How to anticipate and profit from shorting scams in the cryptocurrency market?

How to profit from shorting scams in cryptocurrency?

Author: Jonas@Foresight Ventures

1. What is a short squeeze?

Shorting can allow traders to profit from falling asset prices. This is a common way to hedge existing positions or bearish market conditions. However, short selling can sometimes involve high risks. First, when there is a sudden increase in buying volume, a large number of short sellers are forced to close their positions and buy the asset, which can lead to a short squeeze due to insufficient supply and push up the price. Second, when a manipulation group absorbs and concentrates the circulating float, causing there is no other source for short sellers to buy back chips except this group, it will also trigger a manipulative short squeeze.

Short squeezes are more likely to occur in small-cap or low-liquidity altcoins. Especially in the cryptocurrency market that uses high leverage, due to the waterfall effect caused by continuous forced liquidation, price changes are more severe. Some advanced traders will observe potential short squeeze opportunities, accumulate positions in the early start-up stage, and sell them when the price rises rapidly.

2. Several key indicators of short squeeze trading

1. Funding rate of futures contracts: The premise of short squeeze is that the short position overwhelms the long position. The specific manifestation is that when the funding rate of a certain altcoin futures contract is lower than -0.1% (that is, the daily interest rate of the short position is 0.3%, and the annual interest rate is more than 100%), it indicates that the short-term bearish sentiment is extreme, and if it exceeds -0.75%, it will accelerate the rise. Several extreme negative funding rates have been seen in the following discussion cases.

2. Futures contract position: More importantly, the more liquidity that is trapped, the greater the volatility that short squeezes will bring. This is mainly reflected in two aspects: first, the closer the contract position is to the market capitalization, and the closer the contract transaction volume is to 50% of the spot transaction volume, the easier it is to cause a short squeeze. Secondly, if the contract position increases by more than 50% in the short term, it indicates that the main funds are entering the market. If the position decreases, it means that the main funds are retreating, and profit-taking is needed at this time.

3. Chip distribution: Suitable for the manipulation of short selling by the banker. The more concentrated the chip structure, the more extreme the market volatility.

III. Analysis of Several Recent Classic Cases

1. LINA: Linear is a cross-chain compatible synthetic asset protocol with poor fundamentals. Starting at the end of May, it began pledging to mint the stablecoin LUSD. The pledge ratio was as high as 22% of circulation. The yield on LP mining LINA tokens with stablecoin LUSD and BUSD pairs was as high as 60%, attracting an expected 10% of hedging mining. Market makers entered the market and bought 23% of the circulating supply, locking up a total of about 50% of LINA chips. This is a typical manipulative short-selling strategy, where the banker holds the spot market and manipulates the contract.

We can see that LINA’s contract funding rate has been significantly below -0.1% since May 28, with a peak of -2% on May 31 and June 3. The contract position also rose sharply from May 28, with a position of $50 million while the circulating market cap was only $70 million. The contract trading volume was $50 million, nearly 50% of the spot trading volume of $90 million, which easily led to a situation of short covering supply shortage. As a result, from May 28 to June 3, the price of LINA quickly rose 2-3 times.

2. ARBlocking: ARBlocking Network is a decentralized secure computing network and a privacy public chain in 2018. Recently, it completed the construction of a random number generator and began the second phase of testing on the testnet, with the mainnet expected to go live soon. The market maker switched to DWF in April, which has repeatedly manipulated other cryptocurrency projects in the past.

We can see that the ARBlocking contract funding rate has been significantly higher than -0.1% since May 12th, although it has experienced ups and downs, the high rate has continued until May 16th, with a peak of -1%. More importantly, the contract position has surged since May 12th, with a position of $30 million, close to the circulating market value of $40 million. The contract trading volume was $30 million, close to 50% of the spot trading volume of $70 million. As a result, the short squeeze of ARBlocking has risen 3-4 times in two weeks.

3. MTL: Metal is a cryptocurrency asset payment platform with user incentives, a project from 2017. The market’s main control is about 10% of the circulating supply, and the recent trading volume is very exaggerated on the Korean exchange Upbit.

We can see that MTL’s contract funding rate was abnormal on May 6th, but the short squeeze ended one day too quickly. Then on June 6th, an anomaly occurred again, with an extreme value of up to -1.8% in the later stage. More importantly, since June 6th, the contract position has increased sharply, with a position of $60 million, very close to the circulating market value of $80 million. The contract trading volume was $80 million, close to 50% of the spot trading volume of $160 million. This short squeeze caused MTL to rise 2-3 times in a week.

Similarly, last year’s LEVER, BEL and other small-cap altcoins also experienced similar short squeeze techniques, such as high funding rates, high contract-to-spot position ratios, high contract-to-spot trading ratios, and suddenly surging positions, which will not be repeated one by one here.

Four, risks of short squeeze trading

Every coin has two sides, and there is also a certain degree of uncertainty in short squeeze trading.

1. Cryptocurrency exchanges may temporarily modify rules. If the default position limit increases, it is bullish; if the default position limit decreases, it is bearish. For example, Binance temporarily adjusted the leverage and margin ladder for LINAUSDT on June 3rd, and for MTLUSDT on June 7th. Both are strong warning signals that “we are going to change the rules at any time”, meaning that don’t think about making money and let us exchanges take the blame.

2. The subsequent value regression of altcoins. Although many altcoins have risen after being shorted, more of them have continued to fall as the prices have soared. There is a commonly used indicator of a top, which is the comparison of the spot (or contract) trading volume of altcoins to that of the king of altcoins, ETH. From historical data, when the spot (or contract) trading volume of altcoins exceeds or approaches that of ETH, it is highly likely to be a short-term emotional top. It is also necessary to take profits when the 4-hour swing exceeds 20%. Overall, the short-selling trend is biased towards technical patterns rather than fundamental events, often leading to losses for some retail investors.