short selling

How to bet against the bitcoin megabubble

December 5, 2013: 1:12 PM ET

One reason the virtual currency has been soaring could be that figuring out how to profit from its fall is tough.

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FORTUNE -- Can you bet on the likely eventual bitcoin crash?

You bet. But it's an expensive trade. And even if you're right, you won't walk away with much, if anything.

The traditional way you bet against something is to "short it." But in order to do a short sale you have to borrow a share of stock or bond or whatever you are looking to bet against. And borrowing bitcoins is nearly impossible. There is a company based in Hong Kong in testing phase that seems to offer bitcoin shorting, but I couldn't find out much about it.

MORE: Bitcoin's tipping point

What you can buy is a derivative contract that will rise in value when bitcoins fall in price. There are a number of places that sell options and futures on bitcoins.

One place -- ICBIT, a bitcoin exchange -- is run by a guy in Moscow.

MPEx, a stock exchange for companies with shares traded in bitcoins -- there are four of them -- also lists bitcoin options.

BitInstant, a Brooklyn-based payment processor, is planning on launching a bitcoin futures exchange early next year.

All of these places require that you open an account to start trading, and none of them take dollars. So you have to buy some bitcoins elsewhere, which in itself is no easy task, and transfer them to your ICBIT or MPEx account before you can get started.

MPEx charges 30 bitcoins to open an account, which at Wednesday's closing price was $33,000.

I heard good things about ICBIT, which offered accounts for free but charges a commission when you trade. But to see the prices of the contracts, you had to get your account up and running and deposit a minimum of 0.1 bitcoins. (You can buy bitcoins in fractions.)

MORE: What is bitcoin?

I decided to check out Coinbr, a brokerage firm that allows you to trade options on MPEx without opening an account there. You still have to deposit 0.1 bitcoin in a Coinbr account to get started. But MPEx allows anyone to see the prices of its contracts, so you know what you are getting into before you start.

Here we go: If you are betting against bitcoins, what you want to do is buy a put option, which is a derivative contract that allows you to sell something at a set price. If the actual price of the thing falls below the set price, or strike price, you make money.

You could also sell a call option, the right to buy at a set price, but that is riskier and requires collateral. So I stuck to looking at put contracts.

It cost 0.045 of a bitcoin, or $49.50, to buy a put contract to sell 1/10 of a bitcoin at a strike price of $1,100 per bitcoin. The contract expires at the end of the month and will expire worthless if the price of a bitcoin is above $1100 at that point. But the value of the contract will go up before then as long as the value of a bitcoin drops.

Let's supposed bitcoins were to fall to $500 by the end of December, a 55% plunge in less than a month.

If that were to happen, the price of my bitcoin put contract would jump.

Here's the problem: To book my profit, I ultimately want dollars.

With normal currency options you can choose to collect in whatever currency you are using to bet against another currency. So if you are betting the price of a euro will fall against a dollar, you can collect in dollars when the contract settles, thereby offsetting the fact that the euro just dropped in value.

MORE: A decade of markets, mayhem, and investing

You can't currently do that with bitcoins. All of the bitcoin options and futures contracts are settled in bitcoins. This is a very bad deal. Because even if I end up with a bitcoin windfall, they will be worth a lot less when I convert them back into dollars.

Here's the math:

To open an account, it has to be funded with 0.1 bitcoin, which will cost $110 as of Thursday morning.

The put option costs 0.045 bitcoins, leaving 0.055 bitcoins still in the account.

After our imagined 55% plunge, the value of the put contract has soared to 0.12 bitcoins.

Combine that with what is still in the account, and it's now 0.175 bitcoins.

At a bitcoin price of $500, that's a mere $87.50.

That means even if you are right, and you call the top of the bitcoin bubble, correctly predicting a whopping 55% plunge in the value of the currency and do all of this, you would lose $22.50.

You can get around this by upping your bet against bitcoins. If instead you buy two contracts, for $99, and once again the price plunges 55%, you will end up making a whopping $15. And I haven't factored in fees, which would probably run you about $4 for the whole transaction, including the dollar-to-bitcoin round trip, taking your profit down to $11.

On top of all that, this isn't like trading on the New York Stock Exchange. Midday Wednesday, MPEx appeared to shut down, and the prices of the contracts disappeared. I was told this happens a lot. As of early Thursday, the exchange still wasn't listing prices. What's more, after running through my math of the trade with a Coinbr broker in a chat room, with the conclusion that basically the trade doesn't make sense, he offered to sell me contracts at 0.033 bitcoins, so I could buy three contracts instead of two with my 0.1 bitcoins. That led me to question just how real the prices MPEx was quoting were.

All of this may explain one reason why the price of bitcoins until recently has been heading straight up. Why bother betting against it?

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