Is it time to be bearish on Bitcoin right now?

By Jeff Broth. Jeff Broth is a financial writer and investor. With over 5 years of trading in the financial markets, Jeff contributes his knowledge and insights on market developments

Bitcoin is on a roll. It was trading below $11,000 in the first week of October 2020 and almost touched $42,000 on January 9, 2021. That’s an appreciation of almost 282% in a little over three months. From the looks of it, the flagship cryptocurrency seems to have finally come into its own.

The last time bitcoin rallied like this was during its glory days in 2017. However, at the time, the rally was based on demand from retail investors and there were a lot of governments around the world who couldn’t quite figure out how to deal with bitcoin and other cryptos.

A number of countries banned trading or disallowed banks from supporting exchanges and ensured that demand for crypto died down quickly. Bitcoin fell from a high of over $19,000 in December 2017 to less than $5,500 in November 2018. This was when crypto bears made a ton of money when they shorted bitcoin. 

Investors of repute like Warren Buffett as well as large institutional players such as JP Morgan were previously skeptical about Bitcoin. While the Oracle of Omaha is still wary about the applications of Bitcoin, JP Morgan is now eyeing cryptocurrencies as an alternative asset class. 

It’s quite evident that the rally seems different right now. In fact, JP Morgan even published a note saying that it expects bitcoin to hit $100,000 in 2021.

The Long Squeeze Challenge

The very quality that makes bitcoin an attractive investment, its limited availability, also makes it prone to massive and sudden corrections.

Hedge fund Pantera Capital told its investors that fintech firms have been raking in a majority of the new bitcoins in 2020. The fund estimated that Square’s clients have accounted for 40% of the bitcoins in the last two years while PayPal’s new offering in October 2020 accounted for 70% of the new bitcoins.

Large investors like Stanley Druckenmiller, founder of hedge fund Duquesne Capital, and Rick Rieder, BlackRock chief investment officer of global fixed income, have been talking up bitcoin in 2020.

Wall Street never looks at any investment for the long term. If there is fast money to be made in the short term they will press the switch. With regular fiat currencies, as economies grow, the amount of currency available also expands. However, this is not the case with bitcoin. Since its supply is fixed, its value goes higher and that means bitcoin owners use smaller fractions of the cryptocurrency to pay for goods and services.

However, this also gives a few traders ungodly influence over bitcoin. Bitcoin futures are today trading at over $11 billion. This is the most number of players in bitcoin’s history who are playing on its price movements. If a few traders decide to go in for a long squeeze, it could send bitcoin prices cascading downwards.

A long squeeze works when buyers are forced to liquidate their positions when bitcoin prices drop to a certain threshold. If these squeezes play out one after another, it will cause a domino effect. The liquidation of one contract at $35,000 could lead to another at $34,000 which would lead to another liquidation at $33,000 and so forth.

Just Another Investment

As bitcoin has shot up, Nigel Green CEO of financial group deVere, and long-time bitcoin fan, believes that it should be treated as just another investment. In an email to Forbes, he said that he sold off half his bitcoin holdings when the crypto was trading at $25,000 in December 2020.

“I have sold half my holdings of bitcoin as it hit an all-time high. Why? Because it should now be treated as any other investment—that’s to say, where possible, it’s better to sell high and re-buy in the dips,” said Green. He said that the digital currency was the best performing asset of 2020 and it delivered a return of over 200% to him, and that is why he sold a part of his stake.

However, Green clarified that his decision to sell shouldn’t be taken as a sign that he has lost faith in bitcoin. He says he has booked his profits and is waiting for the digital currency to dip so that he can re-enter the market.

There is another inherent danger to the bitcoin rally. What happens if large players stop accumulating bitcoin? The Grayscale Bitcoin Trust hasn’t seen any slowdown from large players so far but if they decide that bitcoin is too expensive for them, there is a chance that a pullback to occur.

Slower accumulation by large players could also lead to the cascading long squeezes that were mentioned earlier in the piece. If that happens, it’s almost a guarantee that bitcoin prices will see a very sharp correction.

Ray Dalio, founder and co-chairman of the world’s biggest hedge fund, Bridgewater Associates, has said that bitcoin has established itself as a “gold-like asset alternative.” The problem with bitcoin is that its market cap is only around 7% that of gold. It is a lot more prone to short term corrections than the yellow metal.

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