Bitcoin Is on a Winning Streak. Beware the Sentiment Shift.

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Bitcoin and other cryptocurrencies paused Tuesday, holding on to the bulk of gains from a rally that has carried cryptos to their highest level in months. But analysts caution that the recent move higher is fragile, and a shift in sentiment could cause a fast and painful retracement.

The price of Bitcoin is little changed over the past 24 hours to $22,899.53. The largest digital asset has traded near $23,300 in recent spikes, marking the highest point since August and representing a return to price levels not seen since the collapse of crypto exchange FTX rocked the market in November.

“Bitcoin has tentatively found a home above the $22,500 level as risk appetite remains healthy,” said Edward Moya, an analyst at broker Oanda. “A lot still could go wrong for the broader market and if that happens, it will be interesting to see how crypto reacts.” 

Rallying more than 30% in two weeks, Bitcoin has led risk-sensitive assets in a move upward amid improving sentiment around the future of inflation and interest rates, with the

Dow Jones Industrial Average
and

S&P 500
also seeing gains.

But crypto traders should be careful.

“​​The short-term breakout preserved positive momentum, but we would not chase the rally,” said Katie Stockton, managing partner at technical research group Fairlead Strategies. “Initial support for Bitcoin can now be gauged by its 200-day moving average near $19,600. However, a retracement is likely to go much deeper once risk-off positioning returns to global markets.”

Of particular concern to analysts is what has accelerated the recent crypto rally—and how those same factors could similarly exacerbate a move downward. 

In focus is low liquidity in crypto markets, a trend that has been in place since the bankruptcy of FTX and its associated market maker, Alameda Research, a few months ago. A handful of firms dominate trading volumes in crypto, providing much-needed liquidity to markets. FTX’s collapse stranded some market makers’ assets on the trading platform and also took down Alameda, itself an influential market maker.

When liquidity is low or the market is shallow, a wave of buying and an absence of sellers push esprices sharply higher very quickly. The same can happen in reverse, too.

“A low market depth has allowed a smaller number of traders to move prices up sharply,” analysts at crypto exchange Bitfinex wrote in a Monday note. “Short closures and short liquidations have fuelled the move up rather than organic demand.”

Indeed, short sellers—traders betting against Bitcoin prices going up—have also played a role in the recent rally. Traders often take short positions with margin, or borrowed money, and can be forcibly closed out of their position by brokers if the market swings against them. This process, called liquidation, can trigger automatic buy orders, which adds pressure to an already upward-trending market.

It’s another reason to believe the current rally could peter out or even take a more violent turn downward.

Beyond Bitcoin,

Ether
—the second-largest crypto—slipped less than 1% to $1,620. Smaller cryptos or altcoins were more mixed, with

Cardano
1% in the red but

Polygon
1% higher. Memecoins were more muted, with

Dogecoin
and

Shiba Inu
both down 1%.

Write to Jack Denton at jack.denton@barrons.com