Will There Ever Be a Bitcoin Short Squeeze?
At the start of this year, the price of Bitcoin was trading at around $37,000 Canadian. In less than three months since that time, the price is hovering at over $71,000. There are many reasons for the run-up.
For one, governments are printing more and more money to try and help businesses and individuals cope with the impact of the coronavirus pandemic. This means investors have more money to pour into investments. Secondly, many investors are pouring stimulus checks into cryptocurrency. Thirdly, institutions are following that logic on a mass scale and lowering supply to levels the crypto market has never seen before – and doing it quickly.
You can consider all of the above reasons for a fundamental increase in the value of Bitcoin. Bitcoin isn’t spiking in price because of short-sellers getting squeezed.
Chances are you’ve already heard about what’s happening to a publicly-traded video game rental company in the United States known as GameStop (called EB Games here in Canada). An ongoing attempt by retail investors to create a short squeeze situation with the stock is why the price is fluctuating so much over the last several months. So much so, United States Congress held a hearing about it just last month.
In this post, I’ll explain what a short squeeze is and go beyond that because let’s face it, you probably want to know if a short squeeze scenario can happen to Bitcoin and how you can make the concept go viral on Reddit so that you can take advantage of the opportunity.
No promises that you’ll be able to take care of that second part, but learning about what a short squeeze is and whether or not it can ever happen to Bitcoin or any other cryptocurrency will certainly make you a better progressive investor.
What Is Short Selling?
To understand what a short squeeze is, you need to understand short selling or what it means to ‘go short’ on Bitcoin.
When you buy Bitcoin, you’re hoping that the price will go up. Most of the world’s wealthiest investors follow a long-term strategy when they buy an asset. This is why when you buy Bitcoin hoping it will go up in value, it is said that you are going long’ on Bitcoin. Its informal investors speak.
The opposite of ‘going long’ on Bitcoin is ‘going short’ on it. In this scenario, you sell Bitcoin at its current price to your crypto exchange and hope to buy it back at a cheaper price later. The difference in the price drop is your profit.
Short Selling Bitcoin Means Your Only Collateral Is Your Crypto
Crypto exchanges and DeFi projects are glad to help you go short on Bitcoin because they are going to earn interest on your transaction.
However, there is an additional string attached you need to consider. Short selling is a form of lending. In finance (decentralized or not), you can’t borrow without having collateral. Since crypto platforms aren’t going to check your credit score to do business with you, the only collateral you have to offer is your crypto.
They have to be sure it can earn interest and service your request without losing any money themselves. The only way crypto platforms can do that is by liquidating your short position if Bitcoin starts going up. They are going to need access to your crypto before your balance gets to zero because they’re not in the business of swallowing part of your losses.
That’s why exchanges and lending platforms will only give you a certain amount of breathing room if you’re wrong about going short. That breathing room is expressed as a percentage called a margin requirement and can theoretically be whatever percentage the platform decides. In the stock market world, going short on shares of a big company usually means your margin for error is between 30% and 50%.
This means the value of the stock you’re short selling can go up by 30%, and the brokerage can sell you out of your position at a loss to you (no need to ask for your permission). This way, the brokerage can meet its obligations to other investors. The act of doing this to you is referred to as a margin call. The brokerage is calling on you to meet your obligations.
In the crypto world, this percentage is usually way higher since the volatility of Bitcoin and other cryptocurrencies is much higher than the shares of most large publicly traded companies, like Walmart and Microsoft.
Margin Requirements Make Short Selling Very Risky
The point is you can lose money going short on Bitcoin without actually losing 100% of your investment because you’re always at the mercy of whatever crypto exchange or DeFi project is facilitating your desire to go short.
What can you do to cut your losses if the price of Bitcoin is skyrocketing and you know your short position is about to be liquidated? You can do one of two things. Stare at the price as it goes up and down hoping that you don’t get liquidated and the price of Bitcoin goes back down, or you can bet against yourself and buy Bitcoin so that if the price keeps going up, you’re at least getting some of your value back.
What Is a Short Squeeze?
By betting against your short position, you’re trying to cut your losses. A short squeeze is what happens when a lot of investors start betting against themselves on a larger scale. Remember that going short on an asset means that you’re hoping to buy back Bitcoin at a lower price and pocket the difference. If the price of Bitcoin starts moving up and large numbers of investors in the same boat will start buying larger and larger volumes of Bitcoin, which means that the price will start accelerating even faster.
Where the real fun begins is when other investors who aren’t short on Bitcoin notice the trend. They can also pile onto the gravy train because they know they don’t have anything to lose by the price going higher and higher up. They are effectively putting the squeeze on you and forcing you to buy Bitcoin even though your fundamental belief might be that it is overvalued.
This is exactly what is happening with GameStop. Smart retail investors did their research and figured out that way too many investors are going short on the stock. So much so that more shares are being short-sold than exist. Short-sellers are lending out their short positions to other investors who want to go short too! It almost defies logic (I can’t even explain to you how that’s possible here because I would need to write a novel to do it).
The reason why GameStop started skyrocketing at the beginning of the year and why it appears to be getting ready to do so again this spring is because when billionaires get involved, it’s not that easy to enter and exit positions in one swoop. This means that the skyrocketing of share price happening (as a result of a short squeeze) can go on for several weeks or months, not just a few days.
Can a Short Squeeze Happen to Bitcoin?
Yes, a short squeeze can happen to Bitcoin. The truth is however that at a large-scale, both the traditional financial market and the crypto market move very fast and they can both be very volatile. As much as Bitcoin is maturing as an asset, the price can still drop 50% within a week. It’s also valued at more than $1.3 trillion Canadian, which is significantly more than the current value of GameStop.
GameStop’s short squeeze phenomenon is happening because of large amounts of people on Reddit participating in a coordinated effort to put pressure on hedge funds and earn a big-time profit in the process.
Making that same idea a reality with Bitcoin is more challenging not just because Bitcoin’s market cap is so much higher than GameStop’s, but also because gaining access to large amounts of liquidity and making large volumes of transactions is still way easier in the traditional market than it is in the world of crypto.
This leads to a broader point about investing and short selling.
Short Selling Is a Highly Complex, High-Stakes Game
Anytime you read something about investing in stocks, cryptocurrencies, or any other financial instrument, always remember that you should never invest more than you’re willing to lose. Going short on an asset means you can lose more than your principal investment.
Just remember that although a short squeeze scenario in Bitcoin is a possibility given the right market conditions, there are no guarantees. And most investors who lose money or Bitcoin during a short squeeze aren’t going to tell you about it on social media.
Why You Should Invest in Bitcoin with Netcoins
The best reason to invest in Bitcoin or any other cryptocurrency is that you have a fundamental reason for making the investment decision that you’re making. That means doing research and educating yourself.
If you’re already at the stage where you’re ready to invest in Bitcoin because you believe in the future of cryptocurrencies, register for a free account at Netcoins. Netcoins is a cryptocurrency exchange in Vancouver that can help you get started on your crypto investing journey.
Bitcoin is proving time and time again that it is not just a meme, and as long as you’re bullish on it in the long run, any short squeeze that happens will only mean more price appreciation for you.
Writer, content marketing at Netcoins.