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:
- Spread betting brokers: tax free profits
- CFD brokers: contracts for difference
- Futures broker: trade the CME bitcoin future
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
- 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.
- 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.
- 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.
- 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.