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Are Bitcoin's (BTC-USD) best days behind it? It depends on who's asked.
For most of January, the digital coin has floated within a narrow range of $40,000 to $48,000, and well below last year's record highs after a brutal late year sell-off. Investors think the relatively stable trading band masks the risk of more wild swings triggered by a short squeeze, but the jury is still out on whether Bitcoin has set a base at current levels.
Cryptocurrencies have been highly correlated with risk-sensitive assets, falling in sympathy with volatile Wall Street stocks: in Wednesday's session, the Nasdaq Composite hit correction territory and dragged digital tokens lower, with Bitcoin pinned below $42,000.
However, bulls remain convinced that the currency has more upside than down.
“This is now a very resilient asset class,” LMAX Group CEO David Mercer told Yahoo Finance Live last week. “This sell off is to be expected in what is still quite a thinly traded and small asset class within wider capital market."
Even if Bitcoin trades back toward $30,000, however, "just the sheer weight of institutional money that's coming, and if you speak to anyone, every banker, every asset manager has a strategy for crypto. Medium to long-term, you should just see the price pop from here."
The Federal Reserve's widely telegraphed plans to hike interest rates to ward off inflation haven't helped. With the central bank aiming to withdraw the vast sums of liquidity injected by its crisis-era policies — which have fed inflation and undermined fiat currency purchasing power — the near-term “macro backdrop” looks less certain for Bitcoin, according to Chris Matta, president of 3iQ Digital Assets US.
“There is this possibility for a short squeeze but there could always be further pain," Matta told Yahoo Finance, referencing the temporary bounce an asset can get when bearish investors are forced to cover short positions during whipsaw price action.
"Generally, when Bitcoin gets into these really tight trading windows like right now, the breakout is pretty violent whether it's to the upside or not,” he added.
In the cryptocurrency markets, which Bitcoin still leads, such a move is almost always exaggerated by speculative efforts in derivatives. On Monday, blockchain analytics platform Glassnode called this current dynamic “a powder keg of short term volatility.”
According to Glassnode, funding rates for BTC perpetual futures contracts — a derivatives swap with no expiration date — have trended into negative territory in recent weeks. Negative funding rates signal that the majority of trading momentum is biased towards short-sellers.
Funding is starting to turn bullish on some exchanges like Binance, yet open interest for perpetual futures contracts now sits above 250 BTC. That level has occurred four other times in the last year, and has always culminated with a major whipsaw in Bitcoin’s market value.
From May to July (the last time funding rates for BTC perpetual futures trended into negative territory) Bitcoin surged from $30,000 to $47,000. Of course, other factors were at play during that time, and may not boost the token this time around.
“We’re still waiting to see [those] factors manifest in today’s market,” said Will McEvoy, a digital asset researcher with Fundstrat.
The trigger for the past summer's upswing came after weeks of negative funding by short sellers. Yet the key ingredient according to McEvoy, that pushed momentum to the bulls proved to be increased buying of BTC on exchanges in the spot market.
To see a similar dynamic, McEvoy told Yahoo Finance that the BTC price must “continue to grind lower” in a reflection of general market sentiment, while funding rates need to remain negative for longer.
In this scenario, a sharp change in buyer demand — whether from sentiment or larger institutional players such as accumulation by crypto exchanges — could catch short sellers off-guard, forcing them to cover their positions.
“This may be something to watch in particular for Ethereum which is nearing multi-month high short positions on Bitfinex,” McEvoy added. After a small bounce, ether (ETH-USD) is still shaking off a more than 7% loss over the last seven days.
On the other hand, Phillip Swift, a Bitcoin trader and founder of the Bitcoin data dashboard Lookintobitcoin.com, said the short squeeze perspective might have already “become too mainstream.. which naturally makes it less likely to play out.”
He cited the number of BTC active addresses, or wallets, relative to its 28-day price change — as well as Bitcoin’s skittish 24 score on the Fear and Greed Index. Swift expects a price “bounce” over the next week, arguing that "Bitcoin is at or close to a bottom."
If that thesis proves correct, the currency may test $49,000 this week, according to Yuya Hasegawa a market analyst with Japan-based exchange, Bitbank. However, he insisted "it will likely be another anti-climatic week."
David Hollerith covers cryptocurrency for Yahoo Finance. Follow him @dshollers.