This week, financial news sources and institutional investors have been crying foul over a wave of individual investors betting against hedge funds. There has been plenty of reporting on the issue this week, but many people are still confused about the situation. Most mainstream coverage focuses on the fact that a large group of self-described “degenerates” have used memes to drive up stock prices on companies that were thought to be on the verge of bankruptcy, but the motivations behind these coordinated investments are often overlooked.
Over the past several months, members of a Reddit forum called r/wallstreetbets began buying and recommending GameStop’s stock using memes. GameStop may not have the brightest future, but the group’s analysis determined that the stock was still undervalued and had room to grow. They also discovered that hedge funds had shorted GameStop to an impossible, and fraudulent level. GameStop’s stock was shorted for more than 130% of its entire worth.
— Elon Musk (@elonmusk) January 26, 2021
If you aren’t familiar with a “short” it is a type of trade in the stock market that is essentially a wager that a stock will go down in the future, and the promise to purchase the stock from a broker at a later date. This type of trading can get extremely dangerous because it can leave the trader overleveraged to the point where they end up owing many multiples of their initial investment, depending upon how much the price surpassed their prediction.
As the GameStop stock price rose, hedge funds that had heavily shorted the company, specifically Melvin Capital, began to lose billions of dollars, and are now facing the prospect of bankruptcy as other hedge funds rush to their defense with billions more to cover their accruing debts and losses.
GameStop’s stock rose from $4 to nearly $300 in just a few months, and as the story began to go viral, the group began targeting other “undervalued” stocks to promote like Nokia, AMC Theaters, and Blackberry.
Billions of dollars were transferred from hedge funds to everyday investors with stock trading apps and a few bucks to spare, which is basically a reversal of what usually happens in the markets. As expected, institutional finance and their media attack dogs went into panic mode. News organizations like CNBC, Bloomberg, and Forbes were quick to shift the blame onto the retail investors and away from the institutions. All major stock trading platforms that are accessible to the average person have suspended trading for the stocks that were being promoted by the Wall Streets Bets group and its growing army of followers. It is important to note that none of these retail traders were doing anything illegal by sharing stock tips online or betting against hedge funds. In fact, if any laws were broken it was on the part of the hedge funds that shorted a stock for more than its worth and the platforms like Robinhood App that halted trading to protect their wealthy partners. Incidentally the ironically named Robinhood is now facing class action lawsuits from its customers for halting their trades of Gamestop in their attempt to protect Wall St hedge funds.
The events this week have exposed the cracks in the system and shown how many central points of control in traditional financial markets keep the economy rigged. This situation has created an even greater demand for decentralization of power and control in financial markets. Many of the newest blockchain projects in the realm of Decentralized Finance (DeFi), already have automated platforms that are essentially run by the community and less vulnerable to the central points of failure that allowed this week’s market freeze to take place.
In many ways, the entire crypto-economy is a hedge against Wall Street and Central Banks. Removing your money from the system gives them fewer opportunities to take advantage of you. In addition, DeFi is now making the traditional financial system obsolete in many ways, and very soon we will no longer even need institutional banks for financial products like loans. The Winklevoss twins, founders of the regulated Gemini exchange, attempted to explain the potential of DeFi to CNBC hosts, but faced some hostile opposition.
The fact that trading was shut down just when the average investor was starting to get ahead has only emboldened this movement and caused it to grow exponentially as lockouts and bans amplify the signal even more, in a classic example of the Streisand effect. This is the start of a new movement, because now people have learned that some of the most corrupt financial institutions in the world have just left their money on these markets for the taking. This past week has shown that everyday people can beat Wall Street at their own game if they join together.