There is a bit of a contraction taking place in battered stocks across the cryptocurrency sector. All it takes is a quick look at the likes of
The "style" dynamic is at work.
(ticker: COIN) soared 24% on Thursday, taking its gains over the past five days to 54% and its year-to-date rise above 140%. Crypto banker Silvergate (SI) jumped 29% on Thursday and is up 60% since late last week. Other stocks exposed to digital assets, such as Bitcoin miner
(MSTR), a software group with large cryptocurrency holdings, are showing similar price action.
While all of these stocks have fallen in the pre-market on Friday, the dynamics that caused the surprising moves remain intact.
Sure, the stock market is on a roll. He
S&P 500
It is up more than 3% since last Friday, with the Nasdaq, packed with high-growth stocks like crypto, up 6.4%. But the biggest digital asset,
Bitcoin,
which has a lot of influence on the sentiment of crypto stocks, little changed over the same period.
What investors see it's probably a short squeeze—a technical market factor behind the incredible rallies in “meme” stocks popular with retailers in 2021, including
game stop
(GME),
AMC
(
AMC
), and
bed bath and beyond
(BBY). It has to do with betting against stocks.
To bet against a stock, or "short," investors have to borrow the underlying stock and then sell it, betting that it can be bought back at a lower price. Trading consists of pocketing the difference between the price at which the shares were borrowed and the price at which they were returned.
If the bet goes wrong and the price rises, investors may come under pressure and some may choose to buy back and return the shares at a higher price, "hedging" their position and taking a loss. The pressure can be particularly pronounced if the trade was placed on margin or with money borrowed from a broker. If the short sale is a busy trade, investors may end up clamoring to buy the same shares, "squeezing" the prices higher.
Shorting crypto stocks is a very, very crowded trade. And that is understandable. Cryptocurrency prices have collapsed from its peak in November 2021, with a series of bankruptcies and high-profile fraud allegations shaking up the digital asset industry, raising the possibility of existential threats from regulation and wary investors.
But now what once seemed like a smart trade seems dangerous. Short contracts can be unpredictable, and investors would do well to exercise caution. The scope of the risk of short pressure is remarkable.
Among US stocks, the average short interest (the percentage of a company's shares sold short) is 4.9%, according to financial data group S3 Partners. Coinbase is short interest of more than 25%. A staggering 75% of Silvergate shares are shorted. Short interest in both Riot and
microstrategy
It's in the double digits.
As these stocks drop, the pain for short sellers increases. Those who bet against Coinbase, Silvergate, Riot and MicroStrategy lost more than $730 million at market price in Thursday trading alone, according to S3. Market losses for traders shorting these four stocks exceed $2.5 billion by 2023.
“Because of these losses in market value, these shares are highly squeezeable,” said Ihor Dusaniwsky, managing director of S3. "I'm looking for the short squeeze in these stocks to push stock prices higher."
And there's reason to believe that the ride will only get more bumpy. Short sellers have yet to cover their positions significantly, which means that the squeeze has the potential to accelerate, driving prices even higher, if the pain becomes too much.
"Surprisingly, even with these stocks rallying, we still haven't seen massive short covering," Dusaniwsky said. "But we expect this to change as large market value losses in 2023 will start to drive shorts out of their positions."
But, on the other hand, this does not mean that staying long on Coinbase or Silvergate is a good idea. Short grips can go away, and change, just as quickly as they started. These stocks have gained due to unpredictable technical factors, not fundamentals. The same can be true in reverse.
Write Jack Denton at jack.denton@barrons.com