As a leader in crypto tax reporting, it's probably no surprise that CoinTracker has a bullish bias toward digital assets. However, the crypto market’s volatility often raises a critical question for traders: Can shorting – betting against crypto assets – be a viable strategy when prices take sharp, double-digit dives?

While shorting hasn’t proven effective for long-term holdings in assets like Bitcoin (BTC) and Ethereum (ETH), it can still offer opportunities during short-term market downturns or periods of heightened volatility.

In this guide, we’ll explain how to short crypto, why traders consider this approach, its advantages and disadvantages, and the risks involved. 

What does it mean to short cryptocurrency?

"Shorting," or "short selling," is a trading strategy where investors aim to profit when an asset's price decreases. Unlike the traditional approach of buying low and selling high, short sellers aim to sell high and buy low, earning a profit from the price difference. Typically, this involves borrowing funds from an exchange to sell an asset at its current price and then repurchasing it at a lower price to repay the loan.

Along with short selling, a growing range of synthetic financial products (derivatives) and prediction markets offer indirect ways to capitalize on price declines. While shorting has been a staple in markets like stocks, commodities, and foreign currencies, it’s becoming increasingly accessible on crypto exchanges as traders explore more ways to capitalize on market trends. 

Ways to short crypto

Traders can short crypto through various methods, such as borrowing funds, using derivatives, or participating in prediction markets. Some strategies rely on loans and leverage, while others provide simpler ways to take bearish positions on digital assets. Each involves unique mechanics and risks, allowing traders to choose the approach that best fits their goals.

Here’s a closer look at the different approaches to shorting crypto:

Margin trading

Margin trading involves borrowing funds from an exchange or protocol to sell a cryptocurrency with the intention of repurchasing it at a lower price. To participate, traders must meet platform-specific requirements, such as maintaining a minimum collateral balance or trading volume, and pay fees to the lender until the loan is settled.

Some crypto exchanges also offer leverage, allowing traders to amplify their position size by depositing a fraction of the trade value as collateral. While leverage increases potential profits, it significantly magnifies losses. Even a small unfavorable price movement can result in losses that exceed the collateral. If the collateral’s value falls below the required margin, the exchange may issue a "margin call," requiring traders to deposit additional funds. Failure to meet the margin call leads to liquidation, where the exchange sells the collateral to cover the position, potentially leaving the trader with no remaining funds.

For example, a trader shorting Ethereum (ETH) at $3,000 per coin with 10x leverage might deposit $300 as collateral (10% of the trade size). Every 1% change in ETH’s price results in a 10% change in the collateral’s value. This amplified effect lowers the threshold for liquidation, making leveraged trades more volatile.

Options trading

Options are financial contracts whose value fluctuates based on the price of an underlying cryptocurrency. A common way to short crypto using options is to buy put options, which grant the holder the right to sell a cryptocurrency at a predetermined price (the strike price). The objective is for the cryptocurrency’s price to fall below the strike price before the option expires, allowing traders to sell at the higher strike price and profit from the difference.

Another approach is to sell call options instead of buying puts. Call options give holders the right to buy a cryptocurrency at a predetermined price and gain value as the cryptocurrency’s price rises. By selling calls, traders receive a premium upfront. If the cryptocurrency’s price falls, the call options become worthless, and the trader keeps the premium as profit.

Futures and perpetuals 

Futures are derivative contracts that allow traders to speculate on a cryptocurrency's future price. Unlike options, futures create an obligation to buy or sell a specific amount of cryptocurrency at a predetermined date and price. Perpetuals, on the other hand, are a type of futures contract without an expiration date. Instead, perpetuals use a funding rate system to balance long and short positions through periodic credits and debits between traders.

In both cases, traders who take short positions profit when a cryptocurrency’s price decreases. Leverage is often used to amplify these positions, though it comes with the added risk of liquidation if the market moves unfavorably.

Prediction markets

Prediction markets allow traders to buy or sell shares representing the likelihood of a cryptocurrency reaching or exceeding a specific price level by a set date. Traders looking to short crypto in these markets focus on buying shares predicting a negative outcome, profiting if the cryptocurrency’s price falls below the predefined level.

Unlike other shorting methods, prediction markets don’t use leverage, so traders only risk the amount they invest, making them less costly upfront and easier to calculate potential gains and losses. However, these markets are often less accessible, as they are rarely available on major platforms and offer fewer options for traders than other shorting strategies.

Where can I short crypto? Explaining how to short cryptocurrency

While not all crypto trading platforms offer shorting privileges, finding options that support derivatives or margin trading is becoming easier. Centralized exchanges (CEXs) like Kraken, Deribit, and Binance, along with decentralized exchanges (DEXs) such as dYdX and OKX, are popular choices for shorting digital assets.

Using centralized exchanges (CEXs)

To use a CEX, traders must first comply with know-your-customer (KYC) requirements, providing personal details such as their name, home address, and phone number to meet anti-money laundering (AML) regulations. After registration, traders transfer funds from a linked bank account, payment card, or another crypto wallet to the exchange. These funds can then be used to purchase short derivatives or initiate margin trades.

Using decentralized exchanges (DEXs)

On DEXs, traders connect a self-custodial wallet like Phantom, MetaMask, or Coinbase Wallet to a decentralized application (dApp) built on a blockchain. Unlike CEXs, DEXs operate without intermediaries, relying on smart contracts and liquidity pools funded by other web3 users to facilitate trades. As long as traders hold a supported cryptocurrency in their wallet, they can access short positions directly through the DEX.

Benefits and risks of short selling Bitcoin and other altcoins

Flexibility is one of the key advantages of shorting cryptocurrencies. This strategy allows investors to profit from market downturns by capturing short-term gains or hedging long-term positions. However, while shorting opens up additional opportunities in the digital assets market, it also comes with risks.

Here’s a closer look at the pros and cons of short selling crypto:

Pros of shorting crypto

• Capture gains in declining markets: Shorting is particularly useful during periods of volatility. Whether traders believe a coin is overvalued or expect a deep downtrend, short positions provide a way to realize gains even when market sentiment is low.  
• Effective hedging vehicle: Shorting strategies allow traders to offset losses in their long-term holdings by profiting from falling prices. This can help lower a portfolio's cost basis and reduce exposure to market downturns. 
• Diverse products: Shorting isn’t limited to margin trading. The growth of crypto derivatives and prediction markets offers a variety of tools for betting against assets, each with distinct benefits and drawbacks.
• Access to leverage: Leverage amplifies gains if traders correctly predict market moves. However, while leverage can boost profits, it also increases the risk of liquidation without careful risk management.

Cons of shorting crypto

• Infinite theoretical losses: There’s no upper limit to how high a cryptocurrency’s price can rise, leaving short sellers exposed to potentially unlimited losses. Unlike long positions, short trades lack a defined loss cap.
• Borrowing fees or premiums: Shorting on margin incurs borrowing fees, and derivatives contracts often include premiums or funding rates. These costs can quickly add up, making shorting expensive if trades don’t succeed quickly.
• Only suitable for short-term trades: Shorting requires active monitoring. Unlike long-term strategies like dollar-cost averaging (DCA), short positions demand daily attention to adjust for losses or lock in profits. 
• Complexity: Shorting involves a steep learning curve. Traders must understand concepts like margin calls, lending rates, and liquidation, making it less intuitive than simply buying and holding crypto.

Monitor your crypto positions with CoinTracker 

No matter how you trade cryptocurrencies, CoinTracker makes it easy to stay on top of your positions. Our Portfolio Tracker integrates seamlessly with your exchange APIs and wallet addresses to give you a real-time overview of your buys, sells, and transfers. CoinTracker also helps categorize complex transactions and activities in decentralized finance (DeFi), ensuring your tax reports are accurate and thorough. 

Ready to simplify your crypto taxes? Discover how CoinTracker can help keep you IRS-compliant by signing up for a free account today. 

Disclaimer: This post is informational only and is not intended as tax advice. For tax advice, please consult a tax professional.