You can short bitcoin by borrowing BTC on Bitmex, Bitfinex or Poloniex with the intention of paying it back at a later date. Investors and traders can short other cryptocurrencies on these sites as well, such as Tron, XRP, Litecoin, Cardano, Bitcoin Cash, and 0x.
Traders must pay an interest fee on the bitcoin that they borrow, and there is a borrowing limit depending on the size of your account and the amount of leverage that the exchange offers. The ability to ‘short’ cryptocurrency derives from the ability to borrow the coin.
When an exchange allows a trader to enter short and long positions that is often referred to as allowing margin trading. This article will go over the basics of margin trading at a high level.
What is margin trading?
Margin trading is simply the ability to borrow an asset from a broker to fund trading (similar to a loan) which allows you to trade more of the asset than you normally would. This gives you what’s called “purchasing power.”
For example, if I want to buy (long) 10 bitcoin and I only own 1 bitcoin then I can borrow 9 bitcoin from a broker and return it after I complete my trade. Margin trading increases your risk, which means you can win big, but lose even bigger – so it is incredibly important to do your own research before opening a margin account.
There are two types of trades to make:
Short: You are betting that the price of bitcoin will decrease. You borrow bitcoin from your broker and then sell it on the market with the intention of repurchasing the same amount at a lower price. For example, let’s assume bitcoin is currently trading at $6500 but I believe it will fall to $5500. I can borrow 1 bitcoin, sell it for $6500, repurchase the bitcoin at $5500, and then return the bitcoin to the lender. I’d profit $1000 from this 15% decrease in the asset.
Long: You are betting that the price of bitcoin will increase and purchase bitcoin on the market with the intention of selling it at a higher price.
A trader can make larger trades in both of these scenarios with what is called “leverage”. Leverage means taking on debt and is an investment strategy of using borrowed money to increase the returns on investment (ROI). The term “high leverage” refers to having a high ratio of debt (borrowed money) to equity (your money). Leverage magnifies gains and losses.
Why is margin trading risky?
Margin trading allows you to borrow someone else’s money to make a trade. This is referred to as increasing your purchasing power. You need to return that money regardless of the outcome of that trade. You can amplify your potential earnings, but you also amplify your risk. The epitome of that risk is referred to as getting “margin called.” A margin call occurs when your collateral (for example the bitcoin position you own) falls below the required minimum value. This minimum value changes depending on the amount of leverage you are using.
For example, Bitmex offers 100x leverage. 100x leverage means that you can trade 100x your available balance. If you have 0.01 BTC you can trade 1 BTC, but if bitcoin drops 1% you get margin called and lose your 0.01 BTC.
Here is a more sensible example of why margin trading bitcoin can be risky. Let’s assume you own 1 bitcoin, but want to short 2 bitcoin at 2x leverage and that the price of bitcoin is $6500.
Scenario A: Bitcoin rises 50% to $9750
You get margin called and lose 100% of your investment. You used 2x leverage, which means a 50% move in the opposite direction gets you margin called; forcing you to buy bitcoin at $9750.
Scenario B: Bitcoin falls 50% to $3250
You close your position and buy bitcoin at $3250, which earns you 100% return on your investment.
Key Terminology
Opening a margin trading account can be daunting because there are a lot of terms and jargon that investors may not be familiar with. The most popular site right now for margin trading is Bitmex, and key terms there are:
Quantity: This may sound trivial, but futures products on Bitmex settle in bitcoins. Your order is for the amount of USD you want in bitcoins, or the number of units you want in altcoins.
Mark Price: Current market price. Price is defined as the last agreed upon sale. This number is used to calculate your ROE (explained below).
Liquidation Price: This is the price, based on the leverage you’ve used, where your position will be liquidated and you’ll lose your position to cover.
Unrealised PNL: PNL stands for “profit and loss” and ROE stands for return on equity. Your PNL is calculated based on a scenario where you immediately exit the position at the mark price, and the ROE % is the percent gain on your initial position (not including what you borrowed). This value automatically updates on Bitmex as you buy/sell on a specific contract.
Realised PNL: When you are in a position you may have to pay or receive interest every 8 hours. Your realised profit and loss is a calculation of the interest you’ve received or earned since opening that position.
Perpetual Contract: This is a Bitmex product that aims to replicate the actual bitcoin spot market by not having an expiry date. This contract uses a price index to closely track the spot market and Bitmex.
Funding Rate: When you are trading on margin you need to pay an interest rate on the money you are borrowing. On Bitmex this is done through the funding rate, which is paid every 8 hours to those who are holding a position at that time. When the funding rate is positive that means longs are paying shorts and vice versa. The amount of funding you receive/pay is irrespective of your leverage, and is just on the notional value of the contracts that you hold.
Funding Book: As a trader on Bitfinex you can lend your coins to traders engaging in margin trading. The funding book acts as a market for loaning your coins, and you can set the interest rate you’re looking to receive.
Limit: Posting a limit order means you are being a “maker” – you are making a market by providing liquidity to the orderbook. Bitmex actually pays you a fee to be a maker.
Market: Posting a market order means you are being a “taker” – you are taking what is given in the orderbook at the best rate. You need to pay a premium fee on Bitmex to incentivize makers to be in the orderbook for you to take from.
Post-Only: These are limit orders that are only accepted if they are not immediately executed. Ticking this box on Bitmex can aid a strategy where a trader wants to only be a maker, and never a taker to take advantage of Bitmex’s fee structure. High-frequency traders and market makers often use this strategy.
XBTUSD: This is the name of the perpetual contract on Bitmex. The price is generally within 2% of the actual Bitcoin spot market, but it’s important to identify that it is a futures contract.
Short Squeeze: This is a very common term. It refers to a scenario where a heavily shorted asset experiences a sharp uptick, which margin calls short sellers, adds more buy pressure on the market, and continues to increase the price of the asset since margin called traders are being forced out of their positions at the market rate. This is a risk that a lot of traders are afraid of when taking a short position.
We’re currently seeing market conditions of low volatility for a sustained period of time, which signals that we are due for a sharp price movement in either direction. I believe that we are due for a sharp downward movement and have a short position on Bitcoin.
Opening a short position can be done on Bitmex.
But don’t say I didn’t warn you.
This author is invested in Bitcoin, which is mentioned in this article.
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