Short selling in crypto: How does it work?

Short selling is a trading strategy where you borrow a cryptocurrency, sell it at its current price, and later buy it back at a lower price to return it, aiming to profit from the price difference.

In other words, while most traders buy crypto expecting prices to go up, short selling traders take the opposite view: they try to earn a return when prices go down.

In this guide, we’ll explain how short selling works, why traders use it, and what to keep in mind before getting started.

What is short selling?

Short selling lets you benefit when the price of an asset falls.
Here’s what happens step by step:

1. Borrow: You borrow a cryptocurrency (for example, Bitcoin) through an exchange.
2. Sell: You immediately sell that borrowed crypto at the current market price.
3. Wait: If the price drops, you can buy it back for less.
4. Return: You return the borrowed amount.
5. Keep the difference: The profit is the difference between your sell price and your buy-back price (minus fees).
6. However, in case the price increases, you will have to buy the asset back for a higher price and make a loss.

This is basically selling high first and buying low later.

A simple analogy

Imagine your friend lends you a designer watch worth €1,000. You sell it right away on the market for that price.
A week later, the same watch costs €800, so you buy it back and return it to your friend.

You’ve made €200 from the price drop. That’s the idea behind short selling - but with crypto instead of watches.

Why do traders short sell?

Short selling isn’t only about betting against the market. It’s a useful tool for managing risk and creating balance. It allows traders to:

• Trade across cycles: While normal buying allows traders to benefit in rising markets, short selling allows them to also benefit in falling markets.
• Hedge against downside risk: Protect the value of a larger portfolio when markets fall.
• Balance exposure: Offset volatility by short selling correlated assets.

By short selling, traders gain more flexibility, whether it’s a bull market or a bear market.

How short selling works in crypto

Here’s what happens in the background when you open a short position:

• You use euros as collateral. This acts as a safety buffer to make sure you can buy back the borrowed crypto if the price rises instead of falls. 
• You borrow the crypto you want to short sell.
• You sell it on the exchange at the current market.
• If the price drops, you buy it back cheaper and return it. You keep the difference.
• If the price rises, you need to buy it back more expensive using (part of) your collateral and return it. You will have made a loss in this case. 
  
  What is the health ratio?

Your health ratio shows how secure your open short position is. It compares your collateral to your potential losses.

• A high health ratio means your position is well covered.
• A low health ratio means your position is at risk of liquidation.

If it reaches the liquidation threshold, your position automatically closes to prevent further loss.

Example: short selling Bitcoin at €100,000

Let’s say you expect Bitcoin’s price to fall from €100,000.

1. You use €1,000 as collateral to open a short position.
2. The exchange lends you 0.01 BTC, which you sell at €100,000 = €1,000.
3. Later, the price drops to €90,000.
4. You buy back the same 0.01 BTC for €900.

(Note that throughout this process, fees may be applied for trading and borrowing the asset.)

Your gross profit is €100 (before fees). After trading and borrowing fees, your net profit is slightly lower, but still positive because the price dropped.

If instead Bitcoin’s price rose to €110,000, you would have to buy back at a loss (€1,100), and part or all of your €1,000 collateral would be used to cover that.

What are the risks?

Short selling can carry higher risk than regular buying. When you buy crypto, your maximum loss is your initial investment. When you short sell crypto, losses can accumulate if the price rises sharply.

Here’s what to keep in mind:

• You may lose your entire collateral if the market moves against you.
• Liquidation can occur automatically to limit further losses. A liquidation fee may apply.

Warning: Short selling involves risk. Always ensure you understand how it works and only trade with amounts you can afford to lose.

Short selling can be a powerful strategy for traders who want to benefit from market downturns or manage risk more actively. But it also comes with higher complexity and potential losses. Before trying it, make sure you understand how it works, from borrowing and collateral to fees and liquidation, and start small while you learn.

This article is for informational purposes only and does not constitute a marketing communication or recommendation. None of the content herein should be considered as investment advice or a substitute for it. Bitvavo makes no guarantees regarding the accuracy or completeness of the provided information. Investments involve risks. There is a possibility of losing your entire invested capital.