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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?

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    What would happen if they gave money to your account and you didn't repay the stocks you borrowed?
    – curiousdannii
    Apr 10, 2021 at 8:13
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    @curiousdannii that is the point that made me feel worried, when learning from the textbook the concept of short selling.
    – Eiffelbear
    Apr 10, 2021 at 8:15
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    When you short a stock, money is credited to your account (it's tied in your account as part of the margin requirement). The transaction occurs on an exchange but the source of that money is the counter party to the trade who has purchased the stock from you. I can't help you with how Binance or Coinbase handles short sales since I don't do crypto. All I can think of when I read about crypto problems is "Run, Forrest, run!"
    – Bob Baerker
    Apr 10, 2021 at 10:30
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    Yes, the money is actually credited to your account. However, margin for shorting is 150% of the short proceeds (brokers can require more) but the proceeds of the short sale are used against the 150% so effectively, the margin requirement is 50% (cash or marginable securities). In isolation, you could not short stock and spend the money to buy a car. If you had $50k of marginable securities in your account and your shorted say $20k of stock, you could pull the $20k out because the $50k of stock would cover the margin requirement.
    – Bob Baerker
    Apr 10, 2021 at 14:09
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    If you're new to trading, I would respectfully suggest that you may not want to be in the business of shorting things. How have you hedged your short? What is the maximum amount of money you could possibly lose? By default, the answer to those questions is that there is no upper limit to the amount of money that you can lose, so you should really think long and hard about whether this is a wise investment strategy.
    – Kevin
    Apr 10, 2021 at 19:33

3 Answers 3

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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.

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  • Yesterday, I have learned the difference between "naked short selling" and "covered short selling". And you are saying that we should provide collateral to go short, only covered short sellings are allowed in both crypto and stocks, right?
    – Eiffelbear
    Apr 11, 2021 at 6:41
  • The text book definition of short selling is "naked short selling" while only the "covered short selling" is allowed in crypto exchanges. Did I understand it correctly?
    – Eiffelbear
    Apr 11, 2021 at 7:07
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    @Eiffelbear A naked short can be covered or not. A covered short can be naked or not. Whether a short is naked or not is a property of the thing borrowed. Whether a short is covered or not is a property of the borrower's position.
    – David Schwartz
    Apr 11, 2021 at 21:02
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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.

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  • The issue is collateral. When I sell a covered call option against my apple shares with Schwab I get the cash credited at the time of sale of the option, but 100 of my apple shares are locked as collateral to the option. I can absolutely transfer my cash away. If I sold the call naked the collateral would be a margin loan, and Schwab and I are both located in the US so Schwab can sue me and get judgements against me where a random crypto exchange in Hong Kong can’t so they don’t give you the cash and they probably turn off your ability to perform outbound transfers while you’re short.
    – quid
    Apr 11, 2021 at 1:47
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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.

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    Funny, but doesn't actually clarify how it does work.
    – Daniel Wagner
    Apr 12, 2021 at 14:22
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    Why stop at 10 million?
    – amquack
    Apr 12, 2021 at 19:31
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    @amquack: It should be enough money for the rest of your live, but not so much money that the counterparty decides to make that "rest of your live" a lot shorter.
    – MSalters
    Apr 13, 2021 at 8:26
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    Daniel: The question was “why doesn’t it work like that” and that is clearly answered. And it wasn’t funny, it was dead serious.
    – gnasher729
    Apr 13, 2021 at 12:49
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    My question is asking "Why A?" and you don't answer the question directly. You are just stating the consequence if A is the reality. The question that you are answering is, "If A is real, what would happen?". So your answer is not relevant to my question, sorry.
    – Eiffelbear
    Apr 23, 2021 at 6:04

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