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Democratizing of Free Markets' Mission Failed

a corporate piece with Marco Schletz at Duke's FinReg Blog

The democratization of finance is the self-proclaimed noble cause that Robinhood1 is pursuing by enabling commission-free investing for everyone. However, recent events revealed that the old saying “if it’s free, you are the product,“ has been successfully implemented in the retail investment world. In this article, we cover the recent GameStop fiasco, Robinhood’s business model, and what it means for a modern retail investor.

GameStop Fiasco

It all started with GameStop (NYSE: GME), a US video game retailer, and initially, a small group of retail investors that liked the stock. These retail investors used chat groups, most notably the WallStreetBets (WSB) forum on Reddit, and their investment platforms, such as the popular Robinhood app, to drive up the price of GameStop shares.

At the time, GME was massively shorted and the WSB community identified the opportunity to trigger a so-called short squeeze. This is when the price of the stock goes up and the shorts, in this case a number of hedge funds, have to purchase additional shares to close their posistions which drives the share price continuously higher. As a result, GME went from $10 in October 2020 to over $325, causing the hedge fund Melvin Capital Management to lose 53% of $12.5 billion in assets under management. As a result, Melvin received an emergency liquidity injection of $2.75 billion from Citadel LLC and Steve Cohen’s Point72 Asset Management2.

The price continued to trend higher with more and more investors joining the GameStop frenzy, with the stock reaching almost $500 on January 28th. Then on the 29th, something unprecedented happened. Robinhood and multiple other platforms restricted trading for GameStop and some other stocks prominent in the WSB forum, such as AMC Entertainment, Nokia, BlackBerry, and Pearson. More precisely, Robinhood halted the buying of GameStop shares but continued to allow the selling of shares. As the major trading platform for most WSB traders, Robinhood’s decision caused a drastic sell-off of the GameStop shares by almost 75% (see Figure 1), arguably saving Melvin, Citadel LLC, and Point72 billions of US dollars.

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Continue on: Duke FinReg Blog

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