“The Power of DeFi” is a series of articles that explains why we need decentralized finance (DeFi). We use current events, such as the GameStop (GME) stock price surge and the Robinhood restrictions on GME stock trading, to demonstrate our points.
Introduction
Being a retail investor can really suck! The funds that retail investors generally have do not meet the entrance criteria to big quant funds that yield superior returns — they are closed to serve the rich. Also, there are many areas in which a retail investor cannot invest. For instance, it is difficult for ordinary investors to invest in start-ups. Let’s not forget that funds that retail investors can invest in tend not to outperform the market, so, often, investing in index funds can yield higher returns than investing in actively managed funds. So, if retail investors decide to handle their investments personally, they must spend much time studying the market, hoping to outperform the market while lacking the funds, information, brainpower, and infrastructure that the “big whales” possess.
The good news is that things have started to change recently. Robinhood has made stock investing far more accessible to retail investors by eliminating trading fees. Also, other companies, such as public.com and republic.co, are collectively contributing to the democratization of investing.
The development of online communities, such as Reddit and 4chan, and social media platforms, such as Twitter, have also accelerated the spread of information and democratized access to information, helping retail investors reach consensus and coordinate actions. These outcomes have only been available to Wall Street insiders until recently. Hence, one tweet from an influencer such as Elon Musk suddenly creates a huge buzz in the online community and boosts stock prices tremendously, even if it involves boosting the wrong company’s stocks. This mix-up recently happened when investors rushed in to buy Signal Advance shares instead of Elon’s choice of the non-public messaging app, Signal!
The latest episode of this online trend is the meteoric surge of GME’s stock price. An army of traders from a Reddit group, r/WallStreetBets, stormed in to purchase GME stock, mostly via Robinhood. The Wall Street hedge funds that had shorted GME stock suddenly had to buy the stock to cover their losses, raising the stock price. A short interest ratio of more than 100% pushed the stock price even higher! This outcome is called a “short squeeze” and has led to huge losses for these hedge funds.
Robinhood restricting GME trading
However, because of the enormous market volatility, Robinhood decided to restrict GME trading. Since large institutional funds (like these hedge funds) have many privileged channels to buy and sell stocks, this action only limited retail investors’ purchasing power while big institutional funds are still free to trade. As a result, the price of GME dropped significantly, at least for now. As Wired clearly stated, “Robinhood is clearly acting in the interest of institutional short-sellers rather than the individual retail investors that rely on it”. [1]
Robinhood set out on a journey to democratize finance by giving trading power to retail investors. However, in the process, they are becoming the Goliath that they wanted to defeat, behaving like a tech giant with the ability to block any trade and manipulate the market. This incident even created unthinkable agreement between Ted Cruz and AOC:
DeFi to the Rescue
It is undeniable that the increasing coordination of retail investors with their massive buying and selling has created much turmoil in the market, leading to unprecedented and unexpected volatility. Nevertheless, it is unfair to only block trading from retail investors, which is exactly what most online brokers have done in response to the market turbulence. Markets always have turbulence! Don’t forget the substantial risk-taking behaviors of large institutional funds in 2008 that caused such market turmoil that they started a financial crisis that forever changed our world.
Robinhood's unfair move seems even worse when one realizes that those large institutional funds, in addition to their massive market power, can be bailed out of their losses while retail investors cannot. This outcome is what happened during the 2008 financial crisis. Wall Street's greed was the primary cause of the crisis, yet they were the ones who received a bail-out with taxpayer's money. As one Redditor put it: "We don't have billionaires to bail us out when we mess up our portfolio risk, and a position goes against us. We can't go on TV and make attempts to manipulate millions to take our side of the trade. If we mess up as bad as they did, we're wiped out." [2]
In the current centralized architecture of finance, it seems impossible to truly democratize investing. As more individuals have access to proper trading tools, these tools’ malfunctioning can create a lot of market turbulence. There are always large firms that have too much monopolistic power that they can use to manipulate the market. Robinhood is just one of the most recent cases where “they stopped helping the poor steal money from the rich.” Instead, they are now helping rich institutional investors steal money from poor retail investors.
In this era of Reddit and meme stocks, decentralized finance on blockchain is really the only solution that can truly democratize investing and empower retail investors to participate in and benefit from investing in the same way as institutional investors have for so long. With blockchain, there are no centralized institutions with enough power to block retail investors or manipulate the market, so the market can always work on its own and reach full efficiency. We will explain more in future articles.
We are Cook Protocol and our mission is to bring finance to the masses. You can read more about our project here.
[ Website] https://www.cook.finance/
[ Telegram ] t.me/cook_english
[ Medium ] cook-protocol.medium.com
[ Twitter ] Twitter.com/cook_finance
[Reddit] Reddit.com/r/CookProtocol
[YouTube] Youtube.com/channel/UCGiAQqspfq9LE0XgFlywN7w/
[1]https://www.wired.com/story/robinhood-gamestop-stock/
[2]https://www.reddit.com/r/wallstreetbets/comments/l54ky3/an_open_letter_to_cnbc/
