Crypto is a volatile beast. In 2021 alone, Bitcoin experienced lows of $29,000 and highs of $67,500. The peaks and troughs of smaller coins were even greater. Solana started the year at $1.8 and had risen to $259 by the summer… only to crash to $90 by early 2022.
Some traders devote their investment dollars to crypto in the hopes that it’ll rise, and that they can cash out at a profit. But a small subsection of traders hopes to profit from disaster and ruin. Those who make money when crypto loses value are called short sellers. (It’s the opposite of going “long” on an asset—when you bet that the price will rise.)
You may have heard the term from the film The Big Short, based on the Michael Lewis book of the same name. It’s about traders, most famously Michael Burry, who made a lot of money by predicting the 2008 financial crash. One of the most influential short-sellers these days is Hindenberg Research. (The price of the stock of Nikola Corporation plummeted after the investment firm published research alleging that the electric car company was “an intricate fraud built on dozens of lies.”)
But how do these people make money from betting on crashes, and how could you implement similar strategies to short crypto?
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How does shorting work?
The most common method for shorting cryptocurrency is to borrow lots of it, then sell that cryptocurrency, immediately, to someone else. That leaves you with a huge financial hole in your pocket since you have to get those assets back to repay the loan at a later date.
The hope, then, is that you’ll be able to rebuy that crypto at a cheaper price at a later date using the funds you raised from selling it. That’s because the loan is denominated in cryptocurrencies, not, say, US dollars. So if the price of the cryptocurrency crashes, you can buy it all back at a bargain price and use it to repay the loan.
Since it costs you less money in US dollar terms to repay the loan than it did to take out the loan, you can treat the difference as a profit.
To clarify, here’s how that trade would work if you wanted to short Bitcoin (with some numbers).
On January 1, you take out a loan of 1 Bitcoin with an interest rate of 10% a year. Assume that one Bitcoin costs $10,000 at the time of the loan and that you do not have to pay any collateral.
Head to a crypto exchange and sell your Bitcoin for US dollars immediately.
Wait precisely a year. Assume that Bitcoin has, magically, retained its price of $10,000 – but you still believe it’ll crash. You decide to pay $1,000 of interest in this time – the cost for taking out your loan. (Some lenders let you pay your interest as the final step).
On January 2, boom! Bitcoin suddenly crashes to $5,000. You were right all along! While everyone else is in tears, you buy Bitcoin at $5,000 using your remaining $9,000, then use it to repay the loan. You pocket the remaining $4,000.
You have made a profit of $4,000.
This type of trade involves margin trading, also known as leveraged trading. Crypto leverage products let you borrow more money than you have. Most crypto platforms offer margin trading—some offer up to a hundred times your initial capital. Anyone can take out a loan, even if they don’t have any professional qualifications.
How to margin trade on a crypto exchange
When you take out coins on margin for the purposes of short selling crypto, you’ll have to pay interest. On Binance, the largest crypto exchange (and one of the most popular among leveraged traders), interest is calculated on an hourly basis. There, you can take out loans of up to 180 days.
If Bitcoin is worth $10,000 and you want to margin trade on Binance, you’ll have to post $10,000 of a US dollar stablecoin as collateral to your margin account, and then hit borrow, then margin sell BTC.
Once you have done that, you can borrow multiple Bitcoins and sell them for $10,000 each. Let’s say that you borrow two Bitcoins and sell them for $20,000. If the price of Bitcoin falls to, say, $6,000, you’ll hit “repay” and buy Bitcoin at a lower price. By repaying your loan with the cheap Bitcoin, you’ll have made a profit of $6,000. Ignoring Binance’s fees and interest, you’ll have made a profit of 60%. The same short trade can be executed for any cryptocurrency.
Short trading with margin accounts: the risks
Short trading on margin trading can go wrong if the price of the crypto you are shorting happens to rise. If it does, you’ll have to pay even more interest (in US dollar terms) when you have to repay the loan, since the price of Bitcoin has risen and your loan is worth more. Binance advises to hit a “OCO” or “one cancels the other order” to manage risks. This cancels the loan if the price of Bitcoin rises by a certain amount, meaning that you can repay the loan and only lose a small amount of money.
If you can’t repay your loan or post margin—money you might have to pay if the market moves against you, known as a margin call—you could be liquidated. Liquidation occurs when the exchange will cancel your loan and seize all the money you owe.
Is short trading crypto on margin legal in Canada?
Yes, trading short positions of crypto is legal in Canada. However, several exchanges that are popular among margin traders do not operate in Canada.
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Futures and options markets
Margin trading isn’t the only way to short crypto. Futures and options contracts are derivatives that let you bet on the future price of Bitcoin—and help you profit from price crashes.
A futures contract lets you set a price today to buy or sell Bitcoin at another price in the future. An options trade accomplishes the same thing, but grants you the right to not buy or sell Bitcoin when the contract matures—with a futures trade, you’re locked in.
There are several ways to short Bitcoin with derivatives contracts.
The first is simply to buy Bitcoin today at a lower price in the future, and then sell that Bitcoin for a higher price once the market picks up. This, admittedly, isn’t quite as straightforward as the margin trading example, since profiting from this type of trade requires you to accurately predict that the price of Bitcoin will crash and then rise again.
You could also implement this trade by buying put options. Put options give you the option to sell the underlying asset when the contract expires. You are “in the money” if the price of Bitcoin has fallen by the time you have to sell—known as the “strike price”—since that Bitcoin is worth less than you bought it. Buying put options as opposed to futures helps you manage risk, as you don’t have to buy that Bitcoin if you are “out of the money”—i.e. if the price of Bitcoin rises over time.
If all goes well, you can maximize your profits by taking out a big loan of Bitcoin and then use it to sell a futures contract for a lower price than you bought it. This requires other people to believe that Bitcoin will crash. When it comes time to sell that Bitcoin, you can repay your loan at that lower price. The benefit of using futures is that you have locked in that Bitcoin at that lower price—you don’t need to pray that the market will fall in the meantime.
Like margin trading, derivatives trading is heavily regulated in Canada—particularly in Ontario. But options are huge business. Thelargest options exchangeis Deribit, which as of this writing manages $6 billion in outstanding Bitcoin options contracts. The next largest exchange is the Chicago Mercantile Exchange (one of the world’s largest derivatives exchanges), which manages $280 million in open interest. Deribitdoesn’t allow Ontariansto use its services.
Is shorting crypto safe?
Futures and options trading is very complicated, and becomes even riskier when you add leveraged trading into the mix—horrifyingly so once you start playing around with crypto. U.S. brokerage Robinhood came under fire for how easy it made trading complicated derivatives products, the likes of which were previously only available to seasoned professional traders.
Shorting crypto inherently comes with great risk. Unlike “long” trades, where you predict that the price of an asset will rise, shorting requires you to take on debt. If you are not careful, you might struggle to repay these debts. And if the market moves against you, the exchange may liquidate your position to get their money back, leaving you with less than you started.
This complexity is why Binance, for instance, makes derivatives traders take a test before they access complicated and obscure financial products. You can find the answers to these tests online, of course, and in general, there are few barriers to stop traders from wading into the depths of short trading. As always, generic investment adages apply: Don’t trade more than you can afford to lose and don’t buy a financial product you don’t understand.
Frequently Asked Questions
Yes, you can short crypto. You can short cryptocurrencies like Bitcoin, Ethereum, and XRP by taking out loans of those cryptocurrencies, selling them, and then using the proceeds to buy that cryptocurrency at a lower price. If all goes well, you will be able to make a profit by repaying the loan at a lower value (in dollar terms) than you initially paid for it. This is because the loan is denominated in volatile cryptocurrencies.
Short trading is generally considered riskier than going “long”—where you speculate that the price of a cryptocurrency will rise over time—because short trading requires you to take out loans to trade crypto; if the market move against you, the losses incurred by these loans could be infinite as the debt begins to mount.
Short traders often use derivative contracts, like options and futures, to manage risk. When used correctly, options contracts make it easier for a trader to exit a short trade that looks like it’s going to go wrong. However, the trader will usually pay for the premium of risk management, which could cut into their profits.
The most common way to short Bitcoin is to take out a loan of cryptocurrency, then sell that cryptocurrency for another asset that you do not predict to fall, like US dollars. If Bitcoin crashes, you can rebuy BTC from the open market and use that Bitcoin to repay your loan. Since the price of your BTC is lower, you’ll have made a profit—and can pocket the difference.
Short traders often trade on margin—borrow lots more cryptocurrency than they own—to maximize profits from short trading. Margin trading is very risky because an exchange might request its money back if the market moves against you, and you’ll have to pay to maintain your position.
Last Updated
December 5, 2022
