Short Position

These protocols allow users to mint synthetic assets (synths) that track the price of an underlying asset. To short, a user locks collateral (e.g., ETH) and mints a synth representing a short position (e.g., sETH). Selling this synth on the open market creates the short exposure. Repurchasing the synth at a lower price and burning it closes the position, releasing the collateral.

• Example: Synthetix, where users mint inverse synths like iETH.
• Key Feature: No need to locate a lender; exposure is created against the protocol's pooled collateral.

The most direct method, mirroring traditional shorting. A user:

1. Borrows the target asset from a liquidity pool (e.g., borrow WBTC from Aave).
2. Sells the borrowed asset on a DEX for a stablecoin.
3. Awaits a price drop, then uses the stablecoin to repurchase the asset at a lower price.
4. Repays the loan, keeping the difference as profit.

• Risk: Subject to liquidation if the collateral value falls below the protocol's required health factor.
• Primary Use: Shorting widely supported assets on major lending markets.

Decentralized exchanges offering perpetual swap contracts with no expiry. Users can take short positions with high leverage by posting margin. The protocol uses a funding rate mechanism to keep the perpetual contract's price aligned with the spot market.

• Mechanism: Users deposit collateral (e.g., USDC) and open a short position, with profits/losses settled in real-time (P&L).
• Examples: dYdX, GMX, Gains Network.
• Advantage: Deep liquidity and high leverage without managing a borrow/repay cycle.

Protocols that facilitate the creation and trading of put options. Buying a put option gives the holder the right (but not obligation) to sell an asset at a specified strike price. This is a defined-risk strategy to profit from a price drop.

• How it shorts: A trader buys a put option. If the asset price falls below the strike price at expiry, they can exercise the option to sell at the higher strike price, profiting from the difference.
• Example: Lyra, Dopex, Hegic.
• Benefit: Maximum loss is limited to the premium paid for the option.

Advanced strategies used by automated vaults (e.g., on Yearn Finance) to earn yield while being market-neutral. The protocol may short a futures contract or an asset to hedge the delta exposure of a liquidity provision position (e.g., in an AMM LP).

• Purpose: Not for directional short speculation, but for risk management and enhancing yield stability.
• Mechanism: Offsets the price risk of one position with an opposing short position elsewhere.
• Result: Aims to generate returns from fees and funding rates, not asset appreciation.

Shorting in DeFi introduces unique risks beyond traditional markets:

• Liquidation Risk: Borrowed positions can be liquidated if collateral value dips, often in volatile markets.
• Smart Contract Risk: Vulnerabilities in the underlying protocol can lead to total loss.
• Oracle Risk: Price feeds are critical; manipulation or failure can cause faulty liquidations.
• Funding Rates: In perps, a negative funding rate (paid by shorts to longs) can erode profits.
• Impermanent Loss: Hedging with LP positions can lead to unexpected losses if prices move.

The most direct use case is to profit from an expected price decline. A trader borrows an asset (e.g., a stock or cryptocurrency), sells it immediately, and aims to buy it back later at a lower price to return it to the lender, pocketing the difference. This is a pure directional bet against the asset.

• Key Mechanism: Borrow → Sell High → Buy Low → Return.
• Risk: Losses are theoretically unlimited if the asset's price rises instead.

Investors use short positions to hedge or offset potential losses in their long-term holdings. For example, an investor holding a portfolio of tech stocks might short a tech sector ETF or buy put options. If the market falls, gains from the short position help compensate for losses in the portfolio.

• Purpose: Risk management, not primary profit.
• Common Tools: Shorting index futures, inverse ETFs, or options.

Shorting is essential in arbitrage, which exploits price differences between markets or related assets. In a futures arbitrage, a trader might short a futures contract trading at a premium while buying the underlying spot asset, locking in a risk-free profit at expiry.

• Market Neutral: Aims for profit from mispricing, not market direction.
• Example: Cash-and-carry arbitrage in commodities or cryptocurrencies.

Market makers and institutional traders often take short positions to facilitate trading and provide liquidity. By being willing to sell assets they have borrowed, they ensure there is always a counterparty for buyers, which tightens bid-ask spreads and makes markets more efficient.

• Role: Supports market function and price discovery.
• Participants: Professional trading firms and designated market makers.

Traders use pairs trading or relative value strategies, which involve going long on one asset and short on a correlated one. The goal is to profit from the convergence or divergence in their price relationship, regardless of the overall market direction.

• Strategy: Long Asset A / Short Asset B.
• Example: Shorting an overvalued automaker stock while going long on a competitor believed to be undervalued.

The direct counterpart to a short. A long position involves buying an asset with the expectation its price will rise. This is the traditional 'buy low, sell high' investment strategy. In derivatives, it can also mean holding a contract that profits from an asset's price increase.

• Core Concept: Bullish exposure, owning or having a claim to an asset.
• Contrast: Where a short seller profits from a price drop, a long holder profits from a price increase.

The forced closure of a leveraged position when its collateral value falls below a maintenance threshold. For short sellers, this occurs if the borrowed asset's price rises significantly, causing losses that erode their posted collateral.

• Mechanism: The protocol automatically sells the collateral to repay the loan.
• Risk: A defining risk of leveraged shorting, especially in volatile markets, leading to total loss of collateral.

Decentralized platforms like Aave and Compound that facilitate short selling in DeFi. Users deposit collateral to borrow the asset they wish to short, then sell it on the open market.

• Function: Provide the liquidity and trustless framework for asset borrowing.
• Requirements: Over-collateralization is typically required to secure the loan.

A dominant derivative contract for shorting cryptocurrencies. Traders can take a short position on perpetual futures without needing to borrow the underlying asset. These contracts track an asset's spot price and never expire.

• Mechanism: Uses a funding rate mechanism to maintain parity with the spot price.
• Advantage: Enables high leverage and straightforward short exposure without managing a loan.

A primary use case for short positions. Investors open a short to offset potential losses in a correlated long position within their portfolio. This reduces overall portfolio risk (delta).

• Example: A Bitcoin miner might short BTC futures to lock in a future selling price, hedging against a potential market downturn.
• Strategy: A risk management tool, not purely speculative.

The process of closing a short position to realize a profit or loss. It involves buying back the borrowed asset at the current market price and returning it to the lender.

• Profit Scenario: Buy back at a lower price than the initial sale.
• Essential Step: Finalizes the trade and releases the trader's collateral.