Personal Finance & Money Asked on October 3, 2021
The academic definition of shorting is to borrow someone else’s asset such as stocks, sell it now and repay it later. So I assume that when I short the stocks, money is credited to my account from a stock exchange. This is what I learned from my finance textbook.
However, when I trade cryptocurrencies on Binance or Coinbase and short cryptocurrencies, no crypto currency exchanges give me money to my account. Only unrealized Profit and Loss changes in accordance with price changes. What I assumed was that if I short 1 BTC, a cryptocurrency exchange would give me about 60,000 USD, the price of 1 BTC. This never happens.
Can anyone fill in the gap between my understanding of shorting and the reality of it, please?
Update (2021-04-11)
It seems like the textbook definition of short selling is "naked short selling", which allows you to short assets, even if you do not have money nor collateral. However, in reality, cryptocurrency exchanges only allows "covered short selling", in which collateral or deposit is needed to open short selling. Am I right on this point?
The key concept is margin requirement.
Conceptually, when shorting, you are indeed credited with $60k and negative 1 bitcoin. However, first of all, you cannot simply create such a position from an empty account -- any more than you can go long from an empty account and have 1 bitcoin and negative $60k.
In either case, in order to borrow (bitcoin or cash), you must provide collateral to mitigate the broker's risk in lending. The positive asset you receive as a result of the trade is part of the collateral, which is why you can't withdraw the $60k from shorting. The $60k is needed to secure the loaned bitcoin.
But moreover, you typically need to provide additional collateral to cover your potential loss if the position moves against you. If you do have such a loss, then ultimately you have to either deposit more collateral or have your position liquidated (margin call).
So to be short 1 bitcoin, you might be initially required to keep say $70k in your account ($60k of proceeds from the short and $10k of your own). Only cash above and beyond that $70k can be withdrawn, unless you close the position. If the position moves in your favor, you can start withdrawing profit since the collateral required will go down.
Correct answer by nanoman on October 3, 2021
Think of it this way: when you short Bitcoin you are betting that Bitcoin will fall, and you are taking the risk that it won't (you will still be liable to "return what you borrowed" even if the price rises, in which case you will have to buy it back at a loss in order to be able to return it.)
If the exchange gave you the money as soon as you shorted it then all the risk would be transferred to them! You now have the $$$ and can run away with it. If your response to this is "but I would still be legally on the hook to pay it back, so they could pursue me if I didn't" - yes, but if that was their business then they would just make you a normal loan rather than getting Bitcoin involved in it.
Answered by Vicky on October 3, 2021
If that was how it worked, then I’d short 10 million dollars worth of Bitcoin, take the money and head straight to Panama which doesn’t have extradition treaties with any country, and spend the rest of my life supporting the economy there.
Answered by gnasher729 on October 3, 2021
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