From the Big Short to the Big Squeeze; GameStop’s Viral Rebellion and the Growing Need for DeFi
In 2015, Hollywood released the wildly entertaining and critically acclaimed film The Big Short, telling the story of the big banks and financiers that crashed the economy less than a decade earlier. In the film, Wall Street investor Michael Burry discovered that the subprime loans propping up the housing market were in danger of defaulting. He dug deep and found that the loans being lent by the bank would not be able to be paid back by the homeowners, which would ultimately lead to a crash in the market. So he bet on it. When an investor “shorts” a stock, they are betting the value will go down. They borrow the stock from a brokerage and sell it, hoping the price will drop and they will be able to buy it back at a lower price to return to the brokerage they borrowed it from. Burry took out shorts on the housing market and was right, making huge amounts of money when it all came crashing down in 2008. In that story, Burry and the other shorters were the heroes.
So how did we get here, years later with a standoff between the public, led by Reddit’s r/wallstreetbets community on one side, and the short sellers such as Melvin Capital, backed by big institutions on the other. Well, for one, Michael Burry shorted the housing market based on the instability he discovered in the underlying loans. He was playing the traditional and regular role of the shorter in a market, profiting when they discover reasons for a company to lose value, discouraging fraud and keeping a company or an industry honest. However, there’s nothing fraudulent about GameStop as a company. It’s an old school brick and mortar retail chain with thousands of employees that most millennials have fond childhood memories of. It also happens to have some fundamental issues with its current business model that have been exacerbated by the Covid pandemic, but added Ryan Cohen, the former CEO and co-founder of e-commerce giant Chewy to it’s board early this year, pledging to turn the company around. Melvin and other shorters were betting on, and further driving GameStop’s failure, not exposing fraud.
To make matters more interesting, hedge funds apparently over leveraged their risk by betting that GameStop would go bankrupt and they wouldn’t have to pay anything to buy the shares back so they lent out nearly 150% of the total amount of GME shares out in the market. They sold these shares at prices significantly lower than the current price, and since people are holding their shares and are so far mostly refusing to sell, the price keeps rising as the shorters eventually need to buy them at whatever price they can to cover their positions. As owning shares of GME went viral and record amounts of people downloaded Robinhood and other retail trading apps just to buy GME, the public witnessed what appeared to be blatant attempts at market manipulation, further entrenching it as a movement, not just an investment move. People were literally refusing to cash out life changing amounts of money simply to stick it to the man.
To top things off, the evening after Jim Cramer called into CNBC from a hospital bed to tell people to take their home run and go home before they lose all their money and encouraging them to sell, a video surfaced of an interview he gave in 2006 in which he described the tactics his hedge fund used to manipulate stock prices, including calling in favors to talking heads on CNBC.
This struggle also exposed something else, something deeply fundamental about the power the individual investor has in the markets. On Thursday, January 28th, Robinhood restricted the ability of its users to buy, but not to sell, shares of GME and other stocks that were targeted for their short positions such as AMC Theaters, BlackBerry, and Nokia. This essentially cut Robinhood’s users out of the market and enticed them to sell while they still could. Several other popular trading platforms took the same action on the same day. Predictably, the price plummeted as people panicked and sold. While the price dropped and millions of retail investors were locked out of buying, this had no effect on the ability of institutional buyers to buy these stocks, allowing them to cover their positions by buying the shares they owe at lower prices. Robinhood’s users trusted the company to stick to its mission of democratizing finance and to not to do what it did, and they were betrayed. People thought they were participating in a fair and free market, but what happened Thursday revealed that the hedge funds and institutions can change the rules as they see fit. While no outright collusion has been proven yet and any accusations are speculation, the actions taken by multiple parties to restrict retail traders was highly irregular and suspicious, and regulators have promised to hold hearings to look into it.
Just as the global economic crash and subsequent bailout of the big banks in 2008 at the very least influenced the creation of bitcoin, this could be Decentralized Finance’s moment. DeFi is open 24/7, highly transparent, and eliminates the need for trust. A clear comparison can be drawn between the type of handpicked stock halting Robinhood engaged in and the sheer impossibility of that happening on a decentralized exchange such as Uniswap, where you can exchange Ethereum based tokens without trusting a centralized authority. Uniswap is simply an app based on a smart contract, sophisticated lines of software code that automatically processes operations and thus can’t be halted by any one person. It sources its liquidity from its users, with individuals staking their assets for a share of the fees generated. Pulling down an asset would require mass coordination between untold amounts of individuals. No one can restrict peoples’ ability to buy whatever they wish.
Of course, this comes with the risk that literally anyone can create a token and scam people into it and there’s no regulating body to take it down. It requires people to do their own research and fully understand the technologies they’re using and the assets that they’re buying.
In light of the recent events, hugely influential names such as Elon Musk and Mark Cuban have come out endorsing crypto in various ways. Musk changed his Twitter profile to a single word, “Bitcoin”, and Cuban posted a Twitter thread on the need to move to DeFi, and indeed, we’ve seen a general uptrend in DeFi tokens during this standoff. The DeFi Pulse Index, a token that tracks the top blue chip DeFi assets such as UNI, COMP and AAVE, has risen nearly 35% in the past week, from $250 to just above $300 at the time of posting.
This is far from over with Robinhood still restricting buying going into Monday. While these events could lead to further disillusionment, it could also present an opportunity for change. With popular billionaires voicing their support of the retail investor, and public and political sentiment on both sides of the aisle turning against a system seemingly so easily manipulated by the likes of Robinhood and hedge funds, we could see a push for further developments of decentralized systems. In fact, projects such as Synthetix and FTX are already working on tokenizing individual stocks. As countries such as Japan and Australia begin to transition their stock exchanges to blockchain technologies, it could be only a matter of time before the US follows suit.
Thanks for Reading. Cheers!
-JefeDIx
