How to Short Ethereum
Newcomers to the trading markets often only see trading opportunities during boom cycles when prices are rising. But this is only one side of the coin. There are also many ways to profit from falling prices during market corrections and general bear markets. One such strategy is generally referred to as shorting.
What is shorting?
In simple terms, shorting is betting on falling prices. Investors having a bearish (short-term) outlook on an asset like Ether are expecting the price of Ether to decrease in the future. To profit from such a scenario, Ether has to be borrowed and sold at the current market price. The goal is to buy the Ether back later for a lower price and then return it to the original owner. An investor bags the difference between the selling and rebuying price minus the interest paid to the lending party. This mechanism called shorting allows investors to bet on and profit from a falling-price environment.
Traditionally, shorting was mostly done through asset lending. Today, there exist other financial instruments to bet on falling markets, which simplify shorting for investors. Examples are Futures, Options, CFDs, and Bear Tokens. In the following section, these different instruments for shorting Ether are introduced.
Four ways to short Ethereum
Shorting Ether can be accomplished in various ways, some requiring more financial knowledge than others. Below, we present four straightforward ways to short Ether.
For most investors, a convenient way to short Ether is using a crypto exchange such as Binance, Kraken, BitMEX, KuCoin, among others (please note that Coinbase currently does not offer shorting). All of them offer at least one of the following instruments.
Perpetual Futures are the most popular way to short crypto. They are contracts between two parties that agree to pay each other the price difference resulting from a defined starting price. The party being short gets paid the difference by the long party if the price falls below the starting price. Should the price rise above the starting price, the short party has to pay the difference to the long party instead.
Perpetual Future contracts can be closed at any time by each party. Both parties are required to hold a minimum amount of collateral, often referred to as margin, to ensure their solvency. The contract is recalculated every second and the margin increases or decreases accordingly. Should the margin fall under a predefined threshold, the contract will close automatically to avoid defaults. To short Ethereum (or rather its asset Ether) with perpetual futures on one of the exchanges listed above, follow these steps:
- Step 1: Open an account with a CEX offering futures trading (E.g. Binance, Kraken, BitMEX, KuCoin).
- Step 2: Go to the Derivatives or Futures trading section.
- Step 3: Search for a trading pair like ETHUSD Perp/ETH-PERP/ETHUSD Perpetual.
- Step 4: Select sell or short.
- Step 5: Choose the starting price and the size of your future contract.
- Step 6: Choose leverage. For newcomers, a leverage between 1-5x is recommended.
- Step 7: Check your margin and the liquidation price. Make sure to have enough margin to absorb market fluctuations.
- Step 8: Sell/short the futures contract.
As soon as your purchase is confirmed, you will see your price and loss (PNL) ratio and your liquidation price. With most exchanges, you can lower your liquidation price by adding more collateral to your future position, which increases your margin. It is recommended to have a trading strategy in place to take profits or cut losses at certain PNLs.
Bear Tokens/Leveraged Tokens
To further simplify shorting, several exchanges (Binance, KuCoin, among others) have introduced Bull and Bear tokens. These tokens can be purchased like normal crypto assets but have special features. Bear tokens move in the opposite direction of the underlying asset, while the price movement of leveraged tokens is multiplied by the leverage. To short Ether, investors can purchase Bear Tokens, leveraged or unleveraged. Examples are:
Exchanges like BitMEX also offer traditional futures contracts. Traditional futures are contractual agreements to exchange an asset at a future date for a predefined price. To short Ether, investors can sell a future contract with an end date (usually quarterly) and a predefined price. This allows shorting Ether for specific time horizons. To ensure solvency, all parties have to deposit collateral. Should the price move against your position, you will receive a margin call to provide more collateral. If your collateral falls below a certain threshold, your position will be automatically sold.
A large number of traditional online brokerages started offering crypto trading in recent years. Like their counterparts in the crypto space, many TradFi brokers not only offer crypto spot trading, but also crypto derivatives instruments. For investors who are more comfortable with TradFi brokers, this may be a suitable option to participate in Ether shorting. Most brokers allow shorting via CFDs.
Contract for Difference (CFDs)
CFDs, short for contract for difference, are financial instruments that work similarly to perpetual futures. CFDs are contracts between two parties that agree to pay each other the price difference resulting from a defined starting price. The party being short pays the long party when prices rise and vice versa. Some CFD contracts are leveraged, but unlike with perpetual futures, the level of leverage is often not adjustable.
To short Ether, simply sell an ETH CFD contract at a price level and for an amount of your choice. Again, ensure that you have enough margin to absorb price fluctuations and avoid margin calls and forced liquidations. Like perpetual futures, CFD contracts are recalculated continuously and can be closed at any point in time.
Risks of shorting Ethereum
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Shorting, unlike simply holding cryptos, comes with additional risks. The most prominent risk, especially when trading futures and CFDs, is the liquidation risk. Should the underlying asset experience large price swings and move against you, your positions could easily be liquidated and the majority of your investment will be lost. Once the markets turn around again, you will not be able to profit from it as your positions have been closed and you no longer have any exposure to the asset at hand. Thus, always make sure to have enough margin to cover large swings and put stop losses in place if necessary.
Also, using leverage increases your liquidity price and thus requires more collateral to avoid potential liquidation. Use leverage conservatively and start with low leverage levels (1x-5x).
Important indicators for shorting
Open Interest is used in futures and options trading and shows the total number of outstanding derivatives contracts (shorts and longs). In crypto, the indicator usually adds up the total value of all open contracts. The higher the open interest, the higher the current interest in the underlying asset. For Ether, the open interest rate can be looked up here.
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 every couple of hours. 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. The current funding rate for Ether can be looked up here.