Crypto Stock Short Squeeze Could Be a GameStopper For Coinbase and Others

Stocks in the cryptocurrency sector are suffering from a short squeeze, which has caused beaten-down shares to go down in price. The only thing it takes to see that GameStop GME +2.03% -style dynamics are at work here is to take a quick glance at Coinbase Global COIN –2.15% and Silvergate Capital SI –5.03%.

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Among the major crypto exchanges, Coinbase (ticker: COIN) surged 24% on Thursday, bringing its gains over the past five days to 54% and raising its year-to-date gain to 140%. Silvergate (SI), one of the world's leading crypto banks, jumped 29% on Thursday and is now up 60% since the end of last week. The price action of other stocks that are exposed to digital assets, like Bitcoin miner Riot Platforms (RIOT) and MicroStrategy (MSTR), a software company with a big crypto holding, is similar.

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Despite the fact that these stocks have all fallen in the Friday premarket, the dynamics that made these moves so eye-popping still remain the same.

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It is true that the stock market is doing well at the moment. In the past few days, the S&P 500SPX -0.75% has climbed more than 3% higher versus last Friday, while the Nasdaq, which is filled with high-growth stocks like those in cryptocurrency, has climbed 6.4% versus last Friday. BitcoinBTCUSD -0.45%, the largest digital asset and a significant influence on sentiment for crypto stocks, is little changed.

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A short squeeze appears to be at work here-one of the technical factors responsible for the outstanding rallies seen in "meme" stocks, which were popular among retail traders in 2021, including GameStop (GME), AMC (AMC), and Bed Bath & Beyond (BBBY). The idea is to bet against stocks in order to make money.

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When an investor bets against a stock, or shorts it, he or she borrows the underlying shares and then sells them, betting that the shares can be repurchased at a lower price if they are repurchased at a later date. In this trade, you will be pocketing the difference between the price at which the shares were borrowed and the price at which they were returned in order to profit from the trade.

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It is possible for investors to come under pressure if the bet turns out to be wrong, and the price rises, and some will opt to repurchase and return the shares at a higher price, "covering" their position and taking a loss as a result. In the case of margin or borrowed money from a broker, this kind of pressure can be particularly severe in the case of trades made with margin. In the event that shorting is a crowded trade, then the price of the shares may end up being squeezed higher if investors want to buy up the same shares.

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In the crypto market, shorting crypto stocks is a very, very crowded trade. The reason for that is understandable. With a spate of bankruptcies and high-profile fraud allegations rocking the digital asset industry, as well as the prospect of existential threats from regulatory bodies and wary investors, crypto prices have plummeted since their November 2021 high.

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What once seemed like a clever trade has now turned out to be a risky one. As a result, it would be prudent for investors to exercise caution when it comes to short squeezes, since they can be unpredictable. It is remarkable how much risk there is for short-squeezes to occur.

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The average short interest among U.S. stocks, according to the financial data group S3 Partners, is 4.9%, which is the percentage of a company's shares that are shorted. It has been reported that Coinbase has a short interest of over 25%. Silvergate stock is being shorted at an astonishing rate of 75%, which is truly astounding. Riot and MicroStrategy have both seen their short interest in their stocks rise into the double digits.

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It's getting more and more difficult for short sellers to get out of these stocks as they get squeezed. Coinbase, Silvergate, Riot, and MicroStrategy lost more than $730 million in Thursday trading alone, according to S3. The mark-to-market losses for traders shorting these four stocks will exceed $2.5 billion in 2023.

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According to Ihor Dusaniwsky, a managing director at S3, these stocks are extremely squeezable because of the mark-to-market losses they have incurred. “In my opinion, I am waiting for the short squeeze to push stock prices higher as a result of this short squeeze."

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It is reasonable to believe that the ride is only going to get bumpier in the future. Due to the fact that most short-sellers have not meaningfully covered their positions, the squeeze could well be accelerated and prices could go even higher, if the pain becomes too much for the short-sellers.

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The fact that these stocks haven't seen massive short-covering despite the fact that they are rallying is surprising, Dusaniwsky said. However, we are expecting that this will change over the next few years as large losses on mark-to-market in 2023 will start to squeeze short positions out of the market."

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It is, however, important to keep in mind that this does not mean that investing in Coinbase or Silvergate will be a good idea, on the other hand. It is possible for short squeezes to peter out and flip just as quickly as they started. As a result of unpredictable technical and not fundamental factors, these stocks have gained a lot of value. In reverse, the same can be said about the opposite.