Short Selling Limits, Market Impact, and Borrow Availability

# What limits the maximum possible returns when shorting crypto?


# What limits the maximum possible returns when shorting crypto?












I'm new to finance and crypto and this question is more of a thought experiment so I would like to hear both theoretical as well as practical considerations. Suppose I would like to short a particular cryptocurrency token and assume for this experiment that I know its price will drop in the near term, say 1 week. My goal is to maximize profits, given that I am the only one who knows this information.

I understand that the short would consist of placing some USD as collateral on some platform, borrow this token and sell it in the market. This action has no effect on the price of the token since there was one buy and one sell. The borrowing interest rate for the token would go up.

Given sufficient USD collateral, can one rinse and repeat this process arbitrarily many times and close all the shorts when the price drops? It seems like the only things that limit my potential profits are

- Amount of USD collateral I have

- The interest I pay (this can be neglected, assuming the time frame of this experiment is sufficiently short)

- My ability to continue borrowing the token in order to short it.

Is my understanding correct so far? If yes, is it reasonable to assume that there will always be lenders who will continue to provide the token to borrow, given that the interest rate on borrowing the token probably is very high or would something eventually make the "borrowing liquidity" dry out?

## Answer by Dave Harris (score 1, accepted)

https://quant.stackexchange.com/a/70676

Probably the best real-world example of this is the Game Stop short. Of course, that short sale was mishandled.

There are problems with your idea. As you supply coin for sale, you move along the demand curve. You are selling at a lower and lower price with each transaction. When you begin to close your position, you will move in the opposite direction by exactly the same amount. Your profit will be zero, ignoring the stochastic portion.

The only way this becomes profitable is if the demand curve shifts. Of course, that is what happened with Game Stop, but in the wrong direction from the short seller's perspective.

That was their own fault. They unintentionally triggered the demand curve shift by being sloppy. They allowed the price to fall so low that it triggered a value investor to show up and be willing to inject money into the firm and to replace the Board of Directors. That fundamentally changed the prospects of the firm and they should have taken their losses and closed out their positions.

The counter-party to the short, the party you are borrowing coin from, isn't buying coin in order to loan it to you. They are borrowing it from their customers' inventories. You seem to be assuming that the transaction is neutralized, that you are the second side of a buy and sell transaction but you are not. You are the second side of a loan in the same construction as a loan at a bank. Coin is changing hands, but not through an open market transaction but through borrowing.

When you buy the coin back, you are neutralizing your own transactions.

Short selling is profitable if the shorted asset is liquidated or eliminated such as through bankruptcy, or if it triggers a realization of true value and a long-run downward shift of the demand curve. Your discussion is a week, so unless you have true foreknowledge, you will pay commissions and interest and buy back your own position.