.

Unique Aspects

Margin trading allows traders to borrow funds to amplify trading positions, but it also increases risks. Assess risk tolerance, set appropriate stop-loss orders and monitor the market to manage potential downsides. When short selling, traders borrow bitcoin and must later repurchase and return the same amount.

Be aware of the risk of a short squeeze, where a rapid price increase forces short sellers to cover their positions at unfavorable prices.

Advantages

  • Profit from market downturns. Shorting bitcoin lets traders profit from a falling market by correctly predicting a decline in price.
  • Diversification. Shorting Bitcoin helps diversify an investment portfolio. It offsets potential losses in other assets during bearish market conditions.
  • Hedging against long positions. Shorting Bitcoin acts as a hedge against existing long positions. It mitigates potential losses when anticipating a short-term price decline.
  • Leveraging. Shorting bitcoin allows traders to amplify potential profits by borrowing funds to open short positions. Note that leverage also increases the risk of losses.
  • Flexibility. Shorting bitcoin offers flexibility in trading strategies. Traders can open and close short positions at any time to adapt to changing market conditions and capitalize on short-term price movements.

Disadvantages

  • High risk. Shorting bitcoin involves a high level of risk. Potential profits can be significant, but losses can also be substantial if the market moves against the short position. It's crucial to manage risk carefully and set stop-loss orders.
  • Volatility. Bitcoin's volatility makes shorting more challenging. Sudden price fluctuations can trigger liquidations or margin calls, resulting in potential losses for traders with short positions. Close monitoring and risk management strategies are essential.
  • Limited upside potential. Shorting bitcoin has limited upside potential compared to buying and holding. The price can only decline to zero, limiting the maximum profit from short positions.
  • Margin requirements. Shorting bitcoin often requires borrowing funds with margin requirements. Traders must maintain sufficient collateral to support their short positions. Failure to meet margin calls can lead to position liquidation.
  • Emotional stress. Shorting bitcoin can be emotionally challenging. Unlike buying and holding, shorting requires active market monitoring and timely decision-making. Constant evaluation of price movements can induce stress and emotional strain.