Short Selling Mechanisms in Cryptocurrency Bear Markets: Risks, Rewards, and Operational Details

Why Short Selling Becomes the Main Trading Strategy in a Bear Market

In the past two years, under the global interest rate hikes, asset volatility has intensified. Compared to traditional fiat currency markets, cryptocurrencies, with their more dramatic price swings, create more opportunities for short-term traders. In a bear market, short selling becomes a key way for investors to profit, but it is also the operation most prone to losses.

The core logic of short selling is simple: when you judge that an asset is about to decline, borrow the asset and sell it, then buy it back after the price drops to repay, earning the price difference. This approach applies across stock, forex, futures, and other markets, but in the cryptocurrency field, due to its dual nature (both currency and financial product), the tools and strategies available are far richer than in traditional markets.

Meaning of Short Selling in Virtual Currency and Its Core Purpose

The meaning of short selling in virtual currency is to predict the decline in cryptocurrency prices and profit from it using various financial instruments (options, futures, contracts, etc.) during the price drop.

Fundamentally, there are two main purposes for shorting cryptocurrencies:

First is profit. Investors establish short positions based on market judgment, expecting prices to fall, and earn from the price difference.

Second is hedging and risk avoidance. Large institutional investors (such as exchange underwriters, big funds, etc.) holding certain crypto assets may hedge risks by shorting other related coins. For example, if an exchange issues financial products that are bearish on a certain cryptocurrency, once investors buy them, the exchange itself must short the corresponding amount of that coin to avoid price risk. This way, the exchange only earns transaction fees and does not participate in the price direction risk.

How Substantial Are the Actual Returns from Short Selling

Cryptocurrency markets are far more volatile than traditional financial markets, which is both a risk and an opportunity.

Taking Bitcoin as an example, during the 2022 downturn:

• In early May, it dropped 22% in 8 days
• In early June, it dropped 35% in 10 days

In such market conditions, using 10x leverage to short:

• A 22% decline can translate into 220% profit
• A 35% decline can translate into 350% profit

In comparison, traditional forex markets can offer higher leverage, but their volatility is much lower than cryptocurrencies. Stocks are volatile but less directional than currencies. Cryptocurrencies tend to have more clearly defined bullish or bearish trends, often lasting longer, providing better opportunities for trend-following short trades.

Main Risks of Short Selling Cryptocurrencies

Despite attractive returns, short selling also faces significant risks:

Platform risk: Choosing an inappropriate platform can lead directly to principal loss. It is recommended to use regulated, reputable, compliant trading platforms. Do not be tempted by sign-up bonuses or high-interest offers from small platforms. Currently, many fake exchanges are used to scam users into depositing funds.

Directional risk: Misjudging the market direction can lead to losses. It is essential to set strict stop-loss mechanisms because cryptocurrency trading involves leverage or options, which amplify both gains and losses. Especially with options, there are expiration dates; if the underlying asset does not reach the target price before expiry, you need to close positions early.

Whale risk: Many cryptocurrencies are highly concentrated among a few large holders. Once these whales sell off or publicly announce bullish/bearish views via social media, it can cause sharp short-term price shocks. Therefore, before investing, you must set clear stop-loss and take-profit points and monitor price movements constantly.

Comparison of Main Tools for Short Selling Cryptocurrencies

1. Options and Futures

Options are characterized by “the right but not the obligation.” Buying a put option (put warrant) is equivalent to gaining the right to sell Bitcoin at a specific price. If Bitcoin’s price falls below that price, the option gains value; if not, the maximum loss is just the premium paid. This “limited risk, unlimited profit” feature is attractive to conservative investors.

However, options have time value. Even if the price does not move as expected, the value of the option will decline over time, known as “time decay.”

Futures are mandatory contracts. Investors must settle at the agreed date and price. The advantage of futures is that leverage can significantly amplify returns, but similarly, risks and losses are also magnified. In theory, futures losses can be unlimited.

2. Contract for Difference (CFD)(

CFD is a contract signed with a trading platform, where the investor profits from the price difference during the holding period. Compared to futures and options, CFDs have unique advantages:

No expiration date: Investors can hold positions long-term without time restrictions.

Limited risk: Since no actual product is purchased, maximum loss is limited to the principal.

High flexibility: Investors can invest in the price difference using fiat currency without holding actual cryptocurrencies, making it more convenient for most people.

Small-scale participation: The minimum trading unit can be very small.

However, CFDs also incur costs: holding positions overnight requires paying overnight fees (interest on borrowed funds), making it more suitable for short-term trading strategies.

Preparations Before Short Selling

First: Choose a compliant platform. Before trading on any platform, thoroughly research its background, regulatory status, and user reviews. Do not trust official claims blindly; verify information through independent channels.

Second: Fully test with demo trading. Most reputable platforms offer demo accounts with virtual funds for strategy testing. It is recommended to conduct enough simulated trades before investing real funds to familiarize yourself with platform rules, trading procedures, and risk control mechanisms. Continuously improve your trading strategies during this process.

Third: Develop a clear risk management plan. This includes setting maximum loss limits per trade, stop-loss and take-profit points, position sizes, etc. Strictly follow the plan and avoid changing strategies due to emotional fluctuations.

Fourth: Continuously learn market knowledge. Understand the fundamentals of different cryptocurrencies, macroeconomic impacts, technical analysis methods, etc. These are the foundation for increasing short-selling success rates.

Summary

Short selling cryptocurrencies can indeed bring substantial profits in a bear market, but it is a high-risk, high-reward trading approach. Achieving profits requires correct market judgment, strict risk management, appropriate tool selection, and comprehensive knowledge.

Whether professional traders or retail investors, they should approach short selling cautiously. Choose safe and reliable trading platforms, develop detailed trading plans, and set reasonable risk controls. These are essential conditions for long-term success in financial markets. Remember, in the cryptocurrency market, those who profit are often not the most accurate predictors but the ones with the strictest risk management.