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Bitcoin prices are now in a bubble that’s set to burst, say the detractors. The run up in prices in 2017 has been faster and quicker than in other known bubbles, such as the tech stock bubble of 1999. The price run is even being compared with the tulip mania seen in Europe in the 1600’s. This period saw a parabolic movement in the futures price of a single tulip bulb to ten times the annual income of a skilled worker. Inevitably, the speculative bubble popped and the price crashed. Fortunes were lost in a matter of days, and many believe this is likely to happen to bitcoin and other cryptocurrencies.
What causes bitcoin to devalue?
There have been a number of events in bitcoin’s past that have caused significant downside pressure. Here are some of the causes:
- Bitcoin exchanges closing or failing, for example BTCC or Mt. Gox
- Changes in regulation on a governmental level, such as China banning bitcoin
- Contentious changes in technology or the risks that come with hard forks
- Delays in technological upgrades to the blockchain
- Scalability issues, slow network validation, and expensive transaction costs
Whilst these risks are inherently part of a decentralised cryptocurrency, it’s interesting to see that while many people are calling the top for bitcoin prices, not many have followed up with a trade. There are many potential reasons for this, but a prominent answer you hear is that it’s hard to short bitcoin.
How does shorting work in traditional markets?
In more traditional markets, shorting is possible by borrowing a share or contract from someone else, selling it at the current market price, and then buying back the original asset when the price has (hopefully) moved lower. You can then give back what you originally borrowed, and pocket the difference in the price.
This can be hard for bitcoin because there are significant risks in lending out your cryptocurrency to someone else without an intermediary. If you were to lend bitcoin directly to someone else, there would be nothing to stop them from pocketing the digital currency and disappearing forever. There are, however, other options if you are looking to short bitcoin.
One option would be to spread bet or place a CFD trade on the price action of the cryptocurrency. This can be accomplished without holding or borrowing the underlying coin.