Crypto bank Silvergate (SI) has attracted a ton of short sellers over the past few months, opening up possibility of a short squeeze that could drag its share price upward.
Silvergate stock, which had surged 1,000% across late 2020 and 2021 as crypto markets ripped through their bull market, has sunk nearly 84% over the past year and 65% since the FTX scandal first broke.
SI’s short interest — which measures how much of its outstanding shares are tied to short sales — is now 72.80%, per Seeking Alpha.
That makes Silvergate one of the most shorted stock on US markets, if not the most. It has far more than meme stock Bed Bath and Beyond (47.91%), bitcoin miner Marathon (41.53%), meat substitute startup Beyond Meat (36.88%) and direct rival Signature Bank (36.13%).
About 18 months ago, Silvergate didn’t even make the top 50.
But such astronomically high short interest suggests the possibility of a squeeze — short sellers could face pressure to buy back shares to cover their shorts if the price rises significantly from here. Essentially, that would mean their bearish bets backfired.
The most famous short squeeze of recent history would be GameStop. A ragtag group of retail investors sought to bankrupt Melvin Capital and Citron Research, who’d heavily shorted the game retailer (GameStop’s short interest reached 140% during peak short squeeze in Jan. 2021).
Melvin eventually closed down, having lost billions after being forced to buy back heavily inflated shares to close its shorts. Citron said it would stop publishing short reports to focus on disclosing long theses moving forward.
“When some people think of a short squeeze they immediately think of the GameStop lunacy, but that isn’t necessarily a good representation of heavy short interest situations because it was the result of massive coordinated buying pressure,” UFD Capital analysts wrote in a recent report.
Short squeezes can be far more boring, they explained, in that the short thesis could simply become less compelling relative to the realities of opening shorts (opportunity cost and borrowing fees).
“Not everyone can cover at once, which can lead to a modest short squeeze. This is what could happen if Silvergate can demonstrate that their business is fundamentally sound,” UFD Capital said.
One way this can happen is if the company, in this case Silvergate, improves their fundamentals.
Bear case spurs short squeeze for Silvergate
As one of the only US banks that can freely move fiat to crypto exchanges, Silvergate supports a raft of companies in the space, including Circle, Coinbase, Binance US and Kraken, via its internal payment rails known as the Silvergate Exchange Network (SEN).
SEN is intended to help such firms process funds round-the-clock, rather than rely on the US’ Automated Clearing House, only available during certain business hours.
Silvergate also serviced FTX, leading to fears of contagion and an influx of withdrawals (Silvergate initially hinted at more than $1 billion kept on FTX at the time of its demise, funds now apparently stuck in bankruptcy proceedings).
At the end of last year, Silvergate managed $3.8 billion in customer deposits, down from $11.9 billion in the third quarter. Its customers had grown concerned about the bank’s ability to continue facilitating operations without disruption.
To fulfil withdrawals and generate liquidity, the bank was forced to sell assets at an unfavorable time, according to its fourth-quarter earnings report, resulting in a loss of $1 billion. It also reported a loss to bankrupt crypto lender Genesis amounting to $2.5 million, although those funds are small compared to its balance sheet overall.
The US Department of Justice is now reportedly probing Silvergate to see if it assisted FTX and Alameda Research in fraudulent activities, such as lending and commingling user funds. Its client Paxos is also coming under increased scrutiny from US regulators over its Binance-branded stablecoin.
All these concerns, tied with multiple class action lawsuits, have impacted the business’ attractiveness to both customers and investors, leading to a large sell-off in the stock and increased short sales.
The family office of legendary trader George Soros, for one, recently disclosed holding put options on 100,000 SI shares worth $1.74 million as of the end of December. Their status and expiry dates remain unknown.
Bitcoin buoys Silvergate bull case
Silvergate has clearly had it rough. But its correlation with recovering crypto markets has pushed its share price up 30% over the past month.
And while high short interest exists, market data indicates those shorts would be quick to cover if a squeeze formulates.
A stock’s “days-to-cover” ratio estimates the number of days it would take for all short sellers to acquire enough shares to return to their lenders. The figure is based on the average daily trading volume of the stock and open short interest.
High days-to-cover ratio, typically over five days, suggests increased potential for a significant short squeeze.
SI’s days-to-cover is currently 2.17 days, according Seeking Alpha data. So, any potential short squeeze would be relatively short-lived, reducing potential upside for squeezers.
Nelson Alves, investment analyst, told Blockworks that he wasn’t completely convinced that Silvergate will undergo a short squeeze any time soon.
“Do I think that Silvergate is going to turn around from its current stock rout? Yes. Do I think it will be due to an incoming short squeeze. It might happen, but not very likely,” Alves said.
He agreed that the amount of short positions is huge relative to the float — and when Silvergate stock goes green, upward movements would be exacerbated by such high short interest. But Alves again highlighted Silvergate’s small days-to-cover ratio compared to prominent recent short squeezes.
“Not saying that a short squeeze can’t happen (in some instances, volume might dry up), just that it is not hard for shorts to solve the problem. If you compare it to the meme stocks, you’ll see that when those squeezes happened, it took several days for shorts to cover,” Alves said.
Meanwhile, Mike Zaccardi, CFA, CMT and Seeking Alpha analyst, reckons a Silvergate short squeeze is on the table considering bitcoin price action has been rather constructive. This suggests the “pain trade” for Silvergate could be to the upside.
Still, Silvergate’s short interest is “ridiculous,” so it “wouldn’t take much upward momentum to really scare the shorts,” he told Blockworks.
“Technically, I think the $25 level is key. A move to about that could bring about significant short covering. I see the next resistance near $50,” Zaccardi said. Silvergate shares last traded for $18.05.
Zaccardi conceded that he doesn’t see any corporate events for Silvergate that could be the catalyst, but noted that Option Research & Technology Services shows an implied volatility of 191% for Silvergate.
“That’s a one-week expected move of 26% — crazy high.”
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