Coinbase and Others Are Poised for a GameStop Moment in the Crypto Stock Short Squeeze

While these stocks have all fallen in Friday’s premarket, the dynamics that caused the eye-popping moves remain intact.

Of course, the stock market is on its way. The

S&P 500

has marched more than 3% higher since last Friday, with the Nasdaq — filled with high-growth stocks like those in crypto — climbing 6.4%. But the greatest digital resource,

Bitcoin,

which has a lot of influence on sentiment for crypto stocks, is little changed in the same period.

What investors are seeing is likely a short squeeze — a technical market factor that was behind the incredible rallies in “meme” stocks popular among retailers in 2021, including GameStop ( GME ), AMC ( AMC ) and Bed Bath & Beyond ( BBBY ) ). It has to do with betting against stocks.

To bet against – or “short” – a stock, investors must borrow the underlying stocks and then sell them, betting that they can be bought back at a lower price. The trade involves putting in 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, “covering” their position and taking a loss. The pressure can be particularly pronounced if the trade was made with margin, or money borrowed from a broker. If shorting is a crowded trade, investors may end up clamoring to buy up the same stocks, “pushing” prices higher.

Shorting crypto stocks is a very, very crowded trade. And that is understandable. Crypto prices have collapsed since peaking in November 2021, with a wave of bankruptcies and high-profile fraud allegations rocking the digital asset industry, raising the prospect of existential threats from regulators and wary investors.

But now what once seemed like a smart trade looks dangerous. Short squeezes can be unpredictable and investors will be right to exercise caution. The magnitude of the short squeeze risk is remarkable.

Among U.S. stocks, the average short interest — the percentage of a company’s stock that is sold short — is 4.9%, according to financial data group S3 Partners. Coinbase has a short interest rate of more than 25%. An astonishing 75% of Silvergate shares are shorted. Short interest from both Riot and MicroStrategy

is with two digits.

As these stocks get squeezed, the pain for short sellers increases. Those betting against Coinbase, Silvergate, Riot and MicroStrategy lost more than $730 million in market value in Thursday trading alone, according to S3. Mark-to-market losses for traders shorting these four stocks exceed $2.5 billion in 2023.

“Because of these mark-to-market losses, these stocks are very squeezable,” said Ihor Dusaniwsky, a managing director at S3. “I’m looking for the short squeeze in these stocks to push share prices higher.”

And there is reason to believe that the ride will only get bumpier. Short sellers have yet to meaningfully cover their positions, meaning the squeeze has the potential to accelerate — sending prices even higher — if the pain becomes too much.

“Surprisingly, even with these stocks going up, we haven’t seen massive short covering yet,” Dusaniwsky said. “However, we expect this to change as large losses relative to the market in 2023 will begin to push shorts out of their positions.”

But on the other hand, this does not mean that it is a good idea to go long on Coinbase or Silvergate. Short squeezes can disappear – and reverse – as quickly as they started. These stocks have risen due to unpredictable technical, not fundamental, factors. The same can be true in reverse.

Write to Jack Denton at [email protected]