Centralised vs. Decentralised: Was Gamestop just the beginning?

Wyndham Plumptre

·

Feb 18, 2021

A lot has been written already about the meteoric rise in a US stock Gamestop (GME). However, what is not being widely discussed is the implications of the battle that has occurred over the course of the last few weeks and whether this is a sign of things to come. I have watched each twist and turn, fascinated by the sociological factors at play and how this could be a big insight into things to come.

In short, was this the first very public battle of traditional centralised vs modern decentralised structures and who was the clear winner?

A quick recap for those that don’t spend their day submerged in the world of Reddit! For decades Hedge Funds have had the weight of $bns sometimes $tns of capital behind them to work the stock market, often readily affecting the price of a stock to the detriment of smaller retail investors and often the company itself. This is part and parcel of the modern financial system we have built over the last 50+ years. They do this through either taking a long or short position against a specific stock and more often than not due to the size of the investment causing the stock to move in the direction of the long or short position. This is magnified by copy-cat funds or retail investors and PR put out by the Hedge Fund e.g. Citron’s campaign against Shopify in early 2019. This is exactly what was happening with Gamestop over this week with Citron and Melvin Capital (renowned hedge funds with a short strategy) both holding vast short positions in Gamestop.

To date, digital technology has not enabled the crowd to consolidate in a way that enables retail investors to go toe to toe with some of the bigger funds. However, the democratisation of investing that has occurred over the last couple of years through platforms (that gamify trading and make it frictionless e.g. commission-free) such as Robinhood has created a shift. That shift realised itself over the last week.

For those that may have missed the news (for those that didn't, feel free to skip this paragraph). A group of retail traders noticed the short positions held by Citron/Melvin on Gamestop and discussed a strategy on Reddit on how to go up against the funds and see if the crowd could apply pressure to the shorts and ultimately break them. A couple of weeks ago they started placing long positions on the stock increasing its price. Such is the power of social media that it quickly became the latest viral sensation. The difference here is everyone was investing and the money meme snowballed upwards day by day. It then all broke on Thursday 21st of Jan when it became clear that the crowd of small retail investors had essentially beaten one of the hedge funds (Melvin) at their own game, reportedly causing a loss of $3.5bn and nearly bankrupting the fund. On the flip side, some of the Reddit members in the WallStreetBets discussion group apparently made close to $25m.

The key question now for most people is why should I care? And why was this a battle to take note of? This week was so much more about who made money and who lost money. It was about the power of digital technology, the power the crowd can create and the power of existing infrastructure to try and stop it.

The activity above has been going on for decades within Hedge Funds and other financial institutions where the weight of their funds and balance sheets enables them to make an extensive amount of money at the expense of the ’little guy’. A true David and Goliath themed story where the crowd, through the democratisation of technology and learning, and turning into David. 

What the progress of digital technology has created is the ability for humans to organise themselves in a different way using democratised technology at their fingertips to level the playing field with larger organisations/institutions. This was evident in the battle of Gamestop 2021.

It evidenced that the crowd could go toe to toe with big organisations and have a chance of winning. This will have a material impact on the financial markets and broader markets in the years to come in a way we currently cannot fathom. This is also not new and has been brewing for the best part of 30 years since the birth of the internet. What this event showed is that we are at the precipice of change that could rewrite the rule book.

One of the key challenges that came out of this was with new retail investor focussed trading platforms e.g. Robinhood and an old stock market process of settlement periods. To explain in a little more detail, all securities have two key dates, the trade or transaction date and then the settlement date which is the date the security changes ownership. The difference is known as T+1,2, 3 etc. explaining the duration between. Critically, the settlement date is when you are noted in the company books as a shareholder. The issue here was that the clearing houses that support trading of this nature work on a trade T+2 day settlement basis and could not keep up with the volatility. This then required Robinhood to request liquidity from Citadel to the tune of $2bn and in closing the buy functionality on the platform. Since this has occurred Robinhood has gone on the front foot becoming a leading voice to drive real-time trading and settlement in the industry, something that has vast costs and implications associated with it.

This series of events could be somewhat an anomaly which many will pass off as a co-ordinated ‘pump and dump’ at the expense of retail investors. But interestingly what it exposed is the need for a more decentralised, transparent system, and perhaps the revolution of the archaic trade + 2-3 days settlement times to ensure that trades are executed and settled instantly. Many will also take issue with the fact that Robinhood disabled the ‘buy’ functionality whilst retaining the ‘sell’ functionality on their platform - despite there being significant technical, clearing and settlement and collateral challenges that warranted this action. Many will feel it was an act designed to protect hedge funds and Wall Street at the expense of the retail investor.

The only thing the above has achieved for central institutions is the increased mistrust that retail investors have. The only route for them to go now is to organisations that are more decentralised or crowd governed. And that is the key. That is what the new decentralised organisations have been building and waiting for which may very well open the door to the world of DeFi (decentralised finance) for the masses. 

Where do we see this all going? Well, this is definitely only the start of an extensive series of battles that will occur as DeFi starts to scale with decentralised systems and centralised systems running in parallel. DeFi is becoming more and more reputable as each day goes but with systems gaining increasing technical and scale based maturity. Centralised systems are going to have to fix systemic issues in order to survive such as transaction/settlement days. Robinhood’s lobbying since the GME instance is a clear indicator of ‘lets change or we will find a better way’. The crowd has spoken with one clear voice.

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