What Does GameStop vs. WallStreet Tell Us About Societal Change?
Ethan Gray / Feb 15 / Economics
In mid-January, WallStreetBets (WSB) and GameStop ($GME) were two relatively unknown names. Two weeks later, social media and the news had plastered both names across the world. Wallstreet bets, typically a subreddit that makes memes about risky option investments, got global recognition and added nearly a million subscribers a day. Gamestop, a floundering video game retailer, saw its market cap rise over 1700% to reach a $20 billion valuation. Dogmatic opinions portrayed in much of the news overlook some of the deeper implications of the event. Beyond retail investors merely sticking it to Wall Street, this story raises some more profound questions. Questions about the role of trading applications in free markets, hedging investments, financial regulations, and how technology shifts society at increasingly larger scales over shorter timeframes.
On July 27th, 2020, a Reddit user named u/DeepFuckingValue posted a video on his Youtube channel explaining his bullish case for $GME. He identified that $GME shares were in a “naked short” position. In brief, to short sell a stock, the seller borrows shares from a shareholder. The short seller then sells that borrowed share at the current price with the expectation the share price will drop. They then purchase the shares back at the lower market price and return those shares to the original owner. They pocket the difference. Many misconceptions regarding naked short positions made illegal after 2008 are floating around this concept in GameStop’s situation. Some hedge funds that held large short positions, such as Melvin Capital, did not short sell non-existent phantom shares as some have purported. In reality, some loopholes around the clearing time for trades to execute allow a stock to be over-shorted. This likely should not be allowed to happen, but strictly speaking, it is not illegal. Regardless of the misconception, these positions expose the funds to exceptionally high risk and open up questions about the role market makers should play.
u/DeepFuckingValue had been posting monthly updates of his original $100 thousand stake in $GME since 2019, much to the ridicule and amusement of WSB. Fast forward to August, and the former CEO of an online pet food retailer Chewy, Ryan Cohen, bought $76 million in Gamestop shares, a 12.9% stake. GameStop’s share price and u/DeepFuckingValue’s bullish case for $GME started to show some signs of life after nearly a year of stagnation. As soon as his monthly posts showed him accruing larger and larger gains from his faith in GameStop, the subreddit rallied behind him in the new year and began aggressively purchasing the stock. The cycle became self-reinforcing. As $GME continued to rise, it received more coverage. Hedge funds lost more money, WSB gained millions of subscribers from its increased notoriety, new users then purchased more stock and continued the cycle. GameStop hit $469 per share at its peak, u/DeepFuckingValue turned $100,000 into nearly $48 million, and hedge funds collectively lost tens of billions covering their short interest. The world's most popular online trading platforms, including Ally, TD Ameritrade, Schwab, and most infamously, Robinhood, all put trading restrictions on $GME.
Many of those on Wall Street profited off the situation despite the narrative, but it remains a David vs. Goliath story. Wall Street controls the rules of the game, and they never seem to lose, no matter how egregious their conduct. Most of the traders on r/WallStreetBets grew up during the financial crisis, where they saw rapacious behavior on Wall Street crash the global economy and perhaps their parents' wealth and their job prospects along with it. This was a chance to stick it to the proverbial man. Platforms like Robinhood halting retail traders' ability to access the stock was seen as a move to back big financial institutions. Users lambasted the platform, protested outside of Robinhood headquarters, and signed up for alternatives such as Fidelity (who did not halt trading) in droves.
However, it is essential to understand how trades are executed. In the two-three day time it takes to settle trades, companies like Robinhood need to post capital to back the transaction before it executes. As demand and volatility increase, so too does Robinhood’s capital requirements. They raised billions from investors and drew on lines of credit to cover the trades. The company eventually released a statement on the situation, stating, “Last week, in part due to volatility in some popular stocks, Robinhood’s deposit requirements rose tenfold. The combination of the deposit increase and the extraordinary increase in volume on these particular symbols led us to put temporary buying restrictions in place on a small number of those stocks.” Whether or not you choose to believe this statement is entirely is up to you, but it is worth noting. Robinhood is not a massive institution like Fidelity, which has $3.3 trillion in assets under management. Fidelity has the luxury of posting an enormous amount of capital with little effort for their users because they simply have more resources. This leads me to believe Robinhood’s statement on the issue. Robinhood is far from perfect and it has made numerous blunders, but it has objectively democratized financial markets regardless of its flaws.
The public relations disaster this event has created for Robinhood poses an existential threat to the future of Robinhood, which is a topic more well suited for another platform. The human perspective of this story is concerned with financial regulation and technological change. The relatively new paradigm of free online stock trading has not been grappled with. We have seen in infinite margin glitches, the $GME debacle, and by far the most tragically, a suicide from an inexperienced trader who did not fully understand the risk of options contracts. We are in uncharted territory, and changes in technology are outpacing policy. Retail traders identifying an overexposed short position from hedge funds and squeezing it should not be illegal but utilizing shorts to hedge other positions' risk should not be vilified either. That is an important market stabilizing mechanism. Traders should not be able to turn small sums of money into an infinite margin. And inexperienced traders should not be able to trade volatile options contracts without at least some safeguards and education in place.
Increasing market accessibility has been a cornerstone of new financial technology and, in aggregate, has done immense good. More people can grow their wealth through equities than ever, and anyone would struggle to form a coherent argument to the contrary. But companies like Robinhood should never even be placed in a position where they can unilaterally impede the free market. They also shouldn’t be exposing users to immense risk without proper education. These were not issues ten years ago, but they are now, and governments need to wake up. The point to take away from this is a failure of government—a failure to assess new technologies' potential impact on the status quo. Quantum computing, decentralized ledger technology, and cryptocurrencies will shake up markets even more once they become more established. Serious discussions on understanding the gravity of changes these technologies could have are not the kinds of the debate taking place in most governments. It is not difficult to apply this vein of thought to more rapidly changing industries that should not be ignored, such as social media, web hosting, gene editing, and artificial intelligence.
It took regulators decades to enshrine laws that grappled with how industrialization changed their societies. Child labor rights, union rights, trust-busting, and rural electrification all helped account for the economic and societal shifts that resulted from new technologies. The pace of change is faster today, and it is happening at an exponential scale that has a global reach thanks to the internet. Reddit vs. Wall Street and the GameStop saga is simply one small event that helps tell a broader historical story about how technology is continually upending the ways elements of our society operate at a fundamental level. In this case, short-sellers learned that a decentralized group of retail traders on Reddit could decimate their risky positions. It is hardly the worst possible shakeup we could imagine. If we do not start thinking a little more proactively about how technology will impact society, something worse is inevitable.