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Should shorting be banned on crypto exchanges after rapid price drop?

Image by Stock Catalog from Flickr

Mon, 23 Mar 2020, 12:20 pm UTC

Cryptocurrencies including Bitcoin (BTC) have been experiencing a rapid price drop in the wake of the coronavirus outbreak opening the issue of whether shorting on crypto exchanges should be banned or not.

On March 12, bitcoin’s price dropped immensely shedding half of its value. There was a massive sell-off and it wreaked havoc on cryptocurrencies except for stablecoins, Cointelegraph reported.

The crypto economy experienced a “Black Thursday” and it raised serious concerns. In fact, Huobi’s derivatives trading platform Huobi DM added a new futures liquidation mechanism to protect crypto traders against market volatility.

Traditional markets get protection from short-selling pressures. The markets in Belgium, Greece, France, Italy, and Spain have implemented bans on short-selling of some stocks because according to SEC, it “protect the integrity and quality of the securities market and strengthen investor confidence.”

However, Alessandro Beber and Marco Pogano's seminal study of short selling restrictions did not support that. Banning investors from taking short positions can actually harm the market.

“The short-selling bans imposed during the crisis are associated with a statistically and economically significant liquidity disruption, that is, with an increase in bid-ask spreads and in the Amihud illiquidity indicator, controlling for other variables,” the study said.

Researchers Jose Scheinkman and Wei Xiong also reached the same conclusion. Shorting opportunities can create price bubbles.

The publication noted that banning shorting on crypto exchanges is not easy to implement due to the structure of the crypto trading industry and it might only create market distortions. For instance, if one exchange permits it and another doesn’t, traders could use the arbitrage opportunities to buy crypto where there is shorting pressure and sell it where there isn’t.

“Shorting places healthy bearish pressure on crypto assets. Banning it may alleviate some short-term pain during periods of extreme volatility but it would almost certainly stem the ability for the industry to mature over the long-term,” the report added.

Meanwhile, despite the crash in the crypto market, Binance CEO Changpeng “CZ” Zhao remains confident in cryptocurrencies. CZ said that he was not worried about crypto at all because its fundamentals did not change. For CZ, bitcoin remains a currency with limited supply and high demand.

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