How to Short Ethereum
The cryptocurrency market is extremely volatile. In the course of a day or even a few hours, the price of a coin can change significantly. These abrupt price changes create a lot of earning opportunities for traders.
Although the main trading strategy is to buy cheaper and sell dearer, making money on falling prices is also achievable. Short trading is available on many cryptocurrency exchanges. The strategy is not too complicated and can be used even by novice traders. However, it also involves enormous risks.
In this article, we will explore the ways to short ETH, the world's second-biggest cryptocurrency. We will also discuss the risks which you might incur while shorting Ethereum.
Short Selling Ethereum: What Does It Mean?
Short selling is a strategy that allows you to make money on the falling price of an asset. Basically, shorting ETH is selling borrowed coins in order to buy them back later at a lower price. The difference in the buying and selling prices is the trader’s profit.
A classic short-selling transaction can be summarized in the following steps (using ETH as an example):
- You plan to sell one ETH for $1500 because you expect the price to fall soon;
- You borrow ETH from a cryptocurrency exchange and sell it for $1500;
- Your prediction turns out to be correct — the price falls to $1200;
- Then you buy one ETH for $1200 and return it to the exchange;
- So you'll earn$300 ($1500 minus $1200) minus the interest, which you have to pay to the exchange for the loan.
It is crucial to carefully analyze the market prior to opening a short position on ETH. You must be sure that the asset’s price is going to drop. Shorting cryptocurrency can be quite risky and there is an equal chance of making or losing money due to high volatility.
What Are the Risks of Shorting ETH?
Being a good option for traders looking to earn on a falling market, shorting Ethereum comes with a number of risks. This strategy is not suitable for traders with little experience in trading cryptocurrency. Below we cover the main types of risks.
Losing More Than Your Deposit
Cryptocurrency shorting is appealing to many traders because, unlike spot trading, it allows leverage up to 100x. However, the downside of such high leverage is that losses can exceed the total balance amount. Thankfully, most cryptocurrency exchanges enforce various mechanisms protecting traders from excessive losses (margin call, insurance fund)/ However, in some circumstances, a trader can be left with a negative balance which they would have to cover up.
Unlimited Downside Potential
One of the main risks of shorting cryptocurrency is that possible losses are potentially limitless. With the regular long position, the potential maximum loss is equal to the purchase price. The asset’s price simply can not plunge below zero. A short position, by contrast, has no loss limit, as the price of the asset can rise “indefinitely”.
To limit the losses, cryptocurrency exchanges forcibly liquidate positions when the collateral runs out due to ETH price growth. However, sometimes traders prefer to keep adding collateral to their account to maintain a losing position. Thereby, they increase their potential losses in the hope of the trend reversal.
Prices Can Be Very Volatile
Despite the fact that volatility opens opportunities for lucrative profits, it often discourages cautious traders from opening short positions on ETH, and for good reason. Ethereum prices can rise as fast as they fall, often leading to multi-million dollar liquidations of “bears”. Hence, the high volatility greatly increases the demands on traders' level of experience and knowledge.
Active Management
Spot trading allows you to buy an asset and “forget” about it. On the other hand, short trading requires active management of open positions, especially in a volatile market. So a trader should have considerable experience and certain skills of proper position management. They also need to be emotionally stable, to avoid making impulsive actions.
Ways of Shorting ETH
Now, as you are aware of the risks related to short trading, we can discuss the ways to short Ethereum.
Shorting Using Margin on Exchanges
Perhaps the easiest way to open a short position on ETH is to borrow some ETH coins from a cryptocurrency exchange and then sell them on the market, hoping to buy them back at a lower price. The only requirement for opening a transaction is to have some collateral on your account.
Remember that by shorting an asset, you don't actually own it. You simply borrow it and pay some interest on it until the loan is paid back. The coins come either directly from the exchange's own funds, or through peer-to-peer lending from other users.
The borrowed assets are immediately sold on the market. If the forecast is correct and the rate of the cryptocurrency decreases, the trader buys the coins back, but at a lower price. Having bought ETH that went down in price, the user returns them to the exchange. The difference between the sale price and the subsequent buy-back is the trader's profit.
However, there is a chance that the price of ETH will rise. In this case, the position can remain open for as long as there is enough collateral to cover the loss. Alternatively, the trader can decide to close the transaction at a loss. For example, if the trader has a $1,000 deposit and sells $10,000 worth of “borrowed” ETH, then if the price of ETH rises by more than 10%, the deposit is drained to zero, and the trade is closed immediately.
Taking a Short by Going Long Elsewhere
There are several other ways to short ETH. Here are the most popular ones:
- Futures;
- Options;
- Contracts for Difference (CFD).
Below, we will take a brief look at each of the methods.
Futures are derivative contracts which oblige you to buy or sell the underlying asset at a predetermined price at a predetermined date. The terms of these contracts stipulate the profit to be made if the price of the asset changes in the desired direction.
For example, a seller of ETH futures will earn if the price of Ethereum falls. Cryptocurrency exchanges trade futures contracts without delivery, which means the trader immediately receives a profit to their account if his forecast is correct. Again, as in the case with short-selling, you do not take the direct ownership of the underlying assets. They only serve as the base of the contract, from the price of which the user's income is calculated.
Options are also derivative contracts and are quite similar to futures. They give the right (but not the obligation) to buy or sell an underlying asset at a predetermined price at a predetermined time. The distinctive feature of options is that they are asymmetrical contracts. That is, one party receives an obligation and the other receives a right, which they are free to exercise, depending on their interests and market conditions. For this risk, the buyer pays a premium (option price) and the seller receives it immediately after the sale.
Due to their features, options are a more complex instrument than futures, but also enjoy great popularity, especially among experienced traders.
CFD stand for a contract for difference. They are derivatives, like the previous two instruments, and work as a surrogate for the underlying asset. However, unlike futures and options, CFDs only come in perpetuity.
By buying a CFD on a cryptocurrency, the trader does not get possession of the asset. Instead, they try to profit from price movements by predicting whether the cryptocurrency will rise or fall in value. A correct prediction will yield a profit equal to the difference between the ETH price at the time the CFD is purchased and the ETH price at the time the trader closes the position. If the forecast is incorrect, the trader is forced to record the corresponding loss.
When Is a Good Time to Short ETH?
As it was mentioned above, successful Ethereum shorting requires an adequate level of trading experience and the ability to conduct serious analysis. You should know how to read charts, as well as know the nuances of technical and fundamental analysis. Also, experienced traders take into account the behavior of the crowd in the industry and can accurately enough predict its mood.
All these skills help to create a trading strategy, which will work effectively in both short-term and long-term perspective.
Long-Term Outlook
Fundamentally, Ethereum is the strongest asset on the cryptocurrency market. Many experts predict that sooner or later, thanks to the active development and the asset’s unique features, ETH will take the first place by capitalization, replacing Bitcoin. Such sentiments continue to attract new users and instill optimism in long-term investors.
Thanks to the recent update with a token burning mechanism, the ETH coin has become a deflationary coin. That is one of the reasons behind the growing popularity of Ethereum and an increase in the number of transactions on the network. In the long term, this fact can lead to a significant growth of the ETH’s price.
All of these reasons make short selling ETH with a long time horizon a very risky undertaking.
Short-Term Outlook
While Ethereum's long-term prospects are not favorable for shorting ETH, the cryptocurrency-specific volatility and general cyclical nature of the market provides many opportunities to capitalize on bearish ETH movements in the short term.
Usually, a rise in the price of ETH is followed sooner or later by a significant pullback. The amplitude of such price movements has weakened over the years as liquidity increases, but bubble deflation phases occur regularly. Since November 2021, the market as a whole, and ETH in particular, have been in a bearish phase. It means that for more than a year, short-traders have been in a better position and have plenty of opportunities to open profitable short positions.
The Bottom Line
Shorting Ethereum is a potentially profitable but risky way to make money. A trader starting to short cryptocurrency should remember that they trade the borrowed asset, which will have to be given back. Therefore, the strategy should be well-thought-out. However, the risks are balanced by the correspondingly high profits.
FAQ
Can You Short Ethereum With Leverage?
Yes, ETH leveraged trading is available on most popular cryptocurrency exchanges.
Does Ethereum Short Selling Require ID?
It depends primarily on the trading platform. Centralized exchanges usually require verification for higher leverage access. However, trading relatively small amounts of money with low leverage is possible without verification.
If you plan to use decentralized platforms, they do not have KYC requirements.
Why Short Selling Is Bad
Short selling is just one of the existing trading strategies, and it is quite popular among traders. However, shorting is sometimes used to manipulate the price of a particular asset or the entire market in order to destroy a particular project by causing irreparable damage to its price.
*This communication is intended as strictly informational, and nothing herein constitutes an offer or a recommendation to buy, sell, or retain any specific product, security or investment, or to utilise or refrain from utilising any particular service. The use of the products and services referred to herein may be subject to certain limitations in specific jurisdictions. This communication does not constitute and shall under no circumstances be deemed to constitute investment advice. This communication is not intended to constitute a public offering of securities within the meaning of any applicable legislation.
