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A 5 Minute Guide to Making Money When Markets Go Down
Introduction
The last two weeks have been some of the worst for cryptocurrencies ever. The market has been consistently underperforming for the last two weeks, and many people have lost a lot of money, especially as scandals, hacks and ban threats have arisen.
When investing and speculating on an asset, there are two ways to make money off of your predictions. You can predict that the value of the asset will go up by purchasing and keeping it. You will make your money back once you sell it.
But there’s another way of making money. You can bet against an asset. The concept is called Short selling or Shorting. The term originally comes from securities, but can be applied to cryptocurrencies. In this article we will explain how it works, and how to do it.
The Psychology
What makes short selling interesting / difficult is the fact that you have to know and understand the criticisms of a certain technology in order to predict that it will fail or decay. This is harder to do in practice than in theory.
When someone tells you about a new topic or technology, the conversation typically focuses on what makes that technology beneficial and valuable. Less often do you get to hear the criticisms and difficulties within the first conversation.
The reason for this is that you typically have to explain the value of that technology and the principles for what it is trying to improve, replace, or optimize. It is difficult to both describe and criticize a new concept simultaneously.
For this reason, when people are investing in cryptocurrencies, they typically only hear positive or useful information regarding the technology, but not a lot of the criticisms and limitations. How many people hear about the down sides of Proof of Stake, or the problems with scalability and centralization when first describing the Ethereum platform?
No. Instead you typically hear about how smart the creator is, or how innovative and interesting the technology is. In order to really know how something will fail, you have to understand it first. You have to understand the market it is in, and alternatives to the technology, and all of that takes time and effort.
Short selling is a way of doubling down. For example, if you believe that Bitcoin is the future and all altcoins are really a waste of time, then you could bet against the altcoins while investing in Bitcoin. If you are right, you just won that much more.
How to Short Sell
In Theory
Here’s how short selling works. Let’s say the price of Bitcoin is $10,000 per BTC. You believe the BTC market is going to crash any day now. You borrow 1 BTC from your friend and sell it immediately, thus owing your friend 1 BTC. One week later the BTC market crashes, to $10 per BTC. So you buy 1 BTC for $10 and pay back the debt to your friend, thus you just profited the difference: $9,990. You just “sold it short”.
In Practice
Most likely you would struggle to find a friend that would allow you to borrow a Bitcoin, and be paid in exactly the same amount of Bitcoin. Here are some examples of short selling, ordered in increasing level of investment strategy complexity.
Betting Whether it is through a smart contract, an escrow, or with a friend, you could bet someone that the price of a cryptocurrency will crash. This is probably the simplest way of short selling a cryptocurrency.
**Prediction Markets**Prediction markets are very similar to gambling or betting, in that you predict what the price of a cryptocurrency will be, and if you are correct within a certain margin you will receive money for it.
Examples are:
**Margin Trading**Margin Trading means you can borrow money from an exchange to buy cryptocurrency. The idea is that you borrow cryptocurrencies from an exchange, then you short sell it, and purchase back after the market crashes. Typically there’s some interest or leverage attached to the loan.
Example of these are:
Futures Bitcoin now has a Futures Market. In those markets a buyer and a seller agree to trade Bitcoin at a set price in the future. For example one person could agree to sell another 1 Bitcoin for $1,000 in 1 year. If the market crashes and the price of Bitcoin goes to $1, the person selling the Bitcoin made $999 because the other person agrees to buy for $1,000. Obviously if instead, the price went up to $2,000 you just lost $1,000.
Examples of futures markets are:
Conclusion
Shorting cryptocurrencies is one of the most difficult investment strategies. It relies on the investor to have a good understanding of the markets, be naturally contrarian (or skeptic), and also be able to utilize very complex strategies that will only benefit the investor in a certain time period. In short, do this at your own risk, and make sure you stay as educated as possible.
Shorting is not simply about being a skeptic of a technology. If there is enough skepticism the technology will not grow, and the price will go down anyway. In order to be a good short seller, you have to know something that most people do not know. The more the value of the crypto goes up, the more valuable the short selling is if it goes down. Predicting exactly when it will happen is the tricky part.
Short selling is difficult, extremely risky, and requires a lot of time and information. But with the volatility of the cryptocurrency markets, it’s important to understand all your options. Especially if one involves hedging your future if the markets crash.
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