The closing of GameStop’s stock trading through its platform by Robinhood led to a great public uproar. As beneficiaries of this outcry, DeFi and cryptography have gained the attention of politicians, retail investors and entrepreneurs.
Wall Street faces huge losses as GameStop shares rise
On January 11, GameStop agreed to an agreement with Chewy.com founder Ryan Cohen to add three Chewy.com veterans to its board as part of a plan to embrace e-commerce and had a subsequent increase of 60 % in the share price.
Just 10 days later, on January 21, Citron Research and short-seller Andrew Left argued that they expected the GameStop value to fall. At that time, a group of retail investors on the famous subreddit WallStreetBets noticed that the video game retailer based in Grapevine, Texas, was sold in more than 140% of its stock.
They started buying call options on the shares and the shares started an unprecedented rise of about 1,500%. This created two main problems for Wall Street.
1. A little squeeze
A short position is when an investor borrows a stock and sells it in the hope that its value will fall. As soon as their value falls, the investor would plan to buy the shares back and return them to the original creditor, pocketing the difference in price. A short squeeze occurs when the short stock goes up significantly and short investors try to buy shares to avoid future losses.
A large hedge fund, Melvin Capital Management, maintained a significant short position on GameStop and struggled to close its position when the price went up. According Reuters, sources close to the fund said he lost more than 30% and obtained a $ 2.75 billion lifesaver from Ken Griffin Citadel and Steven Cohen’s Point72. An Insider article cited exclusive data that showed $ 19 billion in general losses from hedge funds and other institutions to date.
2. A gamma grip
When retail investors buy call options, the institutions that sell them (known as market makers) also buy stocks to protect their risk. When gamma (the rate of change in the relationship between the movement of the option price and the movement of the stock price) begins to rise, the market maker needs to buy more and more shares to protect his risk. This occurred in the case of market makers for GameStop call options.
These two pressures prompted investors with short positions and market makers to try to buy more and more GameStop shares, which pushed prices even higher. This led to the next big twist in this story: the suspension of GameStop stock trading by some major trading platforms, like Robinhood.
Robinhood stops trading GameStop shares on his platform
There are two main ideas about why Robinhood stopped trading GameStop and other shares sold on his platform:
First, Robinhood faced pressure from institutions and market makers to interrupt negotiations.
Citadel is an investor in Melvin Capital, which was hit by Wall Street Bets. Citadel is also Robinhood’s biggest customer. 🤔
– Tyler Winklevoss (@tyler) January 28, 2021
This theory is amplified by fact that that Robinhood earns most of his money by selling his users’ trades to market makers like Citadel Securities (the same institution that tried to bail out Melvin Capital Management). Citadel can then earn money by fulfilling these requests on its own.
The alternative theory is that Robinhood was facing significant solvency problems and that there is no significant nefarious activity between Robinhood and Citadel.
Okay – here’s my best explanation of why @RobinhoodApp restricted short-squeeze stock trading.
Spoiler: the story is not Ken Griffen named Janet Yellen, who instructed the DTCC to increase the margin on Robinhood to force them to end the speculative purchase.
There you go …
– Silent Cal (@KralcTrebor) January 29, 2021
To summarize the topic of Twitter, when a trader buys or sells a share of Robinhood, the deal only closes a few days. During that time, the net value of cash purchases / sales must be paid or received by Robinhood and this is the credit risk.
As explained by the topic, the NSCC deals with this credit risk, but requires brokers to pay a deposit as a guarantee. The idea for this theory is that Robinhood was unable to continue posting these deposits. That would explain why Robinhood had to to draw on hundreds of millions of bank credit lines and why they lifted up a $ 1 billion bridge round of existing investors.
How DeFi can solve these problems
Regardless of which of the two theories is true, cryptography and decentralized finance can help prevent this from happening again.
Decentralized markets for securities such as stocks would be relatively immune to collusion or pressure from outside forces to interrupt negotiations, as the first theory says that Robinhood did. A decentralized market would work with the power of a network of traders and open source, as opposed to the approval of an individual or entity.
Today it showed us that the SEC got it wrong. The problem is not that some crypts can be bonds. The problem is that all titles are not yet cryptographic.
Now is the time to draft a bill that legalizes security tokens.
– balajis.com (@balajis) January 29, 2021
In addition, the credit risk described in the second theory could be greatly minimized by cryptography, since trades would be settled in minutes, not days. Trading would also take place 24 hours a day, 7 days a week, which means traders would not have to wait for the market to open to trade.
This led to widespread recognition of cryptography in the past week. Many retailers started to trade Dogecoin, leading to a 285% drop increase volume in the last 24 hours. Great public figures like Tesla and SpaceX founder Elon Musk, Mr. Beast influencer and Twitter CEO Jack Dorsey also added #Bitcoin to their biographies.
Russel Okung, an OT from the Carolina Panthers and a great supporter of Bitcoin who gets half his salary in Bitcoin, has been asking people to add #Bitcoin to his biography and got responses from Reddit founder Alexis Ohanian Sr. and others.
Whether this pro-crypto sentiment leads to more adoption and growth is something that can be seen, but WallStreetBets’ efforts to squeeze GameStop’s short positions have led to significant attention to crypto innovation. Some cryptographers are concerned about cryptography’s ability to handle sudden adoption, but overall the cryptographic community appears to be excited about the future of DeFi.
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