The high volatility of the crypto market means these coins could stage dramatic rallies within the space of a day, only for the gains to be negated the following day. For other coins, these fluctuations could happen within hours or even minutes. For most of 2022, cryptos have been largely on the downturn. This brings about a need for investors to find ways to benefit from these frequent downturns. Enter shorting.
What is shorting?
Shorting is a concept that originated from the stock market, just about the time the United East India Company introduced stock trading in 1602. Over the years, it was greatly frowned upon and sometimes even outright banned until it gained widespread acceptance. Today, people can short-sell virtually any tradable asset, including cryptocurrencies.
Essentially, it involves borrowing an asset and selling it at its current price, then buying it back at a later date to repay the debt. This is done in the hope that the asset’s price declines within this period, enabling the short seller to profit from the price difference. This is the complete opposite of going long on an asset, which involves buying it with the hope that its price will rise so you can sell it at a profit.
For instance, if you have reason to believe BTC’s price will plummet, you can borrow one BTC from your broker. At the time of writing, it is retailing at $29,200 a pop. Let’s say a few days later; its price falls to $25,000. You then buy one BTC at the lower price and repay your broker, leaving you $4,200 in the green. This is how short sellers make profits.
Why short crypto?
Valuation
Using fundamental analysis, traders can establish the intrinsic value of any particular coin. Sometimes, the coin may be stuck in a price bubble as people buy out of FOMO. Such overvalued coins can be ideal candidates for short selling, as they tend to stage retracements to their true value. The same fundamental analysis can help a trader better time their short’s exit.
Volatility
Characteristically, crypto is one of the riskiest financial assets one can trade, as their prices tend to fluctuate violently. However, for investors with a healthy risk appetite, this volatility presents numerous opportunities for profit. Traders who are able to identify changing trends and market sentiments can use their insights to trade this volatility to their advantage.
To hedge against the risk
As an investor, you may be in possession of significantly large amounts of cryptocurrency. Due to the aforementioned volatility, its price will at times drop significantly, bringing you untold losses. Rather than sell their holdings to avoid the loss, such an investor may opt to short-sell the coin to offset some or all of their losses.
Risks of shorting crypto
Infinite losses
When you buy a crypto asset, hold it and wait for its price to rise before selling it; the worst that could happen is that the asset’s price falls to zero. This is to mean that there is only so much loss you can make. What’s more, you’re left holding the currency, which could rally at a further date.
On the flip side, when you short a coin, you hope for its price to fall before you can exit your position. If, instead, its price rallies, it could theoretically rise infinitely, which means there is no limit to the losses you can incur.
Margin interest
In essence, shorting involves borrowing the currency, you wish to trade. As with all other borrowed assets, these borrowed cryptos will be charged interest. Therefore, the longer you hold them, the more you pay in terms of this interest.
Best coins to short in 2022
After a tumultuous 2021, 2022 has been a slow year for crypto bulls. For the most part, bears have dominated the crypto market against the backdrop of rate hikes from the Fed and other leading central banks. This is in response to rising inflation, which is threatening to throw the world into recession.
This has made the top cryptocurrencies ideal candidates for shorting. With the right analysis, one can profit from shorting the likes of Bitcoin, Ethereum, Binance Coin, XRP, and Solana.
Crypto shorting methods
Direct short selling
This is the easiest way to profit from falling crypto prices. It involves borrowing crypto from an exchange, then buying the coins at a later date, hopefully at a lower price. After returning the borrowed coins, you earn the difference in price as profit.
Futures markets
In December 2017, the Chicago Mercantile Exchange launched the first Bitcoin futures contract, allowing investors to trade derivatives of these digital assets. Usually, when one buys a futures contract, they anticipate that the price of the underlying asset will rise before the contract matures. To short it, one can take up the sell side of the contract, allowing them to profit on expiry if the cryptocurrency’s price drops.
Contracts for Difference
These are derivatives that allow you to bet on a rise or fall in the price of cryptocurrencies. This way, you can benefit from their price fluctuations without holding the physical coins. To open a position, you only need to put up a fraction of the margin account as a deposit. This allows you to amplify your profits using leverage if prices move as expected. However, this also multiplies your losses if the market goes against you.
Put options
Options are a derivatives contract that gives one the right but not the obligation to buy or sell a crypto token at a later date. If you anticipate that its price will rise, you can purchase a call option. However, if you anticipate a decline in price, you should purchase a put option, which gives you the right to sell the coin at the specified date. The advantage of options is that if the market goes against you, you only lose the premium you paid to hold the option.
Summary
With the backdrop of dwindling prices across the crypto market, shorting is a straightforward way of remaining in profit. It involves borrowing crypto and selling at current market prices, then buying it back later at a lower price. There are several ways of shorting crypto. However, due diligence is paramount as losses from this venture can run up to infinity.