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GameStop, Reddit, and what we all should know about the stock market

Commentary by Erica Kadel |
January 29, 2021
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Chicago, IL - The past few days have seen GameStop and Reddit become the meme-of-the-week and take significant headlines. Some media outlets are saying the recent turn of events “isn’t funny; it’s stupid” while celebrity billionaires like Elon Musk crack jokes on Twitter. Redditors are claiming that they are crashing Wall Street, and yet the market is bullish as ever. What should we be taking from all of this? In short, we must seize this moment to educate about how the stock market works, who it works for, and how we can institute true changes that benefit everyday people.

To understand what has happened, it is important to start at the beginning for a short lesson in what stocks are. Stocks are slices of a business. Stocks like those of GameStock (a video game and electronics retailer) have been sold on a public market. There are many avenues to buy and sell stocks, and the one that’s most important to understand for this tale is Robinhood. Robinhood is a free app marketed toward regular people who don’t have the funds, the interest, or the time to invest through investment firms, hedge funds, and the like. Like its name implies, RobinHood would have us believe that its mission is to steal from the rich and give to the poor, but, as with all free services, if you’re not paying for a product, you are the product.

Robinhood’s business model includes making interest by lending out funds that users have in their accounts and, more insidiously, routing transactions through Citadel Securities. Citadel Securities makes money off of Robinhood transactions and kicks a portion back to Robinhood. Citadel’s agreement essentially means that Citadel is paying for two advantages.

First, Citadel Securities has the option to be the first entity on the opposite side of any Robinhood transaction. If you want to buy a stock, and it’s currently at a $1, when you hit the button to buy, in the milliseconds it takes to buy that stock, Citadel can buy that stock at $1 and sell it to you at $1.01. In fact, this is its whole reason for making the deal with Robinhood in the first place and is called “payment for order flow.” This means that no matter what you may be making off of stocks through Robinhood, Citadel is making money off of you.

Secondly, Citadel Securities has access to all of the Robinhood data; so, not only can they make money off of selling and buying to Robinhood traders, but they also have competitive advantage by getting Robinhood data first and trading off of it. When Reddit decided to buy GameStop, even if it had been planned completely privately, Citadel’s computers would have seen this sudden uptick in buys and traded based on that info before anyone else. Citadel Securities also makes money on selling information about what trades it has made to external buyers, essentially selling the Robinhood information to additional third parties.

There is another entity that’s important to understand before we put all the pieces together: Melvin Capital. Melvin was one of the primary targets of this Reddit/GameStop scheme because Melvin Capital bet the house on GameStop’s stocks going down. Simply, Melvin borrowed GameStop stock, sold that stock at X price, and promised their lender to give them back the same number of stocks at a future date. They are betting that the price at a later date, Y, will be lower than the price they sold them at earlier, X, meaning that they pocket the difference of Y-X. The issue is that if the price of GameStop stock is higher at the later date, then the profit disappears and actually turns into a debt. Melvin would be forced to buy GameStop stock at a price higher than they sold them at. Being forced to buy a stock at rising prices also has the effect of contributing to the further increase in its price, creating even higher prices. And that’s exactly what happened.

GameStop’s brick-and-mortar business model has been going out of fashion, and betting on it to fail seemed to be a pretty safe bet. Many people and organizations, not just Melvin, were shorting GameStop. Redditor day-traders (as opposed to professional traders) noticed this happening and decided to try and pull one over on the big firms by buying up GameStop stock and forcing the firms to lose their bets on the stock falling.

It’s important to note here that even with the price of GameStop stock skyrocketing, there was no change to its assets or business model. Even since this fiasco, there is no reason to suspect GameStop is substantially more valuable in any tangible sense than it was a week ago. Day-traders investing in GameStop on a lark and increasing the share price doesn’t change the fact that the share price will have to fall to reconcile with GameStop’s weakening business position. The point of this scheme is to keep the price artificially high just long enough to mess with those who were profiting off of GameStop’s demise.

Melvin Capital lost an undisclosed, but likely ten-figure, sum on GameStop. Redditors celebrated a victory over Wall Street, but their celebrations are premature. While they did accomplish a laudable act of uncovering the farce that is the stock market, Wall Street doesn’t lose easily. Robinhood froze trading on GameStop as well as other stocks mentioned on Reddit as potential targets for GameStop Scheme 2.0. Melvin Capital was bailed out with an almost $3 billion dollar cash infusion. Interestingly, $2 billion of that came from Citadel. Citadel is not the same organization as Citadel Securities, but they are both owned by the same person and, functionally, it’s not illogical to view what happened as one company that made money off of the GameStop scheme bailing out another company that lost money off the GameStop scheme - leaving those of us in the audience with the odd feeling that nothing has changed.

That’s the key - that’s what’s important. For all of the discourse about bankrupting Wall Street firms, what is being left out is the fact that these businesses are not like us. When we go bankrupt, we lose everything. When they go bankrupt, nothing changes except maybe the name on the building. Even then, the leaders of bankrupted Wall Street firms glide to safety with their golden parachutes, continue to be employed by the firms that buy out their failed endeavors, or simply use their remaining wealth (or that of their friends) to build a new firm. The same can’t be said for any Robinhood trader who got caught up in the moment and invested more than they should have and now is a bit short on rent. The industry remains consolidated, and the system marches forward in growth-for-growth’s sake until the next bubble bursts and we are left to pick up the pieces.

This moment is a lesson. Everyday people are who suffer when the financial industry leaders do wrong.

Capitalists would have you believe that the stock market ‘is’ our economy, that it’s too complicated for us to understand, but that we should trust it because it works for us. These past few days should show us, clearer than ever, that normal people can - and do - understand the stock market and that it doesn’t have our interests in mind.

Tech bros using financial instruments, even the ones with the best of intentions, will not be what brings Wall Street to its knees - at least not for very long. It will take an organized mass movement of real-life Robin Hoods who aim to take power, while taking down Wall Street and capitalism, forever.

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