The recent events around the trading of GameStop, a company which has a retail network selling games, and as a business was suffering from the impact of the Covid-19 pandemic, and strong competition from e-commerce giants. The share price was languishing at around $2 which brought it to the attention of Hedge Funds, who research companies that are showing signs of distress and follow a strategy of short-selling. Selling short involves borrowing stock and paying the lender interest, and selling the stocks with the strategy of buying them back at a cheaper price and giving the stock back to the lender. Short-selling is often criticised as profiteering and exploitative capitalism, but it has a role in providing liquidity and hence making prices more realistic. The risk to short-selling is that the stock price does not decrease but increases, and clearly, there is no ceiling on how high a stock can rise. The short-selling activity can be found on various online platforms that collect the information and publish it.
While this is a normal trading activity, what happened with GameStop is not. A Reddit group WSB decided to “pump” the share price of GameStop knowing that the Hedge Funds had short positions. The subsequent activity pushed the share price from $2–3 to $300 which if you are holding a short position is a bad place to be, especially when the rationale for the increasing price is not economic or market fundamentals but an orchestrated “pump” from a decentralised group.
In some ways, the Reddit WSB group shows all the behaviours of the crypto pump and dump groups. They are treating GameStop as a “meme stock”, are fully decentralised, they are clearly having fun at Wall Street’s expense, but importantly they are manipulating share prices.
The story doing the rounds in the media (who don’t understand the forum/group culture) paint a dangerous picture of a bunch of people who are disrupting Wall Street as a form of activism/protest, like some modern-day Robin Hood (except they are skipping the giving to the poor and keeping the proceeds to themselves). There is also a Twitter storm cheering the “little guy who took on Wall Street”, see it as retribution for the 2008/9 crash and subsequent government bailouts, revenge on all those “profiteering” from the COVID-19 crisis which has seen the wealthy grow their fortunes while many suffer, and somehow a way to redress the ever-widening income inequality by “stealing from the rich”.
While these grievances and anger are genuine before we latch onto the narrative of “taking on Wall Street” we should consider that they are not motivated to expose capitalism like the Occupy movement, or like Extinction Rebellion who strongly believe in action on climate change. The WSB group, like many of the Reddit/Discord/Telegram groups are doing this for entertainment, and now they have found a way to make serious cash are likely to continue.
The response to this will be interesting, at the moment people are scratching their heads on what to do. The first one might be a move from tech to close down the groups on the channels such as Discord, a bit harder in Reddit, Telegram, and Signal, but as we know decentralised groups will find a channel and regroup. Because they are decentralised and act as individuals there will always be a broker who will take their business and they will find a route to trading. Trading may be suspended in GameStop until the excitement fades, but having found this entertainment and a way of getting rich quick then the forums will be ablaze with emojis, GIFs, and excitement with other stocks to target.
The mechanisms to prevent market manipulation for regulated institutions are in place and the punishments vary from fines to licences being withdrawn, however, none of this is in place for decentralised, forum based groups. We see this activity in the crypto markets with the exuberance of DeFi with unsustainable yields of 1000%, no rules or regulations, being driven by Telegram or Discord groups. This behaviour has now gone “mainstream” into the regulated markets, and why not? The prizes are much bigger and there are more liquid markets with well-developed platforms.
Why is this important? Fair and orderly markets are the foundations of any exchange of value. If they can be manipulated, then confidence falls as people perceive that rigged markets work against them, then they will not invest their money. It does not matter in the end who is trying to manipulate the markets be they wealthy funds or forum bros, it is very bad for the markets.
This has serious implications for the design of decentralised, self-sovereign, frameworks for decentralised finance (DeFi). The approach to regulations are outlined in the previous article Decentralised and regulatory compliant. Too good to be true? where the self-sovereign organisation around regulatory compliance is the best step towards fair and orderly markets and investor protection.
What mechanisms can we build in a decentralised, self-sovereign architecture to ensure that the markets remain fair to all? As has been demonstrated the regulators have been left scratching their heads as a response to an orchestrated manipulation of share prices by a decentralised group. They can play a game of “wack-a-mole” in closing down the accounts of individuals and fining those they catch, or perhaps build social media monitoring tools to detect pump-and-dump schemes? It is likely these will prove ineffective.
If the power is held in the self-sovereign groups who trade, and who need to work together to build trust and a solid reputation for a fair and orderly market then if a sub-set of individuals decide to manipulate the prices to the detriment of the group it is possible for the group to censure the individuals through using a set of sanctions with increasing severity. The building of trust and reputation is in the group’s interest as this would make it more favourable to issuers who want to raise capital or borrow money in an orderly market.
The self-regulated, self-sovereign, decentralised approach is what makes the forum based groups strong, but if harnessed in a positive way it provides a robust mechanism for good. Establishing strong governance, incentivising all, and having dispute resolution with defined punishments is a model that has stood the test of time and applied to Finance makes it anti-fragile (things that gain from disorder).
If we are looking to “take on” Wall Street and make a fairer world it pays to have a second look at the wealth in companies that stay private until their eventual billion-dollar IPOs where most of the upside has been captured by a small number of investors or the huge Private Equity business which has a nice tax wheeze called “Carried Interest” which treats revenue as capital gains rather than income (capital gains have much lower rates than the top bands of income tax) and that profits from historically low interest rates providing every more cheap ways to leverage. The re-emergence of SPACs that have proven highly lucrative for a minority. And perhaps the biggest question is that the massive asset inflation has been overseen by Central Banks in their QE programs, and ask questions why the central banks own billions of dollars in US equities?
Clearly something is not quite right in the world of finance, but a pseudo-Robin Hood movement is not the answer. The answer is to look at constructing a better alternative, the future is bright, a self-sovereign governed financial platform. The future is Tgrade.