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GameStop, Hedge Funds, Robinhood, and Blockchain

For those of you who haven't heard, the stock market and social media is going absolutely wild right now in a battle that pits wealthy hedge funds against amateur investors from Reddit's "wallstreetbets" subreddit. Recently, hedge funds have been loosing billions of dollars after amateur investors foiled their attempt to "short sell" GameStop stock. In this article, I'll explain what's why the hedge funds lost billions, the "Revenge of Wall street", and how crypto plays a role in all this. 

Background Information

To start off, we need to go over some basic terms.  A hedge fund can be through of a as a financial partnership that allows investors to pool their funds and use aggressive strategies to try and beat the market and deliver profits. Because hedge funds employ riskier (but also potentially more rewarding) strategies, they are considered private investments in the US which means they can cater to high wealth individuals. This has led to associate hedge funds with the "1%" and "big money" for lack of a better term. 

Part of the investment strategy for some hedge funds is something called a "short sale". When a fund buys stock in the "normal" way, they are looking for a stock that will hopefully rise in price and be sold for more money later on. With a "short sale" a hedge fund looks for companies that are struggling and not doing well. They will then "borrow" shares in that company and sell them. The idea is that a hedge fund can borrow shares and sell them now, and then as the company falls further, it can rebuy the shares at a lower price to repay the investors that they borrowed the shares from.  Its a bit complex, but the key to remember is that during a short sale, the hedge fund makes MORE money as the price of the stock goes lower and looses money when it goes higher.

GameStop

As part of their profit maximization strategy, Citron Research (a hedge fund) suspected that GameStop was a struggling company and decided to initiate a short sell of the stock. A subreddit called wallstreetbets countered the hedge funds by making a group effort to begin purchasing shares of GameStop (GME Ticker symbol). Remember that during a short sale, the hedge fund wants the price of the stock to go down, not up, so every price increase in GME meant less profit for the hedge fund. As the price continued to rise, the hedge funds saw their potential profits flip to losses. 

Many people viewed the GME pump as a way of "sticking it" to hedge funds and saw the struggle as a battle between average, everyday investors and wealthy hedge funds. As the news of the price struggle spread, more and more people jumped on board to pump the price of GME. Even Elon Musk contributed to the action by posting a link to wallstreetbets on his Twitter account with more than 44 Million followers. As the price climbed ever higher, the losses for the hedge funds mounted. 

Wall Street Strikes Back

For a brief period, it looked as if "little guy" investors were finally able to give Wall Street a taste of its own medicine, however, Wall Street's allies were quick to come to the rescue. On the 28th of January, some trading platforms including Robinhood prevented users from buying GME but still allowed them to sell GME. People were quick to realize that this decision to only allow selling had the (perhaps intended) effect of making things easier for the hedge funds while (once again) penalizing average, everyday investors. Since only sell orders were allowed, many people saw this decision as trying to help drive down the price of the stock and prevent the hedge funds from loosing money. 

Many people, including members of Congress, saw this as just another example of how the markets are rigged in favor of wealthy corporations and pointed out the hypocrisy of not allowing people to freely trade stocks. 

And This Applies to Blockchain How??

The ability to exchange value without the need for financial middlemen is a core component of cryptocurrency and blockchain technology. For example, cryptocurrencies like Ethereum or Bitcoin Cash can be sent anywhere in the world without the permission of a government, corporation, or other "gate keeper." Many people know that Bitcoin (and other cryptos) are a decentralized way to send "money", but blockchain has the power to revolutionize the existing financial system by tokenizing traditional financial assets like stocks and real estate as well. 

When an asset like real estate or stocks are tokenized, they are represented as a digital token. These digital tokens can be bough, sold, traded, and exchanged without governments, corporations, or middlemen just like traditional cryptocurrencies. Representing shares of ownership in a corporation as digital tokens solves many of the problems that we saw with Robinhood. Whereas a company like Robinhood is able to freeze investors assets, prevent them from trading, and assert control, tokenized assets are immune from this centralized control. If GME was instead issued as a token on the Ethereum blockchain, it could be traded anywhere in the world as long as you had an internet connection. 

To be fair, this technology is still relatively new, and the only service I am familiar with for tokenizing real world assets is the RealT platform that tokenizes real estate. However, I believe that Robinhood's (and other platforms) decision to limit trading to support wealthy hedge funds will be a wakeup call for many people and that we will see an increase in the demand for fair, open, decentralized, permission less, alternatives in the future. 

Summary

Bitcoin was developed in the aftermath of the 2008 financial crisis and showed people that it was possible to build a fair monetary system that operated in a decentralized way. Tokenization of real world assets and Decentralized Finance (DeFi) promises to extend this decentralziation and build an entire network of financial services (borrowing, lending, trading, exchanging) that operates in a fair, predictable, transparent, and equitable way. Tokenization of real world assets gives people true ownership of their assets unlike the existing financial system in which we must trust banks and stock brokers to be custodians of our accounts and only allow us to buy or sell if we meet all of their conditions, and I expect to see a dramatic increase in the use of tokenized assets in the future.

As always, nothing here is financial advice. 

Thanks for reading!

 

References

https://www.investopedia.com/ask/answers/173.asp

https://www.fool.com/investing/2021/01/22/wallstreetbets-declares-victory-as-gamestop-stock/

https://twitter.com/elonmusk/status/1354174279894642703

https://abcnews.go.com/Business/robinhood-abruptly-restricts-transactions-gamestop-stock/story?id=75537922

https://twitter.com/AOC/status/1354830697459032066

 

Image Credits

https://freesvg.org/rich-mans-strut-vector-clip-art

https://www.redditinc.com/brand

https://realt.co/https://uniswap.org/faq

 

 

 

 

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