Mike’s Minutes: GameStop Stock - A Case Study Of The Little Guy Standing Up To The ‘Big Guy’ (AKA Wall Street)

For those that pay attention to the stock market, you’ve heard about the whirlwind that was the “short squeeze” play out on GameStop’s stock this week.

There are a lot of articles outlining what tactically played out by explaining how large hedge funds ‘short’ a stock position as they believe the stock will go down. I encourage you to google ‘short squeeze game stop’ and in 5 minutes you’ll get the gist of what happened.

But the real story behind all the fancy stock terminology and diplomatic narrative is very simple: The little guy (a bunch in individual ‘retail’ investors) used social media and publicly available stock trading data to get on the better side of a trade. Enter capitalism meets social media meets ‘sticking it to wall street’ mentality at its finest. Overall, pretty smart move for a bunch little guys to use their access to data and access to trading to pull something like this off. Not so pretty for someone on the other side of it.

The moral of the real story at play behind the scenes is the firm belief from retail investors that the traditional finance system of stock trading is not a free market after all. It’s potentially rigged in favor of Wall Street in some way shape or form.

My opinion: After all this really plays out, this will be a great case study and the blockchain/bitcoin craze will get crazier making an even greater case for wide spread adoption of a decentralized free enterprise financial system.

While I remain objective on the matter because I'm not into the day-to-day details nor am I an expert on all this stuff, the facts playing out in this situation look very fishy at best. The stock trading platform Robinhood is at the center of it all.

On a high-level, here's what happened:

1.      Hedge funds shorted a bunch of GameStop stock by buying options (AKA Shorting the stock) betting the stock would go down

2.      Retail investors saw this via publicly available trade volume data, and arguably saw some baseline fundamentals and a new board member that led them to believe GameStop could be a solid stock worth owning long-term, and they realized that those Hedge Funds were likely not covering their position (i.e. buying insurance on it in case it went the opposite direction they were betting/hoping for).

3.      Social media goes crazy and tells everyone to buy GameStop – They do it which drives up the stock price

4.      The higher the stock goes up the more the hedge funds lose because they bet it would go down initially (the loss is essentially infinite as a stock can go up forever)

5.      The hedge fund is forced to finally hedge, or stop the bleeding, of their original position by buying back shares which raises the price even further

6.      Even though the hedge fund bought it back, they still lost millions/billions on the original short trade

The bigger thing that happened is that one hedge fund threw in white flag and needed a bailout (my words). One firm that bailed this hedge fund out is the largest vendor (Citadel) and customer of…you guessed it Robinhood! Citadel is the clearing house for Robinhood which is where most trades go to get processed after a user makes a trade on the platform. Citadel makes their revenue from the split between the bid/ask price and shares a very healthy chunk of revenue with Robinhood for sending the business their way.

Here’s where it gets tricky…Citadel put in $2B to helped the failed hedge fund in this situation. Weird situation at best…

Additionally rumors are that another large short position was “re-upped" by these hedge funds right before Robinhood halted trading after the stock continued to rise…which meant even the "re-upped" position was losing money rapidly because the stock was still being bought up by retail investors.

So what does all this mean and what’s at stake?

Was there collusion between Citadel and Robinhood? It was obviously in Citadel’s best interest for trading to halt to slow down retailers from buying up shares, and as Robinhood’s biggest revenue client they would have an incentive to assist by saving them a bunch of cash as a valued business partner.

If trading for GameStop can be halted by a trading platform (and I’m not talking circuit breakers for those really into stock trading), does that really mean there is a fair market system?

As of the publishing of this, Robinhood did open up trading again and shares continued to rise putting those hedge funds in a worst position…but those hedge funds, and the money that Citadel gave them, was allowed more time to figure out their next steps due to the trading being halted.

Retail investors, the every day David to the Wall Street Goliaths, were shut out of a free market system.

The game is simple in theory: If you are on the winning side of a trade, you win. If you’re on the losing side of the trade you lose. Every trade has a winner and every trade has a loser. There should be no time outs. You enter the game and play it until you close your position...you don't hope that someone plugs the pull, literally, on the retail investors just because they spotted a winning trade and you didn't.

When the losses started mounting, the big guys were able to call a time out which negatively impacted those retail investors who were trying to buy GameStop and make a profit.

If this doesn’t give anyone cause for concern about the power that’s out there from the 'big guys', it should.

This situation in particular is a much bigger deal than most people realize given the timing and rising popularity of blockchain technology. This will be another story retailer traders, and pro-bitcoin/crypto folks, will use to support a decentralized financial system that runs 24/7 and is fueled by individuals across the globe verifying and conducting transactions as opposed to centralized operations being controlled by large banks/institutions/trading platforms.

If there was ever a case for wider adoption of blockchain in the financial system, this could be it. You better believe those that were cheerleaders of bitcoin/crypto/blockchain before are even bigger cheerleaders now. The voices will rise, pressures on financial institutions will grow, and blockchain support will be growing exponentially in the years to come.

About Author

Mike Smith

Mike Smith is a Client Advisor at Lockton focusing on complex risk solutions. Management Liability, in the E&O, Cyber, Fidelity Bond, and D&O arena, is his focus for innovative risk-transfer alternatives.