Robinhood Can’t Democratize Finance Using Old Tools

Despite its best efforts to the contrary, Robinhood did end up stealing from the rich and giving to the poor.

Melvin Capital, the $8 billion hedge fund that didn’t find GameStop (GME) funny, lost 53% of its portfolio in January ($7 billion) trying to short against the rallying cries of the Reddit Capitalist Union. Founder Gabe Plotkin also faces the embarrassment of having to get bailed out by his old boss.

Ken Griffin, owner of the Citadel hedge fund (an investor in Melvin), and Citadel Securities (a massive market maker and buyer-of-order-flow for Robinhood), is seeing capital losses in the former and Washington, D.C., cries for scrutiny into market structure in regards to the latter.

Robinhood itself – which, for goodness sake, is not Wall Street but as Silicon Valley as it possibly gets – raised $1 billion immediately to protect itself from class-action lawsuits, DTCC capital calls and a now-rapidly closing IPO window. That means Yuri Milner of DST Global chipping in yet again.

That’s at least four people that have had a very bad, no good day.

The Reddit WallStreetBets army has eight million members. Robinhood has 13 million users. These are the opposing forces. They are, loosely speaking, having a pretty good day.

This isn’t about how much money you have. This is about a mindset and a framing of the world. It’s about who you are and who you are not.

But other billionaires are having way more fun. The world’s richest man, Elon Musk, is raising the crypto rallying flag and ex-Facebook billionaire Chamath Palihapitiya is trading along with Reddit for quick profits, decentralized hedge fund and all. This isn’t about how much money you have. This is about a mindset and a framing of the world. It’s about who you are and who you are not. And it’s about what you did and did not do.

Do you side with the internet’s gamer heroes, wearing Nyan cat shirts and crying out sarcastically for “moar Stonks, money printer go brrrr, number go up”! A post-Gawker-4chan swirl of human vectors, coalescing into one giant middle finger to every Karen and Ken? Dopamine splashing out from our pituitary glands into a vortex tornado of well-earned resentment.

Or, do you like your finance suited, ministerial, administrative and gated? Do you think it is storied, respectable and important. That you have to go to HYP and then do your “two and two” at Goldman and HBS before hopping to KKR or Tiger or SAC and then into your own cozy fund? All that work, all that sweat for the GMAT and the SAT and the bootlicking, to be undone by someone literally making fun of you in the language of money.

It’s not about some truth about Wall Street or Silicon Valley or the internet or bitcoin or decentralized finance (DeFi) and least of all about GameStop (GME). Those are just flags of our armies. And we are at war with ourselves.

GameStop is a mall shop that sold video games. The mall shops that rented videos (Blockbuster) or sold books (Borders) are bankrupt and rightly dead. The internet, and its children Netflix and Amazon, killed them. And yet, their names are etched into the collective childhood memories of millions. GameStop has no chance against Steam or Epic – both brands that are also deeply loved by nerds all over the world. We say this as self-incrimination. And yet, GameStop is a symbol, a feeling, a reminiscence.

The person building financial models and analyzing this stuff according to economics is “right” to point out bad things about “fundamentals” of the business. Within the game of financial capital markets, the fundamentals are the gears of the economic machines that you evaluate with capital decisions. You buy good fundamentals, says Warren Buffett and you sell bad ones. Another Warren, U.S. Sen. Elizabeth Warren of Massachusetts, also believes in fundamentals. She believes in them so much she wants the government to regulate them into the market and “fair, orderly and efficient function.”

All that might be right, and we are not doubting the wisdom of John Maynard Keynes or the animal spirits. But Warren Buffett is no longer number one. It’s an Elon Musk world now.

Fundamentals are what the financial doctors will tell you that you have. Do you think the internet cares about their diagnosis? No. The internet cares about being patronized by people in coats. Musk and Chamath are the mushrooms of the internet. It is in their DNA.

The GameStop trade itself is worth a pause. While some of the original thinking by DeepF**kingValue that led to his $30+ million capital gain reflected on the GameStop business, the core insight was market structure. The trade was not about GameStop beating its analyst estimates or any of that boring-play-by-the-rules stuff. It was about a short squeeze. It was about restricting the supply of the stock in such a way as to blow up a levered short bet that Melvin Capital was putting into play.

In other words, we are talking about the meta-game, not the grunt Excel spreadsheet game. SAC, Tiger, Point72, Melvin Capital and every other hedge fund worth its salt plays the meta-game. That’s the whole point. You get a PhD in financial instruments by doing the work and testing the levers rather than believing in them blindly. And WallStreetBets dared to play the meta-game as well. Retail investors aren’t supposed to self-organize into a hive-mind of levered derivatives strategy driven by spite. And here we are.

To go short, Melvin has to borrow. To borrow, you have to pay an interest rate. To cover your short, you have to buy back the stock. You’re paying an interest rate and have to buy back the stock. Nobody is selling you the stock, because they hate you. Everyone is buying, to troll you specifically. They are levering up with options. And you keep raising your bids until you cover your position.

Robinhood is a broker/dealer. It came into being in Silicon Valley, a place where consumer services are free because they are actually not services but honeypots that aggregate user demand, package it at large scale and re-sell attention to advertisers. Such is Facebook and Google. Our lives are better because of these services, but also compromised and profoundly insane.

Robinhood uses this playbook to aggregate consumer demand with the honeypot of free trading, and then sends it to market makers like Citadel Securities and gets paid $600 million for the orders. TD Ameritrade and eTrade and other discount brokers do this, too! But Robinhood does it most, and does it best. Check out our prior explanation with Paul Rowady here.

There is nothing unusually nefarious going on. It is just American capital markets structure and a clever lead-generation arbitrage. That is, if customers are still getting best-execution with Citadel. But the structure is ancient by modern technology standards, and far from real-time. It takes two days for a trade to settle, and this among other reasons leads to a requirement of capital to be placed with a “clearing house,” in this case the DTCC. Given the volatility in GameSpot caused by the internet trying to break a hedge fund the way George Soros broke the Bank of England, capital requirements skyrocketed tenfold.

Robinhood, as well as TD Ameritrade, ended up restricting trading in the instrument as a result of this capital call. If you are burning and raising a billion dollars per year, you probably don’t have a “tenfold” of cash lying around to give to the DTCC to make it feel comfy. So, you know, it just removed the “Buy” button for a whole bunch of crusaders on a mission with their capital on the line. They didn’t remove the “Sell” button, thereby throwing fire on the internet conspiracy meme machine.

Was this done on instruction from Citadel billionaires? Was this the banksters colluding against the common person? Was “Wall Street” trying to take away our constitutional freedom to trade on a mobile app? Even U.S. Sen. Ted Cruz and Rep. Alexandria Ocasio-Cortez found common ground in finding someone to blame!

It’s not a lot of rioters yet.

But remember, fintech – including Robinhood, Revolut, SoFi and the rest – is supposed to democratize access to financial services. That meant very little a decade ago, and “dumb money” was disorganized and uninformed. Now, information is free and available to all. Equities trading is largely costless and frictionless. And the scariest part, for the suited part of finance anyway, is that strength lies in numbers and can now self-organize.

In addition to this, we have the crypto currency ecosystem. Unlike fintech, which went after distribution, blockchain goes after manufacturing. If you are a trader or market maker on Ethereum, there is no clearinghouse. There is no broker/dealer. There is only you and the distributed machine with its smart contracts, automated rule sets and software-enforced property rights. All data is real-time. The blocks click into being one after another without a single lawyerly piece of paper in sight. Hundreds of millions of people in the world have touched this asset class and it renders financial intermediaries unnecessary in their imagination.

Now don’t get us wrong. A trade on Ethereum is going to cost you $10 to $100 today, and another 1% in slippage. It is going to cost you some immeasurable but ever-present probability of cyber risk and regulatory overhang. But you nobody can take away your “Buy” or “Sell” button, and the speed and scale issues are mere technical problems to be solved by the entrepreneurial gods.

Here’s the rub, post-fintech-crypto-democratization and all.

Humans are social animals. It is in our bones. The concept of fairness has been selected through the evolutionary filter and fueled a cooperation-based multi-billion person civilization. 

Democracy is not oligarchy. Democracy means each person has one vote. If you were to vote according to assets under management, which is how finance has done it to date, you get very different outcomes than when you vote person by person. Now we have a set of promises and representation from companies like Robinhood that suggest a democratic empowerment of individuals to access the storied products of finance. Most people don’t know, or want to know, how the actual machine works. When the promises have a gap to reality, because of whatever reason, this creates kinetic energy for Twitter and Reddit.

It creates energy for people in the position of leverage who understand the machine, and want it to change. Elon Musk hates short-sellers for their damping, and perhaps manipulating, effect on his promises of Tesla greatness. Certainly Chamath, having launched endless SPACs to take Silicon Valley fintech distributors like SoFi public, understands the machine as well. For them, this tear in the fabric of reality is a power. It is a rallying cry.

Retail investors aren’t supposed to self-organize into a hive-mind of levered derivatives strategy driven by spite. And here we are.

If we really want to put this into dystopian context, let’s at least reference the theory of overcrowding elites from Peter Turchin. The historian eerily predicted the 2020 rioting and disaffection back in 2010, suggesting that societies fall apart when they over-produce members of the ruling class. Education has minted PhDs, MBAs and entrepreneurs who have no seat to inherit from a retiring predecessor. As a result, they take on the populist mantle and position themselves as outsiders to attack the insiders, while of course being fabulously gifted. Thus Donald Trump and all the rest.

If you are holding power today you probably don’t want everything to fall apart just because Redditors hate a caricatured notion of hedge funds. So you tweak things at the edges. Edit out the glitches in the current matrix. It is through this lens that we see Google deleting 100,000 negative Robinhood reviews for being “inauthentic.”

Of course they were coordinated. But they were very authentic to the people who wrote them. They were, however, “inauthentic” to the current rule-set of the game. Based on fundamentals, market structure and a variety of other “this is how things work” explanations, Robinhood did nothing wrong. Nor did Melvin, really, as far as we can tell from the media coverage. It just played a game that has become a cartoon that millions of people despise. Google’s app store is also an incumbent, a rule-set as well of what constitutes good behavior and what you should do according to its Terms, and so on. Protecting Robinhood’s reputation because it did not fundamentally err is what you do when you believe the current system works.

What’s also notable is that TD Ameritrade and other brokers that couldn’t support trading didn’t get such a backlash. The answer as to why is obvious. The brand promise of Robinhood is to bring in a new world, which it simply can’t do using old-world tools.