How to short Bitcoin and what are the risks?

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Please note that since this article was written the FCA has banned retail traders from trading cryptocurrency derivatives. If you would like to speculate on Bitcoin and cryptocurrencies you need to use a cryptocurrency exchange or professional trading account.

As Steve Strongin, head of Goldman Sachs global investment research, suggested in a research note that as cryptocurrencies don’t have any intrinsic value it’s unlikely they will survive in the long run. We answer the question: How to short Bitcoin?

So, if you want to take advantage of cryptocurrencies decreasing in value, how do you short bitcoin and other major cryptos? Here’s a quick run down of how to short bitcoin and the major risks involved.

How do you short Bitcoin?

Firstly, in order to short bitcoin, you need a cryptocurrency broker of some sort. You can’t short Bitcoin through an exchange because you will need the broker to hedge the short exposure. You can short Bitcoin through the following types of broker: All three types of broker basically do the same thing, albeit in different ways. Spread betting, CFDs and futures allow customers to sell something before they own it. Essentially taking a speculative position on a market decreasing in value rather than investing in it. Shorting bitcoin through spread betting is unique to the UK because of the Government’s tax position (no capital gains tax). Shorting Bitcoin through CFDs allows customers to enter a contract based on the different between the opening and closing price of the trade (in reality it’s just like buying or selling stocks on margin). Shorting Bitcoin through futures allows traders to use a direct market access broker to get better pricing and quick trade execution fills. Orders are worked live on the exchange such as the CME or CBOE. The main advantages of shorting Bitcoin are that you can do so on leverage (have greater exposure than your account balance) and profit when the price of Bitcoin goes down. However, there are some serious risks and disadvantages to shorting Bitcoin it’s important to be aware of.

The main risks and disadvantages of shorting Bitcoin

  1. Your losses are unlimited. Unlike going long (buying) Bitcoin the furthest the price can drop is to zero. Which means you know your absolute risk. But when shorting Bitcoin the price can go up indefinitely, which means your losses are theoretically infinite.
  2. There are overnight financing costs to consider. With spread betting and CFDs, your broker will charge you overnight fees to carry a position over. This charge can be quite high as it is expensive for brokers to hedge Bitcoin exposure at the moment.  With Bitcoin futures the financing charges are built into the contract month called the “cost of carry” which will be different from the underlying cash price. The futures price and the cash price will eventually come in line. Although, some brokers still charge financing fees.
  3. Currency risk. Although shorting Bitcoin is very volatile there is still a small currency risk between your local currency and the currency of your short Bitcoin position, which would normally be USD.  If your local currency moves significantly against the Bitcoin currency position it will have an impact on your P&L.
  4. Illiquidity and volatility. When a currency is illiquid it means there is not that much of it around to trade. The more established an asset generally the more liquid the market is. So if you have a very large Bitcoin short position the market may not be liquid enough for you to close it.  When traders try to close a large position in an illiquid market it becomes more volatile meaning it can be hard to close the position at a good price.

Can you profit from falling Crypto prices?

The obvious way to have made money in a falling market is to have taken a short Bitcoin position which can be easily done through a Contract For Difference (CFD). CFDs allow traders to sell a market and profit from a fall in price in the same way that one can buy the market and make money from prices rising. However, if a short is initiated and prices rise then a trader would find themselves in a losing position.

Taking a 1 contract short position in Bitcoin when the price is 4614.80 will see a profit of £1264 if the market drops to 3000. If the market rises to 5200 the position will lose  £457.04. Source: xStation

How you can profit from buying

While shorting the market is the most simplistic way to make money as price falls there are other options. Some traders are less comfortable going short and prefer to buy first rather than sell. Money can be made (or lost, in the interest of being balanced) in buying a falling market outright but it requires a higher level of skill to go against the prevailing trend. This is where Crypto crosses come in. While XTB offer 9 cryptocurrency CFDs against the US dollar (EG Bitcoin/US dollar is BTCUSD) the majority of their markets (16) are against other Cryptocurrencies themselves (EG Ripple/Bitcoin is XRPBTC).

When you take a long position in BTCUSD you are simultaneously buying Bitcoin and selling the US dollar. You will profit if Bitcoin rises or the US dollar falls and lose money if the opposite occurs. If you take a long position in XRPBTC, you are buying Ripple while at the same time selling Bitcoin. You will profit if Ripple rise or Bitcoin fall and vice versa.

While crypto markets having been falling against the US dollar, there’s been a strong move higher in XRP/BTC (Ripple/Bitcoin). This market has respected levels nicely with a break above 0.7230 presenting a nice buying opportunity as well as the retest around 1 week later. This market is up over 50% in the last month. Source: xStation

One of the main reasons why traders and investors prefer buying over selling can be explained using simple arithmetic. The biggest problem with a short position is that you’re maximum payoff is limited to 100% while the downside is uncapped – IE if you short Bitcoin with 1 lot at $4614 the most you can make is $4614 while your potential losses are, in theory at least, unlimited. 

The opposite is true for long positions where your downside is limited to 100%, whereas the upside is unlimited – IE if you buy Bitcoin at $4614 with 1 lot the most you can lose on the position is $4614 (not counting swaps) whereas the upside potential is unlimited.

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