How to Short Bitcoin
Why short Bitcoin
Bitcoin, as the most valuable crypto asset, with a market capitalization of several hundred billion dollars has become less volatile over time, thanks to its growth in market cap. Nevertheless, its price fluctuations are still staggering. During the crypto winter of 2018, Bitcoin’s price declined more than 80% in just a year’s time. From the previous all-time high (ATH) of $20,000, the price dropped all the way down to $3,500. A similar scenario played out in 2021/22. Again, Bitcoin lost 75% of its valuation within a year, going from an all-time high of $69,000 in the fall of 2021 down to $19,000 in 2022.
Such price drops represent excellent trading opportunities. Thanks to shorting, investors can bet on falling prices and profit from market downturns. In the past, Bitcoin price and with it crypto markets have moved in cycles, which have followed a repeating pattern. Each cycle started with a Bitcoin halving, which cuts the miners’ block rewards in half. This halving decreases Bitcoin’s inflation and reduces the BTC supply coming onto the market.
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As a result, the price of Bitcoin begins to rise and crypto investors start to buy Bitcoin, which reinforces the upside trend. The rising Bitcoin price makes headlines around the world, and now money from outside investors starts pouring into Bitcoin, further fueling the price rally. Hype is building up and Bitcoin is omnipresent. Early crypto investors, knowing that the market is now overbought and no longer based on fundamentals, start to unwind their BTC positions. Others follow and take profits, which lead to a shift in sentiment, followed by a market sell-off. This usually marks the beginning of the next crypto winter or Bitcoin bear market.
While precisely timing these cycles is close to impossible, analyzing the overall market sentiment and selling off Bitcoin positions close to the peak of a hype cycle can be achieved more easily. Even for investors convinced of Bitcoin’s long-term success, it can be beneficial to sell off some of their positions in heavily overbought markets to buy them back later at more reasonable prices. Sophisticated investors, wanting to actively bet against hype cycles have, in addition, the possibility to open short positions to profit from market corrections.
How does shorting work?
Shorting is a strategy to bet against falling asset prices. In its original form, investors wanting to short a stock had to borrow that stock from a counterparty. In return, they had to pay interest to the counterparty. The investor then sold the borrowed stock on the open market in the hope of buying it back at a lower price at a later time. After buying the stock back, the investor returned them to the original owner. The profit was the difference between the stock’s selling and buying price minus the interest rate paid for borrowing the stock.
Today, shorting is often done with future contracts. Futures are contracts between two parties that agree to exchange an asset at a predefined price and at a specific date in the future. In crypto though, most futures contracts are so-called perpetual futures. Instead of agreeing to exchange an asset on a specific date, the two parties simply take the current asset price and agree to pay each other the difference. If the asset price increases, the party holding the long position gets paid the difference to the agreed-upon start price by the party being short. However, when the asset price falls, the process works in reverse and the long party has to pay the difference to the party holding the short position. In addition, perpetual futures don’t have an expiration date but run until one party cancels the contract.
The payments are happening in real time (every second) and the future contract can be canceled by either party at any time. To ensure that each party is always solvent and able to carry out their payments no matter how strong and fast the market moves, both parties have to deposit collateral — the so-called margin. Should the market move against one party and diminish its collateral below a minimum threshold, the party will receive a margin call with the request to deposit more collateral. Should the party not be willing or able to deposit more collateral, the future position will be automatically closed. This ensures that both parties are able to fulfill their contractual obligations at all times and neither party falls into debt.
How does leverage work?
Future contracts can be customized by the involved parties. Instead of agreeing to simply pay the difference, parties can agree to apply a multiplicator to the difference payment. This multiplicator is called leverage. Leverage defines how many times the difference between the starting price and the current price has to be paid by the counterparty. A leverage of ten (10x) results in a payment of $10 for every dollar the market moves. Some platforms allow leverage up to 125x, meaning for every dollar the market moves, $125 dollars have to be paid.
What is the funding rate?
When trading perpetual futures on a crypto exchange, there exists a mechanism called Funding Rate. The funding rate represents additional payments that are exchanged between the holders of long and short positions. If the funding rate is positive, long positions pay shorts. If negative, shorts pay long. For example, if the market is bullish, more people are interested in taking long positions. Thus, traders taking the opposite side of the trades and going short are incentivized to do so by the additional payments they receive from the long traders.
Funding rate payments are exchanged on a regular basis. On Binance, for example, the rate is paid and readjusted every eight hours. For future traders, a higher funding rate results in higher costs for holding the position for one side, while the other side is getting paid for continually holding their positions. This mechanism ensures the convergence of prices between the perpetual futures and the underlying asset. Usually, funding rates for BTC fluctuate in the range of +/- 0.1% and are mostly positive. The current funding Rrate for Bitcoin can be looked up here.
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Where to short Bitcoin
A simple way to short Bitcoin is to buy perpetual futures on centralized exchanges like Binance and Kraken (Coinbase currently does not offer shorting Bitcoin). These platforms require users to open an account and complete a know-your-customer (KYC) procedure. This includes a proof of identity, taking a selfie, and with some platforms, also a proof of residence in the form of a tax statement or a utility bill.
For users seeking a more pseudonymous way to short Bitcoin, there exist many decentralized finance (DeFi) platforms that offer shorting Bitcoin as well as leveraged trading. Examples are dYdX on Ethereum, GMX on Arbitrum and Avalanche, Drift on Solana, Perpetual Protocol on Optimism, and Polysynth on Polygon.
How to short Bitcoin
On Centralized Exchanges (CEXs):
On Binance, Kraken, and similar platforms, shorting Bitcoin can be done with a few clicks.
Step 1: Find the BTC Trading Pair
Log in to the platform, click on Trade and search for the BTC-Perp or BTC-USD trading pair. If using Binance, open the Futures section and search for BTC-USDT or BTC-USDC, whatever trading pair you prefer. Click on the trading pair.
Step 2: Choose Short
In the new window, you can choose if you want to buy Bitcoin (long) or sell it (short). Choose Sell.
Step 3: Adjust Leverage
Adjust the leverage (multiplicator) you want to use. If you are shorting for the first time, choose a leverage of 1x (= no leverage).
Step 4: Check Funding Rate
In the top right corner (most apps), the current funding rate is displayed. It shows how high the current funding rate is and the time until it will be exchanged the next time. Make sure the funding rate is at a reasonable level.
Step 5: Choose Amount and Price
Choose the amount of BTC you want to sell and define the price you want to sell it for, or simply choose the market price.
Step 6: Short BTC
Once you have double-checked your trade, click sell. You are now short Bitcoin. You can close your position at any time, 24/7. The PNL (Profit and Loss) metric shows your current profit or loss.
On Decentralized Exchanges (DEX):
To short Bitcoin on DEXs, the process is similar. Open your preferred DeFi protocol, connect your wallet, and search for the BTC-USD trading pair. With some DeFi protocols, you first have to deposit some cryptocurrency into your trading account and confirm the transaction in your wallet. Other platforms let you trade right away by simply connecting your wallet. Once connected, follow steps 1-6 listed above to short BTC on DEXs.