A whole lot of Bitcoin holders have made bank on the cryptocurrency’s recent meteoric rise. But is it possible to make money from a falling Bitcoin price? Well, it is now!
But let’s start at the beginning, by defining terms. In trading, a bet that price will fall is called a “short.” This is the opposite of a “long,” which is buying something in the expectation of a future price rise. Probably a lot of people reading this are long cryptocurrency, or at least thinking of going long. The old joke for people who’ve bet the farm on a long position is that they’re “long like John” (Holmes, the pornstar).
OK, but taking out a short position on Bitcoin is problematic due to cryptocurrency being a bad fit for the process by which regular shorts work. You see, in order to short, you first borrow however many units of the instrument (be it a stock, currency; whatever) and then sell them into the market. To close out the short, you must then buy back the corresponding volume of the instrument. Simply put, you aim to sell high first and buy low later. The difference between your initial selling price and later buyback price is your profit – or loss, if price rises instead of falling.
So, if you want to short Bitcoin it’d be a tricky process due to the problems inherent with lending out irreversible, decentralised and anonymisable currency… Think about it this way, would you be willing to lend a non-trivial amount of Bitcoin to a stranger? Unlike shorting through a regulated exchange, there’s no central authority to manage your counterparty risk. You could really only lend cryptocurrency to people you trust absolutely – and this is why no exchange (to my knowledge) currently offers the option to short Bitcoin.
OK, so given the above-mentioned problems with loaning out crypto, how do you short Bitcoin? Well, this is where the Predictious prediction market comes into play. For those who haven’t encountered the term before, a prediction or information market allows you to bet on future events. The quoted contract price reflects the likelihood of the event occuring, as perceived by market participants. Such markets can cover outcomes from sporting victories to election results to whether Miley Cyrus will get pregnant by Vladimir Putin. Predictious is the first to offer “bets” on cryptocurrency, in cryptocurrency. So this, my friends, is how you effectively short Bitcoin. For example, you can currently take positions on Bitcoin’s price to be at or above $1000, $1400, $1500, $2000, $3000 or $5000 before year-end. So if you believe Bitcoin is going to zero because it’s all a giant digital ponzi with no inherent value, you can now happily put your life savings where your mouth is instead of trolling the Bitbros on Reddit – hurrah!
Moving beyond speculators wishing to profit from both dips in Bitcoin’s notoriously volatile pricing, the ability to go short Bitcoin also serves a valuable market function. Shorting enables one to hedge a position, which is to say insure on a long position by taking a contrary short position. Let’s say you own a lot of Bitcoin, but foresee a possible fall in its value due to some forthcoming event, the next halving day perhaps. You might not wish to sell all your holdings, especially considering that trading between fiat and Bitcoin is often not the most seamless process. But what if deeply you’re unsure as to whether Bitcoin’s price will bounce back? Well, if you’re perfectly hedged by a short, then even if price drops off a cliff you’ll make as much profit on your short as loss on your long… That’s a good way to sleep at night when prices get particularly volatile and uncertainty reigns. Worth considering the next time some bloated central banking entity heaves itself from out its murky den to spew Keynesian bile at Bitcoin.
To illustrate how using this market for shorting / hedging works in practice: the odds of Bitcoin being at or above $2000 by New Year’s Eve are currently skewed to the upside – as I write this, you can sell (go short) that particular contract for 0.15 mBTC or buy it (go long) for 2.50 mBTC. If the prediction is fulfilled, you’ll receive 10 mBTC for every contract you bought. Or if the prediction expires unfulfilled, you’ll be paid 10 mBTC for every contract you sold. So if you believe Bitcoin will crack $2k, you can bet that way for less downside risk than buying Bitcoin itself. What I mean by this is: if Bitcoin is currently at $1000 and you expect it to reach $2000 before 1st Jan 2014. If you buy 1 BTC at $1000 intending to sell at $2000 your upside risk is $1000. But as price can always go to zero (maybe a massive solar flare wipes out all electronics on Earth), your downside risk is also $1000. But if you buy 100 contracts for that same scenario, at 2.50 mBTC each, you’d only need to risk… about $142… for the same upside exposure [my math can be shaky, so I recommend checking it]. Of course, in the case of actually buying Bitcoin you’ll still own the Bitcoin even if your bet doesn’t work out.
Finally, as “bets” on prediction markets are provided by those who’ve taken a definite financial stake in their being correct, you can expect a better-informed and probably more clear-headed assessment than you’d get elsewhere. Indeed, popular prediction markets have been known to provide very accurate information on the future. So even for those with no interest in shorting, hedging or complex option plays (which are a subject unto themselves), this site may be a useful generator of information for crypto-financial decisions.
Disclaimer: I’m not associated with Predictious in any way, I just thought this was an interesting development in the Bitcoin economy. I’ve never used Predictious and have no way of knowing whether they’re honest and awesome, or if they’ll vanish cackling into the night with your Bitcoin. Always do your own research before trading anything.
Last modified (UTC): December 19, 2013 19:18