The growth of the cryptocurrency sector has opened up new options to invest in bitcoin. Here’s a rundown of what bitcoin short selling is, what it’s good for, and how to execute it in four simple steps.
Bitcoin (BTC) lost 20% of its value in 2018, going from $17,000 in January to $3,152 in December, due to increasing restrictions and a general slowdown in cryptocurrency trade. While the collapse in bitcoin’s price was disastrous for some, others viewed it as a chance to short bitcoin.
What is bitcoin short selling?
Shorting Bitcoin is selling a cryptocurrency you don’t own in the hopes of getting it back at a lower price later. The price change can then be used by investors to profit. Short selling is the inverse of the “buy low, sell high” principle: instead of buying low and selling high, the investor sells his asset first and then buys it again.
Why Sell Bitcoin Short?
It’s crucial to think about your reasons before you start shorting bitcoin. The majority of investors expect the market to fall. They frequently do this out of cynicism regarding bitcoin’s popularity, believing it to be nothing more than a fad.
If you’re going this route, it’s critical to keep up with industry developments, since there’s rising confidence about the future applications of cryptocurrencies and blockchain, the technology that underpins them. Many others, on the other hand, are selling bitcoin yet still trust in its long-term potential.
In this situation, shorting bitcoin would be used to hedge against the risk of a long position. If you already hold bitcoin but believe it will collapse in the near future, you may want to hedge your bets by shorting it at the same time. If the market declines, the benefits from your short position will help to offset some of the losses from your initial investment.
How to sell bitcoin short in four steps
Understanding bitcoin
Regardless of the asset, short selling necessitates a solid awareness of the market and a complete comprehension of trading tactics. Because the bitcoin market is still in its infancy, it may appear exciting, but it is also quite volatile. As a result, it’s even more vital for investors to brush up on their bitcoin expertise.
Bitcoin was founded in 2009 by a mysterious figure known only as Satoshi Nakamoto. It is virtual digital money that is protected by encryption and is not regulated by any central authority, making it a very popular method of payment. In 2015 Ethereum was created.
It is not affected by most of the variables that affect fiat currencies, such as central banks and interest rates, because it is a decentralized currency. Other variables, including bitcoin supply, public opinion, integration into everyday life, and ever-increasing rules in the foreign currency market, can still impact the price of bitcoin.
Choose how to sell bitcoin short
Short-selling bitcoin may be done in a variety of ways. We’ll look at two of the most common methods: using a broker and using derivatives.
Traditional Short Selling
Short-selling is a service provided by several bitcoin exchanges, however, it entails borrowing the asset from your broker or a third party and selling it in the market. If the price of bitcoins has dropped, you may be able to buy them back at a reduced price and return them to their owner while profiting from the difference. In general, you will try to short sell an asset that you think will not increase in value.
Suppose the price of bitcoin is $4,000 per unit, but you think the market is going to go down. So you decide to borrow a bitcoin from your broker and sell it on the market. A week later, the market drops to $3,250, allowing you to redeem bitcoin at the new market price. You can then return the money you owe to your broker and make a profit on the difference, which is $750 in this case, excluding broker fees. On the other hand, if the market is moving higher, you should buy back the bitcoin and return it to your broker or the third party you borrowed it from. If the market increased to $4,750, for example, you would have to purchase bitcoin again at the higher market price, incurring a $750 loss. If the market increased to $4,750, for example, you would have to purchase bitcoin again at the higher market price, incurring a $750 loss.
One of the disadvantages of this strategy of shorting bitcoin is that finding a third party willing to lend you bitcoin to do so is practically impossible. If a third party could be found, they could take the bitcoin at any moment, and you’d have to accept the current market price.
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Investment in derivatives
The difficulties of traditional short selling have sparked interest in derivatives as a bitcoin short selling alternative. Derivatives are financial products whose value is determined by the price of an underlying market, such as bitcoin.
Because you are merely betting on the direction the market will go using derivatives, you do not need to borrow bitcoin from a third party. CFDs are one of the most common derivatives:
- “CFDs represent an agreement to exchange the difference in bitcoin value between the time the position is opened and the time the position is closed. If you think the bitcoin price will go down, you open a position to sell it.”
CFDs are leveraged securities that allow you to enhance your market exposure by locking up only a percentage of your cash, a process known as hedging. While short selling might increase your profits if the market declines, it can also increase your losses if the market declines.
Let’s say you decide to use CFDs to establish a trade to sell bitcoin short. Returning to the previous example, at $4,000, you may create a position to sell one unit of bitcoin. Because CFDs are leveraged products, you can only lock in a portion of the value when you open your trade. For instance, if your supplier charges a 50% rate, you should lock in $2,000 in advance.
If the market falls as a project, you may terminate your position by purchasing one bitcoin at the new market price of $3,250. You must compute the difference between the open and closing prices to establish your profit. The computation in this scenario would be as follows: $4,000 minus $3,250 equals $750. Keep in mind that the profit on a CFD trade is computed based on the overall value of your position, not the value of your hedge.
If the market climbs to $4,750, though, you’ll have to buy one bitcoin at the higher market price, resulting in a $750 loss on your CFD position.
Other derivative products have become popular ways to short bitcoin, including futures and options. Not only you can short Bitcoin, but you can also short Ethereum. Before you decide to short Ethereum, ask yourself if Ethereum can make you rich.
Manage your risk
Short selling has become increasingly popular, putting downward pressure on the price of bitcoin as more people join the movement. Keep in mind, however, that short selling entails dangers.
When you short sell, the biggest danger is that there is no limit to how much money you can lose. When you acquire bitcoin, your losses are limited to the amount you paid for it. When you sell a bitcoin, on the other hand, the market might swing against you at any time, thus your losses are also limitless.
That’s why, before you start investing, you should understand how to control your risk. You may add a guaranteed stop loss to your bitcoin position if you employ derivatives, which will safeguard it if the market swings against you.
The price of bitcoin can change rapidly and significantly due to a variety of causes. Although volatility attracts many investors to the bitcoin market, it may also be a source of anxiety if investors do not have a risk management strategy in place.
Open your first position and watch the market
It’s time to open your first short position after choosing how to protect yourself. It’s critical to keep an eye on anything that might cause bitcoin prices to fluctuate unexpectedly. Visit IG’s Trading News & Insights section for professional insights and analysis to keep on top of bitcoin market movements.
What is hedging?
Investors in every market face market volatility and potentially steep falls. When we are overly invested in buying or selling, hedging our wallets with a hedging strategy against exchange risk is an option. This allows you to fully or partially defend yourself. Hedge your wallet is therefore critical for effective portfolio management and long-term sustainability in the ecosystem, especially in such a turbulent market. I’m going to attempt to give you some food for thought on ecosystem hedging. It’s worth noting that these suggestions are equally useful during times of decline (bear market or not).
Conclusion
It’s critical to understand how bitcoin short selling works and the dangers associated before getting started. To understand better, I would also suggest you to read how web3 companies make money. The following are some essential points:
- Short selling is the practice of borrowing bitcoin, selling it on the market, and then purchasing it back for a lower price.
- Investors do so in the hopes of profiting from the disparity.
- This method can be used by short sellers for speculative or hedging objectives.
- Short-selling bitcoin may be done in a variety of ways. Selling through a broker and utilizing a derivative like CFDs are the two most common approaches.
- Short-selling entails risk, which is why a risk management strategy is necessary.
- Following the opening of your initial position, you should monitor any movements in the bitcoin market by reviewing news and research.
