• MicroStrategy (MSTR) and Coinbase (COIN) have the most possibility of a short squeeze – or a rally spurred by short sellers getting out of their bearish bets – S3 Partners said in a report.
• The total short interest in crypto stocks is $10.7 billion, with MicroStrategy and Coinbase making up 84% of these bearish bets, the report added.

The short sellers are piling into the crypto-linked stocks, wagering that they are primed to reverse their year-to-date jump in prices.

However, the trade has become so crowded that it primed these stocks for a short squeeze, said data analytics firm S3 Partners in a report on Monday. A short squeeze is triggered when an unexpected rally in a stock price forces short sellers to unwind their bearish bets, leading to an even bigger jump.

Michael Saylor's MicroStrategy (MSTR) and crypto exchange Coinbase (COIN) are the top two crypto stocks with the highest "squeeze score," S3's Managing Director, Ihor Dusaniwsky, said in the report.

"These crypto related stocks are extremely crowded and very squeezable relative to the U.S. market, with an average Crowded score of 57.34 versus the street average of 32.41 and an average Squeeze score of 78.69 versus the street average of 34.41," the report said, adding that "MSTR, COIN and CLSK are the most squeezable names in the sector."

The total short interest in crypto stocks is $10.7 billion, with MicroStrategy and Coinbase making up 84% of these bearish bets in the sector, Dusaniwsky said in the report. The short interest in the crypto industry is so crowded that it has eclipsed the short bets of the average U.S. stock – over three times larger, the report added. Other crypto-linked stocks that have high short interest include bitcoin miners Marathon Digital (MARA), Riot Platforms (RIOT) and CleanSpark (CLSK).

However, the crypto stocks, specifically MicroStrategy and Coinbase, have defied the bearish thesis and enjoyed sizeable gains this year as the price of bitcoin reached an all-time high. MSTR has risen 179% this year and COIN has climbed 52%, while bitcoin has jumped 64%.

The explanation could be that some traders are going long bitcoin (BTC) but hedging that position by going short related stocks. In fact, "long bitcoin and short miners" was a trade that market participants cited as one of the reasons why mining stocks have underperformed bitcoin.

However, the crypto stocks, specifically MicroStrategy and Coinbase, have defied the bearish thesis and enjoyed sizeable gains this year as the price of bitcoin reached an all-time high. MSTR has risen 179% this year and COIN has climbed 52%, while bitcoin has jumped 64%.

The persistent rally in bitcoin and the crypto stocks has taken some toll on the bearish bets. At the time of the report, S3 has observed that short sellers of crypto stocks have incurred $4 billion in losses month-to-date, with MicroStrategy leading the pack.

If a sector becomes too crowded with short sellers, such a trade can become dangerous if the share price of a shorted stock continues to climb, forcing investors to scramble to cover their shorts, leading to massive losses. In recent years, short squeezes in GameStop (GME) and Tesla (TSLA) led to disaster for short sellers.

The S3 report also echoed the sentiment, cautioning against doubling down on a crowded trade. "Crypto stock short sellers have been selling into a rallying market – either looking for a pullback in the Bitcoin rally or using the short positions as a hedge versus actual Bitcoin holdings. For the trades that are risk positions, there is a strong squeeze possibility in the more unprofitable shorts in the sector like MSTR, COIN and CLSK," the report said.

"If the short exposure is a Bitcoin hedge, then short interest should remain relatively flat, regardless of the Bitcoin rally," Dusaniwsky concluded.