What Is Short Selling and How Does It Work in Crypto?

The financial market is an entire landscape of its own, and surfing this zone is with the aim of staying profitable, at the very least. One way to get profitable is by short selling. Short selling, a well-known investment strategy in traditional financial markets, has found its place in the world of cryptocurrency. Just like in other markets, short selling in crypto simply works by allowing a user to borrow an asset, sell it on the market, and repurchase it at a lower price to return it to the lender – thus making a profit. 

This approach allows investors to profit from price declines, and it is commonly employed in bear markets. However, it’s essential to note that short selling in crypto comes with both potential rewards and risks. This article aims to deepen your understanding of this “Financial trading lingua” while setting a pace for you to make the most of it. Let’s go!

Also read: 10 Best Crypto Signal Telegram Groups in 2023

Practical Explanation of Short Selling Crypto

The practical way to begin shorting any cryptocurrency (Either Bitcoin or Altcoins) often begins with analysis (Technical and fundamental). Traders have this mapped-out plan on a trading chart or diary, after which they fund their trading account. Short-selling crypto often functions with “USDT” but at other times, with some cryptos (Like EOS, BTC, and ETH). Shorting crypto involves making use of the platform’s leverage to trade your chosen crypto downwards for profit.  

Imagine you are bearish on a cryptocurrency, and you want to execute a short-selling strategy. Here’s how it works: After funding (I.e., Your collateral), you literally borrow a specific quantity of the token to be traded and promptly sell it (Either using a market or limit order). This action establishes an open short position. If your predictions are right and the price declines, taking profits gets you to repurchase the same quantity of the crypto you borrowed, subsequently returning it to the lender (Including any interest). Your profit in this transaction is determined by the difference between the initial selling price and the subsequent repurchase price. Apt!

Let’s suppose you decide to borrow 1 $ETH and sell it at a price of $2,000. As a result, you have a 1 $ETH short position for which you are paying interest. Suppose the market price of Ethereum subsequently drops to $1,000. At this point, you proceed to buy 1 $ETH and return it to the lender, typically the crypto exchange. In this particular scenario, your profit would amount to $1,000 (I.e., Minus any interest payments and fees incurred during the process).

Platforms to Explore for Short-Selling Crypto

There are several platforms where you can short crypto and, of course, in diverse forms. Short selling with margin and derivatives (E.g., Some futures and crypto options) are now made possible on different exchanges like Binance, KuCoin, and Gate.io. Let’s explore the most sought-after short-selling strategies.

3. Margin

Traders and investors utilise margin trading for short-selling cryptos on crypto exchanges, where they borrow funds to buy or sell crypto. By borrowing and selling cryptocurrency, they aim to profit from price drops. If the crypto’s price falls, they can repurchase it at a lower price, return it to the lender (I.e., The crypto exchange) and make a profit. However, if the price rises, repurchasing at a higher price leads to a loss.

2. Derivatives/Futures

Derivatives trading is one other key means to short selling cryptocurrencies. It is a contract-based means for traders’ futuristic predictions on a particular cryptocurrency, either to the upside or downside. To short-sell using futures trading, traders sell futures contracts to profit from anticipated cryptocurrency price drops. They agree to sell a set amount of crypto at a predetermined price and date, capitalising on the price difference when the contract expires.

For crypto options trading, traders/investors can buy “Put options” to benefit from expected cryptocurrency price declines. By paying a premium, they acquire the right to sell crypto at a higher price than the current market value, taking advantage of the downward price movement of the traded crypto.

Potential Risk Involved in Short Selling

There are also risks involved in short-selling crypto using any form (Derivatives or margin). Avoidance of stop-losses and necessary measures to secure a trader’s collateral to a bearable minimum can result in the liquidation of a trader’s account. Short-selling cryptocurrency presents an opportunity for profit; However, it carries inherent risks. 

Adverse market conditions can result in substantial financial losses for traders and open a negative feedback loop, as significant selling pressure from short sellers can drive prices lower, potentially intensifying further short selling and extending the downward trend. The toll it can take on a trader’s mental health is also under-emphasised as part of the risks traders or derivative traders are predisposed to, especially those who lack a grip on market analysis.

Setting stop-losses, employing hedge mode, and other risk-management arsenals are necessary measures traders can take to avert recurrent losses and a sustained streak of countless failures in trading the crypto/financial market. 

Frequently Asked Questions

Is Short Selling a Good Strategy for Beginners in the Crypto Market?

Short selling is not recommended for crypto beginners. It is a high-risk strategy that requires advanced knowledge of technical analysis, mental capacity, and proper risk management. New traders are promptly advised to rather focus on building a solid foundation and gaining experience with less risky approaches first. Seeking mentorship from experienced investors or traders is also good.

How Can I Minimise My Risk When Short Selling in Crypto?

When engaging in short selling in the crypto market, it is important to consider risk management strategies to minimise potential losses. Some ways to go about reducing your risk include; Doing your own research plus market analysis, ensuring you set your stop loss, taking profit as at when due and not staying greedy, and also ensuring a fair choice of position size of crypto to be traded either as contract or margin.

Can Short Selling Be Used to Manipulate the Cryptocurrency Market?

Yes, short selling has the potential to influence the price of a cryptocurrency, particularly when undertaken by influential or coordinated “Whale” short sellers. However, it’s crucial to note that market manipulation is unlawful and carries severe consequences for participants like newbies who get liquidated. Instead of attempting to manipulate the market, it is essential to employ short selling as a legitimate investment strategy, focusing on market dynamics and making informed decisions within the boundaries of legal and ethical practices.