With the GameStop bubble coming to its foreordained conclusion on Tuesday the broader stock market was having its best day in a while. Internet progress is sometimes measured in pratfalls. The stumble of the free online brokerage Robinhood over its customers’ trading of GameStop actually hearkens to a precedent that has nothing to do with the Wall Street vs. little guy narrative that preoccupies some.
In 1996, dial-up internet pioneer America Online stopped charging by the hour in favor of a flat monthly fee. Unsurprisingly, customers instantly revealed a preference for being online all the time. But a symphony of busy signals exposed an unappreciated fact of AOL’s business model: It was reselling access to the regulated local phone system designed for calls that last six minutes, not all week.
Robinhood could give small-timers free brokerage because it was selling their order flow, and thus information about which stocks were in demand, to other intermediaries. This model worked until its customers drove GameStop to unrealistic heights for reasons of their own. Then a behind-the-scenes plumbing provider, Robinhood’s clearing agent, spoke up. It would not accept the risk of the brokerage or its customers failing to deliver the cash if prices collapsed during the hours or days before trades cleared. It demanded Robinhood put up collateral it didn’t have. So Robinhood curtailed its customers to buying just a single share of GameStop.
Boom. Suddenly conspiracy theories flowed about Wall Street biggies intervening to stop a phenomenon that had harmed their own bets that GameStop would fall (known as short selling).
Like AOL’s, Robinhood’s snafu was partly due to ancient, clunky infrastructure—in this case for certifying ownership of an asset, such as a share of stock or even a person’s ownership of his or her own identity. (Blockchain is the answer many have proposed just as broadband solved the AOL problem.)
But the brokerage’s tripping up is also about something newsier: the internet’s empowerment of quick-forming online mobs that can get a New York Times editor fired or turn a fantasy like QAnon into a cultural phenom.
Naturally some GameStop bulls claim not to have been promoting a spontaneous, crowdsourced price-manipulation episode. They were betting on a turnaround in the company’s mall-centric retail business.
Such capitalist feats are always possible but don’t come along every day for a reason: The marketplace is competitive. Others are seeking the same opportunities, Murphy’s law, etc. Real investors want to be paid for taking this risk. They don’t buy at an inflated price that already reflects the hoped-for turnaround.
So another narrative had to be conjured: Short sellers themselves had manipulated GameStop’s price downward to defeat its resurrection.
This is another failure of understanding of the sort that social media is good at promoting and giving force in our world. Short sellers don’t prevail by manipulating prices but only if other investors decide a security is overvalued (see Tesla).
Short sales, in fact, are indistinguishable from the zillions of trades that cross the tape and are gone in a nanosecond in a market where a company’s entire outstanding shares can change hands in an afternoon. A short is different from other trades in only one respect: Ironically, it creates a legal obligation to buy the shares in the future regardless of price.
Robinhood might have explained all this to its customers, newbies it likes to think it’s introducing to investing.
It might have explained that Wall Street, by and large, is not playing three-card monte. Its big paydays, as well as its big losses, come from a real business of mining valuable information. Market bubbles based on information-less trading, like the one that drove GameStop from $18 to $483 in a few weeks, may seize center stage for a moment. But Wall Street’s information regime reasserts itself eventually. Only the Federal Reserve has enough money to detach prices from underlying realities indefinitely.
The lesson might have been especially useful given people like Mark Cuban, in honor of the GameStop circus, going on CNBC and confusing people about whether stock trading is a game unmoored from any incentive for long-term value creation by business.
With a few explanations, Robinhood might have saved its customers some big losses. The air-clearing also could have been prelude to requiring them to solve its clearing problem by posting enough cash to secure their own trades if they wanted to keep dabbling in GameStop.
I don’t know what was in the head of Vlad Tenev, Robinhood’s CEO, or why he chose the approach he did, restricting customers comically to buying a single share. Maybe he was worried about losing outlaw cred by speaking to them like they were grown-ups (or capable of becoming grown-ups). But here’s betting he also feared the online Visigoths turning on Robinhood itself and using their orchestrated clout to knock its business offline.
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