In January 2021, a videogames company few people had ever heard of made history for one of the largest share price increases in stock market history. Apart from making headlines around the world, the GameStop story – and how it played out – has thrown up some key questions about the future of financial markets infrastructure. How did it happen and why?
In the first Covid-19 lockdown, many traditional retailers suffered from store closures and GameStop was no exception. On the face of it, the company’s old-fashioned ‘bricks and mortar’ business model seemed broken and its stock was at its lowest-ever level, trading at between $2-4 a share.
Meanwhile, over in a sub-Reddit forum on the internet, retail traders who disapproved of the behaviour of institutional investors and hedge funds who were short-selling GameStop stock, decided to have some fun of their own. Members of the r/wallstreetbets group agreed to purchase as much GameStop (GME) stock as possible and not to sell it. This would reduce the number of available GameStop shares to the point that short-sellers would have difficulty finding stock to buy or cover their trades.
The result was a short squeeze, similar to what famously happened with Volkswagen in 2008 when its stock shot up 93%, although with rather different causes. While some members of r/wallstreetbets were certainly interested in making their own returns, many saw this collective action primarily as a form of digital protest against the power of the mighty hedge funds and as a way of punishing the types of high-rolling investors who engage in short selling. Some commentators have even seen it as a generational protest pitting younger millennials against the ‘Boomers’.
Although GME received the most attention, other heavily-shorted stocks (so-called ‘meme stocks’ or nostalgia stocks) targeted by amateur investing forums also got caught up in this period of frenetic activity. Companies including AMC Entertainment (which owns Odeon cinemas in the UK) American Airlines, Blackberry, Nokia and an American homeware store, called Bed, Bath & Beyond, were all affected.
Democratisation of investing?
GameStop has sparked a wider discussion about the so-called democratisation of investment. Apps like Robinhood, which came to play a central role as a broker in the GameStop story, allow retail or amateur investors to readily gather information and trade in options with no commission at the click of a button, and around the clock.
When trading got so out of hand that margin calls sought astronomical amounts and the New York-based hedge fund Melvin Capital was about to go bust, Robinhood called a halt to the trading of certain stocks and was closely followed by other trading apps who blocked and restricted sale of GME and other stocks caught up in the Reddit rally. The decision was especially significant since around 50% of Robinhood’s 13m users reportedly hold GME stock.
Reports suggested that Robinhood made the move to protect investors running pension funds. According to a statement issued by the company” “We made a tough decision today to temporarily limit buying for certain securities…As a brokerage firm, we have many financial requirements, including SEC net capital obligations and clearing house deposits. Some of these requirements fluctuate based on volatility in the markets and can be substantial in the current environment.”
Although the behaviour of the Reddit investors, many of whom traded on Robinhood, appeared not to be technically illegal, such coordinated buying strategies could be considered a form of market manipulation and also raise wider questions for regulators about the mental health impact on potentially inexperienced investors when things go wrong in ways they may never have anticipated.
Lack of transparency – could blockchain help?
Those experienced in the cryptocurrency markets watched the GME phenomenon with great interest, in part because it resembled some aspects of how certain cryptocurrency tokens have been manipulated in recent years. And there was even a direct connection when the cryptocurrency Dogecoin (DOGE) was itself caught up in the mania. Like GME, DOGE attracted attention thanks to the Wall Street Bets group on Reddit, helped along by a TikTok post about the “dogecoin army” from Carole Baskin of Netflix’s lockdown-hit, Tiger King, and a supportive tweet from Elon Musk. Its price rose to an all-time high and was up 822% in a single day.
Aside from price hikes, however, and perhaps more importantly, blockchain advocates took note of GameStop because they believe that the case has similar facets to what happened with Lehman Brothers during the 2008 financial crisis. That crisis, of course, was one of the stimuli for the launch of Bitcoin, which proposed itself as a direct alternative to the failings of the existing financial system.
Whatever your views on cryptocurrency itself, GameStop has shown again that the use of outdated technology to manage financial markets’ infrastructure leads at best to a lack of transparency and inefficient settlement delays of both trades and the posting of collateral. Proponents of blockchain argue that using distributed ledger technology would allow much better facilities for tracking who owns what and when, along with the stricter demands associated with faster settlement. This would potentially free up capital, open up greater access to financial markets and radically shrink settlement times.
As Chad Cascarilla, CEO of blockchain company Paxos, recently argued on the Unchained podcast, the ‘plumbing’ is really the bad guy holding back the entire financial system and the GameStop situation presents an important warning sign for financial markets that an underlying change to infrastructure is desperately needed.
The market volatility created by GameStop unsurprisingly drew the attention of US regulators who held a hearing in Congress to get to the bottom of what happened. Meanwhile the Securities and Exchange Commission also announced it would “assess the situation and review the activities of regulated entities, financial intermediaries, and other market participants”.
During his Congressional testimony, Robinhood’s CEO Vlad Tenev admitted that the business halted trading on its platform because it did not have the funds to back the huge influx of activity created by the Reddit frenzy.
Regulators now have important questions to consider about short selling, the role of hedge funds, and what constitutes collusive behaviour by retail investors and their exposure to trading risks via platforms like Robinhood, as well as the serious ongoing financial and risk management consequences for US financial markets.
Despite further Congressional hearings being planned, GameStop shares surged again on 25 February as the trading mania returned. The GameStop saga is not over yet – and its memes and their ramifications look set to continue affecting financial markets for some time to come.