Case-Study: How to Borrow Ethereum Safely for Short Selling
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Cryptolending provides interesting strategies for the traders and investors. Recently, I wrote an article about how to leverage from a token portfolio. In other words, how to make your tokens work for you. We took an example of a series of loans, which were placed by a borrower on the ETHLend platform.
The article drew lots of attention and requests for additional tips on how to utilize our platform for trading and investing. Therefore we decided to write an additional article about trading and investing with the use of borrowing.
Today, we will provide a use case example of short selling. Currently, users are borrowing Ethereum on the ETHLend platform. Within a couple of weeks, users can borrow our native token LEND to activate zero-fee lending and by the end of 2018 users will be able to borrow other pre-accepted ERC-20 tokens (for short selling for example).
Borrowing tokens or cryptocurrency means that you can go short on that particular asset. Similarly as short sellers are doing with stocks. The idea is that you borrow an asset that you do not own. For example, you bet that Facebook Inc. shares are going down due to a particular event.
In case of Facebook, such incident could be the data exploitation of over 50 million Facebook users for Donald Trump’s election campaign. The aforementioned news lead to a Facebook stock plunge of more than 20% after a FTC investigation on Facebook’s data privacy practices from 52-week all time high share price.
Traditionally investors can profit from stock value price increases. However, there is a way to profit from the downmarket (bear) as well by short selling. In practice, a short seller borrows a stock (which the borrower does not own) and sells that stock on the market and buys it back when the price has decreased on that particular share. In other words, you borrow 1 share, sell that share at 1 USD and buy it back on 0.85 USD. When you return the share back to the lender, your profit is the difference of 0.15 USD per share.
Cryptocurrency Short Selling
Lets take an example of short selling strategy in the crypto world. First to short sell an asset, the short seller would need to borrow that asset first. Below is an example of a loan where a borrower has pledged 11 224 Icon (ICX) tokens to receive a 46.149945 Ethereum loan for 3.3% a month (total 10% of interest for 90 days).
To make a short sell work, one would need a decrease of a price on a certain asset. Such decrease could be a negative news on the underlying project or a larger bear market. In case, the the investor is betting on a particular event, the loan period could be shorter (even 1 day) to maximise the profit and minimise the costs (lending interest). For the above loan, the short seller expects for a longer bear market and multiple instances.
In the above case, the borrower receives around 46 Ethereum. To be able to short this position, the borrower needs to sell the Ethereum on an exchange before expecting the price to decline. For example, if the borrower sells the Ethereum at 500 USD and buys it back at 470 USD, the borrower makes a profit of 30 USD per Ethereum, which would amount to 1380 USD in total in this single instance and profiting in bear market.
The above short position can be repeated. Lets say that the Ethereum price increases back to 500 USD and another bear is coming during the loan period. Alternative the price could have been 470 USD but another bear is coming, the borrower would sell again on 470 USD and buy back at 450 USD. Multiple short selling opportunities could arise during the 90-day loan-period.
When the whole operation is done, the short seller simply closes the loan position by repaying the loan back.
This is not a financial advice or solicitation. Merely a demonstration of the strategy in the newly born token asset market.
