Your editor here.
The GameStop saga was entertaining. Unless, that is, you are one of the hedge funds caught in a short squeeze – or if you are one of the many retail investors who comprise the $30 billion in value destroyed since the company’s share price fell from its January peak of $483 to $64 on Friday.
Was this a story about the little guys getting their own against Wall Street billionaires? Melvin Capital lost more than half of its $13 billion in capital, while DE Shaw and Two Sigma also suffered losses shorting stocks they thought should go down.
Was this a story about Robinhood and other fintech companies “democratizing finance”? Gamification, great user interfaces, seamless, frictionless trading…gone awry?
Or a story about how those same fintechs had to halt trading as GameStock and other bid-up shares began to tumble, freezing many people’s positions?
Maybe it’s about other billionaires styling themselves as populists to egg on the retail noobs.
Or it’s about the other hedge funds and fat cats, like Citadel, which purchases order flow from Robinhood, or Point72, which along with Citadel recapitalized Melvin.
And while hedge funds who shorted GameStock, AMC Cinemas, Blackberry and a few other unexciting stocks were badly damaged by the retail hordes, those others who went short at the mania’s peak will now be on their yachts lighting cigars with hundred-dollar notes.
I think there are a few obvious lessons from l’affair Gamestonk.
Literacy versus access
First, a great user experience for retail investors should be about financial literacy, not about making it fun and easy to trade, especially when leverage is involved.
Retail investors should have access to many of the opportunities and the tools of professionals. Some of the traders on the Reddit thread Wall Street Bets, where much of the excitement was stoked, are quite savvy. They knew exactly what they were doing. If they want to cross swords with giant hedge funds, let them.
Most retail investors are not this well informed. Money should not be exciting. It should be boring. Compound returns on a diversified basket of index funds is the best way to invest. Can we make a game around getting a lot of Zzzzzs (a good night’s rest) instead of rocket ships and trumpets when you transact?
Trading (as opposed to investing) requires a lot of technical expertise. There is a reason why well-resourced insiders, and/or robots, are good at trading. They’re not in it for sentimental reasons.
If I were a fintech founder, would I see Robinhood’s success and think, that’s my ticket to wealth? Perhaps. But outside of the United States, where the legal and popular culture is unusually permissive, I would be cautious. (Pro tip: don’t encourage stock tips from Elon Musk.)
And if I were a regulator, particularly in an emerging market with a lot of people gaining access to financial apps for the first time, I might consider how literacy fits in with licensing.
Know your domain
The second thing I think I think about this is that a shiny app is all well and good, but it’s the infrastructure that really counts. Robinhood and other online brokers such as Charles Schwab and E-Trade had to halt service at critical moments.
The reason was clearing rules put in place in the wake of the 2008 financial crisis. If brokers were flooding the system with leveraged trades, they had to stump up more capital in the event they needed to cover customer losses.
Robinhood was not alone in this but it suffered huge reputational blowback. First, it is a fintech, not an old-school broker gone digital. Second, its own vibe is all about making trading feel like a game – digital confetti when you place a trade, yay! And its co-founders style themselves as badass rebels.
When Robinhood froze trading, its PR was disastrous. It took them days to come out with a halfway sensible explanation. This is puzzling, because a pair of badass rebel bros should be able to coolly explain that overwhelming demand for their awesome service had overheated the pipes.
The fact that they didn’t do this makes me wonder if these guys actually understood the infrastructure. It would not surprise me if they were learning as they went along. It’s the Silicon Valley ethos.
So fintech founders should take this example and make sure they understand the nitty-gritty. If I were a VC, right now I’d be going through my portfolio companies and grilling the CEOs, basically stress-test the hell out of them, and make sure they’re prepared to turn surprises into opportunities.
Scaling for the future
The third thing I think I think is that Robinhood was right to subsequently complain about the outdated plumbing in the U.S. China has proven that you can run a gigantic capital market on T+0 settlement. The US and many other markets still require two days to make delivery upon payment.
It’s no easy thing to migrate such a vast legacy infrastructure – one that generally works. “If it ain’t broke, don’t fix it,” as the saying goes. The problem with this is that the US isn’t the only capital market in the world, and at some point it will find its 20th century system struggling to keep up with systems designed for the 21st.
If I were a fintech founder, then, I’d be looking to build in markets where governments are pushing to build digital and legal infrastructure that will deliver futuristic efficiencies. That’s how to scale over the next decade without exposing your business to the vicissitudes of an overleveraged bull market.
