Foot to Foot #3 Short Selling DeFi
Today's article was written by a fellow Footballer: How to short sell a token using DeFi protocols.
It’s winter in the northern hemisphere and many of you have packed the shorts away for the cold weather. Don’t worry you can still put on shorts in DeFi.
Shorting (short selling) can be a fun exercise if you take the time to study and learn the tools and when to use them. In case you’re new to the concept or just need a basic refresher, here’s a useful read from Investopedia on the subject of short selling stocks which is very much the same concept we’ll explore here. There no rush here. Many people find it hard wrap their head around the concept of shorting in general.
To simplify the concept: you’d like to place a bet that something will go down in value and capture that difference as a return on your investment. Just as you would buy BTC or ETH and if they go up 10% you pocket the difference when you sell. When you short sell say BTC or ETH, if they go down 10% you pocket the difference when you “buy to cover” (close the position).
Let’s translate this into the world of DeFi and break down the process in stepwise fashion as one way you can accomplish this:
Deposit collateral with a token lender (AAVE, COMP). In most cases this will be a stablecoin (USDC, DAI, USDT)
Borrow the token you’d like to short sell (BTC, ETH, etc..)
Open the short position by swapping your borrowed token for a stable coin
Monitor the position (using Foot Guns cheat sheet) however you see fit
Close the short position by buying back the token you borrowed. (Note - if the token went up in value you will have lost money as you wont have enough stable to buy back your original amount. This is the risk you are taking)
Return the borrowed tokens from step 2 back to lender and collect back your collateral. If your short was profitable you will now have extra stablecoins from step 3.
You’ve just successfully open and closed a short position, nice job!
Note: Step 1 and 2 doesn’t have to be a stable coin, you could for instance trade your borrowed token for another token you think is going up. That’s putting on a slightly more complex trade but if done correctly, can be done for gains in an upside-down market. Also, notice that borrowing stablecoin to buy BTC/ETH etc.. is opening a short position against that stablecoin. You are betting the stablecoin will lose value relative to BTC/ETH.
There are tons of platforms in DeFi where you can achieve a short position using the above steps as an outline. Which ones you choose will be based on the types of collateral they accept, the type of tokens they allow you to borrow against said collateral, and what chains the operate under. Just googling “Top DeFi Lending Platforms” will yield endless results. Some popular ones that you can open up a short position on include Aave, Compound, Spiritswap, Blizz, and Trader Joe.
Some things to pay attention to will be fees associated with what you’re borrowing and weighing that against whatever deposit APY you might be gaining (and in what token denomination) while your collateral sits with your lender of choice. There are several scenarios that can play out so we’d suggest finding a cheaper chain to work on with lower gas fees to try out smaller transactions to get a feel for how this works before diving in head first.
And remember, don’t shoot yourself in the foot, consider a Foot Guns Newsletter subscription (if not already a subscriber) and get access to daily trading cheat sheets (yes-- every day!), and our infamous private pods. Also, join the Foot Guns discord where you can ask all your DeFi questions and share your experiences with us.