Stealing from the Poor to Endow the Rich: The Robinhood Irony


On March 23, 2016, Robinhood, a little-known brokerage app at the time, tweeted “Let the people trade.” By 2018, the app was on the forefront of ‘democratising finance’. It was easily accessible and did not charge fees to small retail investors. Robinhood soon became a favourite of Discord servers and sub-Reddits world-wide. Arguably, Robinhood’s could easily fulfil Friedrich Hayek’s formula for a free market. The app enhanced the freedom to consume, freedom of the seller, freedom of the producer, freedom from government interference, lower cost of trading and the promotion of democracy (Hayek, 1943). The stockbroking middleman was eliminated thus the system transitioned from indirect representation to direct as well as cutting out extra costs. As its moniker claims, Robinhood was truly a saviour of the small retail investor. That was until January 2021 when Robinhood betrayed their central method to placate large Wall Street Funds.


On August 14 2020, Melvin Capital- a New York based hedge fund, through a Form 13F filing, disclosed its positions on 91 stock placements as a requirement for using the options market. It was no surprise that the hedge fund planned to short Game Short, most Wall Street Funds held the same position. GameStop had an archaic business model – most gamers prefer downloads as opposed to physical copies of games. It’s the average gaming equivalent to Blockbuster- which had a much similar fate in this conflict.


On October 27, after Melvin Capital announced its position, a reddit user, ‘stonkflyingup’ released a video on the r/Wallstreet bets message board titled “GME short squeeze and the demise of Melvin Capital”. By January 28, only 60% of the fund’s assets were under management and the GameStop share price (GME) was up over 1625% at the end of January. After reddit user ‘Longjumping’ posted that he paid off over $23,000 of his student loans using the profits he acquired from the GME stock pump, other members of the subreddit and internet users were compelled to pump other stocks widely bet against by large Wall Street firms and funds including Nokia (+75%), AMC (+400%), Tootsie Rolls (+44%), Dillard’s (+62%) and Macy’s (+44%) (LeVine, 2021). On January 26, Robinhood had limited trading options on 13 companies which occurred suspiciously after Wall Street clearinghouse mandated a 1000% increase in the firm’s deposit requirement. However, Chamath Palihapitya claims that this is untrue as Robinhood was insolvent (CNBC, 2021). This number skyrocketed to 50 on January 29 and dropped to 8 on February 1 to include GameStop (GME), AMC Entertainment (AMC), BlackBerry (BB), Koss (KOSS), Express (EXPR), Nokia (NOK), Genius (GNUS) and Naked Group (NAKD).


In a CNBC interview on the 28th of January, Robinhood CEO Vlad Tenev claimed that he decided to halt trading options of 13 companies to “protect the firm and protect the customers”. While Tenev’s reasoning can be widely agreeable, the markets are incredibly volatile which may be harmful to inexperienced traders, the actions of the company completely contradict the tenets of the free market.


According to Eugene Fama’s Efficient Market Hypothesis (EMH), share prices “reflect all information and consistent alpha generation is impossible” therefore, stocks always trade at their fair value (Fama, 1970). Though this theory is controversial and has been commonly critiqued by Warren Buffet and behavioural economics- per the 2008 housing crisis and the Dow Jones crash. By manipulating the markets in favour of larger funds such as Melvin Capital and Citadel, according to the EMH, Robinhood was forcing stocks to trade at an unfair value thus inhibiting the freedom to consume, the freedom of the seller and the freedom of the producer according to Free Market Theory. Fama also posits that:


The current price of a security obviously "fully reflects" all available information. But a frictionless market in which all information is freely available and investors agree on its implications is, of course, not descriptive of markets met in practice.


By withholding information on transactions and trading options, Robinhood effectively rendered the market inefficient. Likewise, Robinhood limiting stock trading options while large Wall Street funds use the Short Ladder Attack to drive down the price of these stocks can only be seen as unfair market manipulation. Another unfair advantage would the amount of capital hedge funds pour into their protection such as investing in scraping bots that predict future trades which retail investors cannot afford. While this is not market manipulation, it certainly creates a massive imbalance. Likewise, free market theory postulates that an efficient market would correct itself without manipulation, the share prices would have been corrected by equity valuation. One can only wonder the impact of the firm antagonising its target market on its upcoming IPO.


In essence, Robinhood, the wrongly perceived hero for retail investors manipulated the markets in favour of colossal hedge funds. According to free market theory, intervention by the institutions charged with democratising finance is far more . Similarly, we were unable to watch Eugene Fama’s prediction that markets correct themselves in his Efficient Market Hypothesis (though it was horribly disproved by the 2008 Housing Crisis). Robinhood ironically became the advocate of massive Wall Street funds in lieu of its long awaited IPO.


References:


Aliaj, A., Mackenzie, M. and Fletcher, L., 2021. Melvin Capital, GameStop and the road to disaster. [online] Ft.com. Available at: <https://www.ft.com/content/3f6b47f9-70c7-4839-8bb4-6a62f1bd39e0> [Accessed 8 February 2021].


CNA. 2021. Melvin Capital ends month with over US$8 billion in assets after investors added cash: Source. [online] Available at: <https://www.channelnewsasia.com/news/business/melvin-capital-ends-month-with-over-us-8-billion-in-assets-after-14082744> [Accessed 8 February 2021].


Garber, J., 2021. GameStop drama dings Robinhood IPO, CEO firmly at helm. [online] Fox Business. Available at: <https://www.foxbusiness.com/markets/robinhood-ipo-ceo-at-helm> [Accessed 8 February 2021].


Hayek, F., 2001. The road to serfdom. London: Routledge.


Levitz, E., 2021. Robinhood Banning GameStop Proves the Free Market Is a Lie. [online] Intelligencer. Available at: <https://nymag.com/intelligencer/2021/01/robinhood-ban-gamestop-share-price-explained.html> [Accessed 8 February 2021].


The Independent. 2021. Reddit users claim victory as $13bn hedge fund capitulates on GameStop. [online] Available at: <https://www.independent.co.uk/news/business/gamestop-share-price-reddit-hedge-fund-melvin-capital-b1793543.html> [Accessed 8 February 2021].


Westerlund, J. and Narayan, P., 2013. Testing the Efficient Market Hypothesis in Conditionally Heteroskedastic Futures Markets. Journal of Futures Markets, 33(11), pp.1024-1045.