By Betting against crypto stocks may seem like a guaranteed strategy, but recent events have turned it into a nightmarish experience for traders. This serves as yet another reminder of the challenges faced when attempting to profit from the volatile world of cryptocurrency.
As Bitcoin experiences a sharp decline and the crypto industry reels from the impact, investors have flocked to place bets against crypto-related stocks. Among the heavily shorted stocks in the market are Coinbase Global (COIN), Silvergate Capital (SI), MicroStrategy (MSTR), and Marathon Digital (MARA).
Shorting a stock involves borrowing shares and selling them with the expectation that their value will decrease. This trade can yield profits if the stock indeed declines in price, enabling investors to repurchase the shares at a lower cost to repay the borrowed quantity.
However, things can quickly go awry if prices rise unexpectedly, putting pressure on investors to “cover” their short positions by buying back the stock at a loss. When numerous short-sellers find themselves in this predicament, it triggers a surge in buying activity, driving prices even higher and exacerbating losses for those bet against the stock – this phenomenon is commonly known as a “short squeeze.”
Short squeezes played a significant role in the infamous “meme” stock rally of GameStop (GME) and other companies earlier this year. Similarly, these dynamics have now manifested within the crypto sector following the collapse of FTX in late 2022, intensifying volatility in crypto-related stocks.
Silvergate, a bank under scrutiny due to its connections with FTX, has become a prime target for short-sellers. Its shares have plummeted by over 80% in the past year, mirroring the downward trajectory of crypto prices and a staggering $1 billion fourth-quarter loss.
Unsurprisingly, shorting Silvergate has gained popularity among traders. According to data analytics firm S3 Partners, over 88% of its outstanding shares are currently held short – making it the most heavily shorted U.S. stock with short interest exceeding $10 million.
Meanwhile, despite the bearish sentiment, Coinbase’s stock has defied expectations by soaring 78% this year. Short sellers who positioned themselves against Coinbase have suffered losses as 22% of its outstanding shares are held short.
MicroStrategy (MSTR), a software company with significant Bitcoin holdings, has witnessed an impressive 93% surge in its stock value this year. Similarly, crypto miner Marathon Digital (MARA) has experienced a remarkable 112% increase. However, both stocks remain heavily shorted, with over 30% of the outstanding shares held by short sellers.
In conclusion, betting against crypto stocks has become a treacherous endeavor for traders. The ongoing volatility in the market, along with the potential for short squeezes, highlights the inherent risks associated with such investments.
A Challenging Landscape for Shorting Crypto Stocks
In the past month alone, net losses on short positions for crypto stocks have reached nearly $900 million, according to S3, a financial data firm. One significant loss occurred on February 2, when both Coinbase and Silvergate stocks experienced a surge of over 20%, resulting in short sellers losing a staggering $630 million.
Shorting crypto stocks has become an even more costly endeavor. Currently, investors looking to short these stocks are facing skyrocketing borrowing fees. For instance, Marathon carries borrowing fees of over 20%, while MicroStrategy has reached 30%, as reported by S3. The reason behind these exorbitant fees is that these stocks have now become “hard to borrow,” with over 95% of the lending pool no longer available, explains S3 managing partner Ihor Dusaniwsky. Consequently, this scarcity will severely limit the amount of new short selling.
S3 has assigned all four stocks studied an alarming “squeeze score” above 80, indicating high vulnerability to a squeeze. In particular, Silvergate received a score of 90, while MicroStrategy’s score reached a perfect 100. This illustrates the precarious situation these stocks are in if the market experiences a squeeze.
When a stock is heavily shorted, even minor developments can lead to significant price movements. For example, earlier this year, Coinbase witnessed a double-digit spike in its shares following the settlement of a case with New York state financial regulators regarding compliance issues in previous years. Despite analysts largely disregarding this news, it caused the stock to soar.
Similarly, Silvergate experienced an impressive 52% surge within just three days last week, as major investment groups disclosed their ownership. However, it is worth noting that these stakes were at least a month old and, in some cases, represented neutral positions among market players.
While Bitcoin has rallied this year, with an increase of almost 50%, regulatory concerns continue to cast a shadow over the crypto market. Additionally, the overall macroeconomic climate remains challenging, with Federal Reserve rate policies serving as a constant headwind.
Despite the mounting pressure, it could prove to be a risky move to bet against crypto stocks in the current landscape.
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