The recent surge in the cryptocurrency market has not only lifted digital assets like Bitcoin but also boosted shares in companies that are exposed to the crypto industry. Giants like Coinbase Global and MicroStrategy have witnessed significant gains as a result, causing traders with short positions to face considerable losses.
Bitcoin, in particular, has experienced a remarkable rally of around 70% since September. Coinbase’s stock, a prominent crypto broker, has also surged by 80% during the same period. MicroStrategy, a software company renowned for its extensive Bitcoin holdings, has seen its shares rise by two-thirds.
According to Ihor Dusaniwsky, a managing partner at data analytics firm S3 Partners, the rally in crypto stocks has dealt a severe blow to short sellers. These traders have now incurred substantial mark-to-market losses due to the strength of the sector.
Shorting a stock involves borrowing shares and selling them, aiming to profit if the stock price decreases. However, short sellers face immense risk if prices rise, pressuring them to “cover” their short positions by buying back the stock at a loss.
During the bear market that commenced in 2022, many investors placed bets against crypto stocks. However, this strategy has backfired as token prices rebounded this year. As a result, crypto stock short sellers have suffered mark-to-market losses of $6.1 billion so far in 2022. Notably, more than half of these losses are concentrated among those betting against Coinbase, as highlighted by S3.
The soaring crypto stocks are basking in their newfound glory, leaving bearish traders nursing their wounds. This trend may persist as the cryptocurrency market continues to show resilience and strength in the face of adversity.
Short Sellers Increase Exposure in Overbought Crypto Sector
Since Bitcoin hit a recent low around Sept. 11, short sellers have been piling into Coinbase et al in an attempt to profit from what they believed was an overbought sector. According to Dusaniwsky, $697 million flowed into these shorts. The primary targets of short covering and short selling have been Coinbase and MicroStrategy. However, this bold move in September proved to be a bad call as it resulted in $2.7 billion of year-to-date mark-to-market losses.
The Possibility of a Short Squeeze
With many short sellers facing increasing pressure, a short squeeze may be on the horizon. A short squeeze occurs when short sellers rush to cover their positions, causing a surge in buying activity that drives up prices. Such a scenario would only add to the losses suffered by the short sellers. Throughout 2023, $2.2 billion worth of short covering has already taken place across 11 crypto equities, including Coinbase, MicroStrategy, Marathon Digital, and Riot Platforms, as reported by S3. Interestingly, Coinbase has borrowed shares equal to 15% of its total shares available for short selling—three times the average amount for U.S. stocks.
Reversal of Short Selling Expected
Dusaniwsky predicts that as cryptocurrency prices continue to rally, mark-to-market losses in crypto stocks will increase, eventually leading to a reversal of the recent short selling trend. He believes that the buying-to-cover activity in heavily shorted crypto stocks such as Coinbase, MicroStrategy, Marathon Digital, and Riot Platforms will not only halt the downward momentum but also push stock prices higher. This trend is expected to be amplified by the ongoing increase in long buying that has been driving up stock prices since the end of October.
It remains to be seen how the market will unfold in the coming weeks and whether the short squeeze will materialize as anticipated. However, one thing is clear—crypto stocks are proving to be a volatile yet intriguing sector to watch.