Shorting cryptocurrency is a high-risk, advanced investing strategy. Here's how it works (2024)

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• 'Shorting' means anticipating a decline in value of a traded asset.
• Traders can short crypto, but the market's volatility and lack of regulation make it particularly risky.
• There are a few ways to short crypto, if you have the appetite and capacity for risk.

When you think about investing, the idea is usually that you profit when the price of an asset increases, and lose money when it falls.

Another, more-advanced approach is short-selling, or shorting. It involves betting against an asset because you expect its price to fall in the future.

Can you short crypto?

"You essentially borrow the asset from someone and sell it," says Peter Eberle, president and chief investment officer of Castle Funds, a California-based investment firm. "You then buy it back some time in the future and return the borrowed assets. If the idea [in traditional trading] is to buy low and sell high, shorting is just reversing the order — sell high, then buy it back lower."

But it's important to understand that shorting any asset, including crypto, is an advanced trading strategy that could easily backfire. While it's possible to make a quick return, shorting also requires deep knowledge of the markets and derivatives.

Experts recommend trading or investing in crypto using a crypto exchange, and one of the bigger ones, if possible. They tend to be more secure and trustworthy and have larger pools of traders and investors, adding additional liquidity to the market.

How to short crypto

Shorting crypto can be done in a few different ways, including buying options or futures contracts, trading on margin, or using a contract for difference. Here's a bit more about each method.

Buy crypto on margin

Buying on margin means that you're borrowing money from a brokerage or exchange. For example, say you have $100 in your account, but are purchasing $1,000 in Bitcoin — the remaining $900 is on margin. You borrowed it from the exchange. This allows for traders to trade larger amounts and earn bigger returns, but it also comes with bigger risks.

It is possible to trade crypto on margin, depending on the exchange or brokerage you use, and whether that exchange has offered you the ability to trade on margin. But be warned that there generally are interest charges (you're borrowing money, after all), and again, a risk of losing more money than you have in your account.

In practical terms, shorting crypto using margin entails borrowing money from your chosen exchange to purchase a certain amount of cryptocurrency, waiting for it to appreciate in value, and then selling and earning a return. You then "return" the money to the exchange, pay any applicable interest fees, and you've made a profit trading with money that you didn't even have.

Use a contract for difference

Using a contract for difference (CFD) is a more advanced method of shorting. The contract pays the difference between an open and closing price on an underlying asset. Depending on your position, a higher price on the close date could net you a profit, and vice versa. So, if you use a CFD to short crypto, you're taking the position that crypto prices will decline.

Note that CFDs are derivatives, and they're unregulated. In fact, they're illegal in the US for retail investors to use in regulated markets. But the crypto market is unregulated, so it is possible for crypto traders to use them. There may be costs, such as commission charges, to consider too.

Here's an example of how this might work: Bitcoin costs $10, and you think its value will decline. You open a CFD position to reflect that, and watch the markets closely. Then Bitcoin's value reaches $8, the contract expires, and you've made the correct bet, and thus, profit according to the contract's stipulations.

Use futures or options

Buying futures or options contracts is another way to short crypto. Both methodsallow investors to buy or sell an asset at a specific price by a specific date. Options give a buyer the option, but not the obligation, to go through with the transaction. Futures, however, require that the agreed-upon transaction takes place when the contract expires.

Using futures or options requires advanced knowledge of derivatives and isn't recommended for beginners. There can also be fees, called a premium, for opening a position in an option.

"You'd do a put on the crypto," says Mark Fidelman, founder of DeFi marketing agency SmartBlocks, and the host of the Cryptonized podcast. A put option is, in essence, a bet that an underlying asset will lose value, which is why it could be used to short a cryptocurrency.

"You'd hope it goes down in the short term — you're really betting on it going down," Fidelman says.

Here's an example: Say you anticipate Bitcoin's value going down over the course of one day. You have 10 BTC valued at $100, and buy a put that gives you the right to sell the 10 BTC at $100 in one day. As you anticipated, the price of BTC falls to $6 — you can let the contract expire, or sell the BTC at the $100 price mark, $40 more than its market value.

Using these types of contracts can allow you to open positions to effectively short different cryptos at different times, and at different prices.

Options trading is an advanced strategy. It's possible to get yourself in tremendous debt without fully understanding what you're doing. As such, most experts recommend avoiding options trading unless you're extremely familiar with the terminology and mechanics behind it.

Risks of shorting crypto

The risks of shorting crypto are fairly obvious. If you're betting that a crypto's value is going to fall, and it rises instead, you stand to lose. How much you could lose depends on the specific instruments or methods you use to open a short position, and how much you have at stake.

Consider this: If you use margin to buy $1,000 in Bitcoin, and Bitcoin's value drops 50% overnight, your investment is now worth $500, and you owe $500 to the exchange, plus interest.

Shorting any security, even stocks, carries similar risks. But crypto's risks are even larger, given that it's a highly volatile market and effectively unregulated. That said, shorting can benefit financial markets, some experts say.

"For example, shorting can enhance liquidity, increase the efficiency of stock prices, minimize market bubbles, and may function at times to reduce market manipulations," says Gabriella Kusz, CEO of the Global Digital Asset and Cryptocurrency Association. But while shorting may have a place in the market, that doesn't mean it necessarily has a place in your investing plan.

Shorting is a high-level trading activity. Although it can offer traders the chance to see outsized returns, it can also lead to outsized losses.

Where to short crypto

It's possible to short crypto on a variety of exchanges or platforms, depending on how you want to do it. For example, large exchanges like Coinbase or Kraken allow users to buy Bitcoin futures contracts. Other traditional brokerages, including TD Ameritrade, offer them too.

Eberle says that sometimes shorting crypto can be a complex process involving numerous exchanges.

"You can short actual Bitcoin by putting up collateral on platforms such as AAVE or Compound, and then you pay a variable interest rate to borrow WBTC, which is wrapped Bitcoin on the Ethereum network, and take it to an centralized exchange like FTX or Coinbase," he says. That's a complex method, he adds, but one that traders could utilize.

Note that many bigger platforms, like Robinhood, won't allow users to trade crypto on margin. So, you may need to do some homework to find a platform or exchange that works for the specific shorting techniques you'd like to use.

The bottom line

Shorting crypto could possibly earn you some quick returns, but it's an advanced strategy. Crypto is an incredibly volatile asset, and experts warn that most people should probably avoid short selling.

"Unless you're an absolute expert on that particular crypto that you're shorting, I would steer clear of it," says Fidelman. "It's not a game for amateurs."