The Risks and Benefits of Short Selling Crypto

Mar 10, 2022
A pile of coins falls out of a jar onto a table

It’s not always a bad sign when an investor sees a market downturn coming. Investors still have other ways of making a profit. In such cases, they might decide to short sell certain types of investments. Short selling is when an investor sells an asset he or she doesn’t own. This is because he or she believes that the price of that asset will go down. This occurs in both stock markets and crypto markets. With cryptocurrency’s volatility, this is an investment strategy that some traders opt to go for and profit from. But how, exactly, does it work?

What is short-selling crypto? 

The European Commission defines short selling as

“the sale of a security the seller does not own at the time of agreeing to buy it back at a later point in time to deliver it.”

To adopt a short position, an investor or trader borrows an asset, such as Bitcoin (BTC), and sells it on an exchange at the current price. If the price does indeed dip, the trader then buys the cryptocurrency later and repays the capital borrowed. 

After returning the borrowed assets, the short seller gets to keep the capital gained from the trade. For example, let us assume that Jim believes that the current Bitcoin price of $40,000 is too high for now, so he decides to open a short position. Therefore, he has borrowed one Bitcoin and sold it at that current price. Bitcoin’s price then goes down to $35,000, and Jim decides to buy it again. He then returns the Bitcoin to the broker he borrowed it from (plus interest) and takes the profit he made. Therefore, Jim gets to keep approximately $5,000 (minus interest). On the other hand, if the cryptocurrency price goes up when he shorts it, Jim would have to buy it later and incur the loss made on the trade.

Understanding short positions vs. long positions

Holding a short position is quite different from the usual trading strategy of the average investor. When an investor believes that the price of a cryptocurrency is about to go up, he can hold a long position. This means that he buys cryptocurrencies. When you go long, it is difficult to know when to sell.  

One way to figure this out is by looking at events surrounding a market decline. Then, you look at how short sellers profit while they're down (or if someone wants their investment back). Short selling, on the other hand, is very different. Instead of buying low and selling high, the investor borrows the cryptocurrency, sells it when he or she thinks it’s at a high price and buys it later when it's lower. The main difference between a long and a short position, then, is that you own the cryptocurrency when longing, while you borrow it when holding a short position.

The benefits of short selling crypto

This would have been a good time to short-sell Bitcoin on Multi HODL

There certainly are benefits of shorting crypto. When one considers certain crypto to be overvalued, they have the option to short sell crypto, and profit from its future price decline. Short selling also provides hedging risks. If a trader’s larger portfolio feels exposed to a potential slump, the trader may benefit from shorting. If the deal is done right, the short position can help reduce the burden of your losses faced on his or her long positions.

Exposure to both long and short positions can also reduce volatility. Furthermore, it equips you with two different ways to profit - when the market is up and when it’s taking a downward slump. Some traders are skeptical about certain cryptocurrencies’ value or believe that they are too early to validate a certain price. Although skeptical, these investors still get the chance to trade on potential slumps of such currencies.

The risks of short selling crypto

There are certain risks of short-selling crypto. With a long position, the risk is set at the price share you bought it. For example, if you buy 1 ETH at $2,500, you have that same $2,500 at risk. Should the cryptocurrency completely falter to $0 (which is highly unlikely given Ethereum’s popularity), you lose the same investment you made. The price of the cryptocurrency cannot go lower than that point. 

The potential loss when longing, then, is capped. However, the same cannot be said when going into a short position. When shorting, there is generally a certain amount of money to be made, but the potential losses are hard to grasp. This is as the price can hike up to extremely new highs, something which is not new in the crypto world. 

For example, let us say that Bob decided to short Bitcoin when its price stood at $10,000. The price then rose to $60,000. When he sold the cryptocurrency, Bob received the $10,000 in hope that he would buy it back at a lower price, only to now find it costing him $60,000. This means that he would have incurred a $50,000 loss in case he has to buy back at that time to return the asset from where he borrowed it. In truth, you can limit such horrendous scenarios generally by setting up a stop-loss order. 

This enables you to close the short position automatically if you incur a specific amount of losses. Having this feature allows you to avoid scenarios that poor Bob endured. Historically, major cryptocurrencies go up in value. Hence, shorting cryptocurrencies is often a short-term strategy. 

Short selling is going opposite to what the cryptocurrency market has done over the years. Given the volatility of cryptocurrencies, generating profit can come as easy as a loss. Short selling is one of the riskier trades to make and exacerbates this to a whole new level. We suggest that you perform good market research before deciding to short investments, especially the volatile cryptocurrencies.

How to short sell crypto on YouHodler

Various exchanges allow you to short-sell crypto. YouHodler is one such app that allows you to short sell with its staple Multi HODL feature. This allows you to open short positions more efficiently than other exchanges. Due to its fully autonomous feature, users can borrow to short crypto (and long it) in a matter of seconds. 

YouHodler lends you the capital to buy crypto at that given time to short it. You can also choose the amount used as collateral from your savings account (the barbell strategy). Furthermore, to hedge risks, set a take profit and stop-loss margin.

The market constantly moves in waves. Even in bull markets, there are lucrative opportunities to short-sell crypto. Whether you are an expert trader or a novice HODLer, Multi HODL has a variety of features to help you take part in the world of crypto trading. Don’t just sit back and HODL with the market. Be active and discover the potential in every market swing. 

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