Shorting Bitcoin: The Definitive Guide 2022 (Bad Idea?)
Posted On January 27, 2022
Generally, this is how crypto trading works – investors buy some Bitcoins (or any other cryptocurrency) and wait for its price to go up before selling it for a profit. Shorting Bitcoin is the opposite. You profit by selling your Bitcoins at a high price and repurchasing when prices dip shortly after. That’s the general gist of it.
Many people believe that Bitcoin and cryptocurrency are just another Ponzi scheme or pyramid scam. And since some influential financial figures suggest that it has no future coupled with its anonymous nature and potential threat to the government, it leads many to believe Bitcoin could be the next “Big Short”. The recent price dip, after Bitcoin peaked its all-time high at over $68,000 on November 10, 2021, seems to fuel that idea too. But then there are people who see shorting Bitcoin as just another trading method to make profits.
What is Shorting?
This is how shorting works – You anticipate that the price of a security is about to dip by analyzing trends and charts or market sentiments towards that security. So, you sell it, and when the prices fall, you repurchase it for less money. Thus, making a profit.
Can you Short Bitcoin?
Yes. You can short Bitcoin. Many traditional methods used for shorting stocks and securities are now also available for shorting Bitcoin, which is what we’ll discuss next.
How to Short Bitcoin?
There are many ways to short Bitcoin ranging from the easiest but the riskiest methods to the most complex but relatively safer methods. Make sure you understand the risks associated with each approach, as shorting Bitcoin in itself is a risky move (more on this later). You yourself are responsible for its consequences, negative or positive.
Margin trading is the most common method for shorting. In this method, you borrow some Bitcoins (or any other cryptocurrency) from a broker or exchange, pay a fee for borrowing and place your short position. If everything goes as planned and prices fall, you return the borrowed Bitcoin while keeping the profits to yourself. Not all crypto exchanges allow you to short Bitcoin, Coinbase being one of them. The ones that do allow shorting Bitcoin include Kraken and Binance.
By creating a contract for a futures trade, you agree to buy or sell Bitcoins on a predetermined date at a predetermined price. So, if you believe Bitcoin prices will fall, you can sell a futures contract at a specified date and price to make a profit. Needless to say, if things don’t go as you expected, you’ll incur a loss. Chicago Mercantile Exchange (CME) is probably the best Derivative platform for buying and selling Bitcoin futures. Crypto exchanges like Kraken or BitMEX and brokerages like eToro and TD Ameritrade also allow Bitcoin futures trading.
Options contracts are very similar to how futures contracts work. The only difference – unlike futures contracts, you’re not obligated to buy or sell your Bitcoin at the specified date and price. You can choose not to. You can short Bitcoin with options contracts on Deribit and OKEx.
Leveraged trading is pretty similar to margin trading. But in leveraged trading, you don’t borrow or own the underlying asset, which is Bitcoin (or any other cryptocurrency) in this case. You only bet on its price. Another fundamental feature of leveraged trading is that you can bet way more than you have, as you’re not required to pay the entire trade value but only a small deposit. It means if things go your way, you earn way more than what you put in. But if they don’t, you incur a far more significant loss.
Predictions market is basically traditional betting but with Bitcoin prices. You don’t have to be involved with any crypto platforms or exchanges. You just bet on whether Bitcoin prices will go up or down. Popular prediction platforms for shorting Bitcoin – Augur, Gnosis’ Omen, and Polymarket.
The DIY Method
This is the most straightforward way for shorting bitcoin. Basically, you do it all yourself. You sell your Bitcoin on any crypto trading platform, and when the prices fall, you repurchase them. However, things can get really complicated really fast once you introduce taxes, something we’ll discuss later in this article.
Shorting Bitcoin Analysis
So far, we have discussed what shorting bitcoin means and how to short Bitcoin. But how would you find out the right time to do it? The following are some ways you can analyze and anticipate when it’s an ideal scenario for shorting Bitcoin:
Technical analysis involves making calculated decisions based on charts and trends. It’s probably the most complex method but also the most scientific. Therefore, it’s more reliable. Here are some methods and tools traders use to understand market trends and make investment decisions:
Relative Strength Index (RSI): Generally, when an asset is overbought or oversold, you can expect its price to fall soon. RSI helps indicate when a particular stock or security, in this case, Bitcoin is overbought or oversold.
Moving Averages (MAs): If a short-term moving average crosses above a long-term moving average, it’s called a “Golden Cross”, indicating a bullish trend. Contrarily, if a long-term moving average crosses over a short-term moving average, it’s called “Death Cross”, indicating a bearish trend. To learn more about moving averages, “click here”.
Support and Resistance Levels: ‘Support’ indicates a price level on the trading where buying interest can overcome selling pressure. On the other hand, ‘resistance’ is the opposite, where selling pressure can overcome buying interest, causing prices to fall.
Fundamental analysis involves analyzing the factors and driving force behind Bitcoin or other cryptocurrency prices to conclude if it’s undervalued or overvalued. Factors and driving forces include financial influences, government decisions, industry trends and much more. As you can probably guess, if Bitcoin is overvalued, you can expect prices to fall and vice versa. Fundamental analysis is less complex than technical analysis but still reliable.
In sentiment analysis, investors analyze the market sentiment towards Bitcoin or other cryptocurrencies. It’s probably the easiest but the most unscientific method for predicting Bitcoin prices. Therefore, the least reliable. For example, there is this website that counts the number of positive and negative tweets about Bitcoin to provide a rough idea of what the market sentiment is. But the problem is, market sentiments don’t always dictate the prices. Other factors come into play too.
Risks Involved with Shorting Bitcoin
Fundamentally, the biggest risk associated with shorting Bitcoin is that its price could continue to rise indefinitely, resulting in unlimited losses. But that’s an extreme scenario and can be prevented with tools like stop-losses. On a more practical level, Bitcoin’s price volatility is the biggest risk when shorting Bitcoin. That’s why we suggest you don’t short Bitcoin without appropriate planning and strategizing. Other than that, the lack of regulatory frameworks in institutions offering futures and options trading allows them to sell offerings that are very risky. Under proper oversight, these offerings wouldn’t necessarily be allowed.
Taxes on Shorting Bitcoin
As we know, Bitcoin and other cryptocurrencies are treated as property, meaning if you dispose of your crypto, you’ll be liable to capital gains tax rates. Now, based on this logic, it’s safe to say that shorting Bitcoin is pretty much tax-free in most cases. Because in most methods like margin trading, options trading, futures trading and leveraged trading, you don’t actually dispose of the Bitcoins. The only tax you need to pay is if you sell the profited Bitcoin in the future.
However, if you short Bitcoin using the DIY method, things get complicated. When selling your Bitcoin, if the cost basis is lower than the fair market value, you’ll be liable to capital gains tax rate. So, you may end up paying more in taxes than what you profit if you do. Check out our complete guide to crypto taxes to know more about how crypto taxes work.
Does all of this sound confusing? Well, because it is. Tax is confusing and complex. But with Bitcoin.Tax, it doesn’t have to be. Bitcoin.Tax is the leading crypto tax software out there in the market that helps you manage, calculate and automate all your crypto tax processes.