The Short Squeeze on Crypto Stocks Will Be a “GameStop Moment” for Coinbase and Others

The cryptocurrency market is seeing a short squeeze in beaten-down equities in its sector. A simple glance at Coinbase Global and Silvergate Capital demonstrates that ‘GameStop-style’ dynamics are at work.

Coinbase (COIN) gained 24% on Thursday, pushing its gains over the last five days to 54% and its year-to-date gain to 140%. Silvergate (SI), a cryptocurrency bank, rose 29% on Thursday and is up 60% since the end of last week. Other firms with exposure to digital assets, such as Bitcoin miner Riot Platforms (RIOT) and MicroStrategy (MSTR), a software company with significant crypto holdings, have experienced similar price movements.

While all of these stocks fell in the Friday premarket, the factors that drove the explosive gains remained intact.

Yes, the stock market is on a tear. Since last Friday, the S&P 500 has risen more than 3%, while the Nasdaq, which includes high-growth stocks like crypto, has up 6.4%. However, the greatest digital asset, Bitcoin, which has a major effect on sentiment for crypto equities, has moved little during the same period.

What investors are witnessing is most likely a short squeeze, which was responsible for the tremendous rises in “meme” stocks popular among retail traders in 2021, like GameStop (GME), AMC (AMC), and Bed Bath & Beyond  (BBBY). It is about betting against stocks.

To gamble against a stock, or “short,” investors must borrow the underlying shares and then sell them, betting they can be repurchased at a lower price. The transaction entails pocketing the difference between the cost of borrowing the shares and the cost of returning them.

If the bet fails and the price rises, investors may feel pressured to repurchase and return the shares at a higher price, “covering” their position and accepting a loss. Pressure could be especially intense if the deal was done using a margin or money borrowed from a broker. If shortening is a crowded trade, investors may end up vying for the same shares, “squeezing” them higher.

Shorting crypto stocks is an extremely crowded trade. That’s understandable. Crypto values have plummeted from their November 2021 high, with a slew of bankruptcies and high-profile fraud claims upsetting the digital asset market, increasing potential existential challenges from regulators and hesitant investors.

However, what previously appeared to be a smart investment now seems to be risky. Short squeezes may be unexpected, so investors should proceed with care. The magnitude of the short-squeeze danger is astounding.

According to financial data firm S3 Partners, the average short interest — the percentage of a company’s shares sold fast — is 4.9% among US equities. Coinbase has more than 25% short interest. A staggering 75% of Silvergate shares are shorted. Short interest is in the double digits at Riot and MicroStrategy.

The agony for short sellers is increasing as these stocks are pressured. According to S3, those who gambled against Coinbase, Silvergate, Riot, and MicroStrategy lost more than $730 million on a mark-to-market basis in Thursday trading alone. In 2023, the mark-to-market losses for speculators shorting these four equities approached $2.5 billion.

“Because of these mark-to-market losses, these equities are very squeezable,” said S3 managing director Ihor Dusaniwsky. “I expect the short squeeze in these equities to drive stock prices upward.”

And there’s reason to assume things will only grow worse. Short sellers have yet to cover their positions appreciably, which means that if the pain gets too intense, the squeeze might be increased, propelling prices much higher.

“Surprisingly, even with these stocks rallying, we have not seen massive short-covering yet,” Dusaniwsky said. “But we expect this to change as large mark-to-market losses in 2023 will start to squeeze shorts out of their positions.”

However, this does not indicate that going long on Coinbase or Silvergate is a wise option. Short squeezes can fizzle out — and flip — just as quickly as they started. These equities have risen as a result of unpredictability in technical rather than fundamental factors. The same is true in reverse.