From: allin
The GameStop trading saga ignited a widespread debate concerning short selling, market manipulation, and the role of platforms like Robinhood in modern finance [00:01:47]. This event exposed fragilities in the financial system and sparked calls for significant reforms [00:13:38].
The GameStop Phenomenon
The saga began in June 2019 when a Wall Street Bets user, DeepF***ingValue, started buying long-dated GameStop calls, betting the stock would rise by January 2021 [00:03:59]. He invested 25 million [00:04:14]. These forums allow individuals to share stock tips and promote ideas [00:04:21].
In August 2019, Michael Bury (known from “The Big Short”) disclosed a 3% position in GameStop, arguing that 90% of its 5,700 stores were free cash flow positive and the company was trading at or near net cash levels [00:05:08]. GameStop, a retail store selling video games and consoles, had seen its stock decline as consumers shifted away from physical stores [00:05:44].
Ryan Cohen, founder of Chewy, acquired an almost 10% position in GameStop by August 2020 [00:06:31]. A Wall Street Bets member then highlighted GameStop’s 120% short interest, defending the company based on an upcoming console cycle, loyalty programs with 55 million users, a strong balance sheet, and Cohen’s stake [00:06:44]. This user predicted a “big squeeze” if the stock rose, forcing shorts to cover [00:07:20].
In November 2020, Cohen urged GameStop’s board to evolve into a technology company and focus on digital experiences, rather than remaining a brick-and-mortar retailer [00:07:26]. Around the same time, it was highlighted that Melvin Capital, a hedge fund, had been synthetically shorting GameStop since 2016 [00:07:56].
By January 2021, GameStop added Cohen to its board, along with two of his affiliates, sending the stock up 13% to 40 by January 14th, a 125% increase [00:08:51].
The Short Squeeze and Market Volatility
This led to a “pros versus joes” battle, with institutional investors shorting GameStop and retail investors buying the stock and call options [00:09:17]. Institutions became massively short, exceeding the actual number of shares, reaching 140% short interest [00:09:45]. Retail aggressive purchasing of call options, combined with quant and momentum funds joining the long side, created a “massive short squeeze” [00:10:15].
Citron Research, a firm known for finding shorts, announced they were short GameStop on January 19th, predicting a drop to 3 billion into Melvin Capital to keep it solvent [00:11:35].
The squeeze spilled over into the broader market, forcing hedge funds to cover other shorts and sell their long positions in companies like Facebook, Netflix, and Alibaba, causing those stocks to fall [00:11:52].
Robinhood’s Role
On January 28th, Robinhood and other brokerage firms prevented users from buying GameStop and other stocks, only allowing them to sell [00:12:27]. This one-way pressure caused a 44% sell-off, though the stock later reversed [00:12:44].
There were questions about whether this was a mandated decision by regulators or a platform-level choice [00:12:58]. Some argue it was a decision made by platforms like Robinhood because they lacked sufficient margin to cover potential losses, fearing a “run on the bank” [00:13:16]. This highlights the fragility of the system [00:13:38].
Robinhood’s Business Model
Robinhood generates revenue through “payment for order flow,” where they sell customer order data to prime brokerage institutions like Citadel milliseconds before trades are executed [00:13:54]. Citadel, responsible for 47% of order flow volume, paid Robinhood nearly 400 million annual run rate [00:14:26].
Robinhood’s business model works well in non-volatile markets, allowing them to offer free trading by making a spread [00:20:52]. However, during volatile swings, they are exposed to losing money and can face liquidity crises [00:21:06].
Arguments and Criticisms
Criticism of Robinhood and Centralized Platforms
Critics accuse Robinhood of being “incompetent” and “negligent” for not being prepared for such a scenario, especially after experiencing a similar liquidity crisis in March 2020 [00:23:40]. They argue that Robinhood “lied on television” by denying a liquidity crisis [00:17:57].
“People were blocked out of their accounts like there was hundreds of mill incalculable amounts of economic loss that I don’t know if that’s gonna wind up being true because all these trades are occurring now and the stock is rock is a rocket ship.” [00:22:15]
The decision to halt buying but allow selling was seen as shutting down “one side of the trade,” giving hedge funds time to regroup and save themselves [00:26:27]. This was seen as a deliberate act that caused “tremendous” economic disruption [00:26:42]. Some questioned if Citadel, who bailed out Melvin Capital, influenced Robinhood’s decision due to their payment for order flow relationship [00:28:00].
Chamath Palihapitiya asserts that Robinhood’s actions caused “tens of billions of dollars” in economic impact and that they were “under equitized” relative to the trading activity they allowed [00:30:44]. He suggests that this problem should have been addressed quarters ago through stress testing and capital planning, similar to what banks must do [00:31:15].
Defense of Robinhood
Supporters argue that Robinhood is responsible for a “revolution in retail trading,” bringing millions of millennials into the stock market through free and frictionless trading [00:16:29].
“I think this is an unprecedented situation with the number of participants. It reminds me of surge pricing with Uber during snowstorms and that also was an unintended thing that you know who knew that it would go up to 400 to take a ride and that’s something that companies will be faced with and they will have to then adjust and then make it work.” [00:32:04]
It’s suggested that the company was caught by surprise by the “hyper growth” and “unprecedented growing pains” [00:23:01]. They believe the company will weather the storm, especially after securing $1.6 billion in new funding [00:18:20]. It is paradoxical that the platform enabling the “revolution” became its perceived enemy [00:18:43].
Criticism of Hedge Funds and Market Structure
Hedge funds are described as “apex predators of Wall Street” who “destroy” companies through shorting [00:24:34]. They are accused of engineering outcomes through tactics like hiring PR people and private investigators, and spreading disinformation [00:24:47]. The high short interest (120-130%) is considered “shenanigans” and a sign of market manipulation [00:15:57].
The financial markets have become a “synthetic casino” or “gambling model,” where trading firms and hedge funds extract wealth without creating value [00:33:10]. In 2020, $121 trillion of notional equity volume was traded in the US, with little of that providing capital to businesses [00:34:05]. This system allows individuals to bet on price movements, where one person wins and another loses, without benefiting the underlying business [00:34:35].
The Long-Term Capital Management (LTCM) crisis in 1998 is cited as an example of systemic risk caused by excessive leverage: LTCM borrowed 4.8 billion of capital, leading to 60,000 trading positions worth $1.4 trillion [00:37:39]. Regulators had to orchestrate a bailout to prevent systemic collapse [00:39:03]. This historical example underscores the need for leverage limits on hedge funds [00:37:00].
Proposed Solutions and Broader Implications
Market Reforms
Several solutions are proposed to address issues identified during the GameStop saga:
- Modern Technology for Share Ownership: Use technology, potentially blockchain, to ensure a share isn’t loaned out multiple times, preventing short interest over 100% [00:36:04].
- Leverage Limits on Hedge Funds: Implement strict oversight and leverage limits on hedge funds, similar to those imposed on banks after 2008, to prevent systemic risk [00:37:00].
- Improved Disclosure: Force all market participants to publish their holdings weekly or monthly to increase transparency and allow watchdogs to identify risks faster [00:39:20].
- Open Trading: Platforms should not arbitrarily decide what can be bought or sold; financial literacy shouldn’t be dictated by a platform [00:39:53].
- Short-Term Trading Tax: Implement a 0.1% tax on every share sold (short-term trading), which could replace capital gains tax and incentivize long-term investing over high-frequency speculation [00:40:12]. This tax could generate significant government revenue and direct capital towards businesses for economic growth [00:41:07].
The Power of Retail Investors and Social Media
The rise of Wall Street Bets and other online forums highlights the growing power of retail investors [00:15:44]. They formed a “trade mob” that challenged the “cartel” of powerful hedge funds [00:25:32].
“Individuals in aggregate can believe something to be true and make it true.” [00:53:23]
This phenomenon is compared to Tesla’s stock rise, where belief in Elon Musk’s vision drove the value, enabling the business to grow [00:53:30]. It’s argued that a stock’s value is not solely based on underlying business fundamentals but also on collective belief and willingness to pay more [01:11:15].
Decentralization vs. Centralized Control and Censorship
The actions taken by Robinhood and other platforms are seen as analogous to the de-platforming of Trump or Parler, where centralized institutions try to block collective action [00:55:13]. This perceived censorship and “economic censorship” are viewed as broadly equivalent to political censorship [00:57:47].
“When the people in power get threatened, they use these rules, they weaponize these rules to shut down the outsiders and the upstarts. That is the problem with censorship.” [00:57:33]
The concern is that when people’s ability to transact or communicate is yanked away, it forces them towards decentralization [00:55:46]. While social networks can enable positive “movements,” they can also foster destructive “mobs” through the “diffusion of responsibility” or “mob behavior,” as seen in events like the Capitol riots [01:04:32].
This highlights the tension between allowing uncontrolled swarming behavior and the need for fair, adaptable centralized systems [01:05:13]. It points to a need for entrepreneurs to focus on decentralization in new systems, including stock trading, healthcare records, and education, ensuring ethical and legal safeguards to prevent chaos [01:08:40].