- A subreddit called /r/wallstreetbets (visit at your own peril), which has exploded in popularity recently and has over 5 million subscribers (and counting) got really excited about three stocks: GME (Gamestop), AMC (the movie theater place), and BB (Blackberry). Gamestop was the main stock.
- Yes, I know all three companies are doing terribly in the real world. I won’t go into why they got excited about the stocks here.
- They convinced a lot of other people to buy the stocks and they did well. Really well. Take a look at their Yahoo Finance pages and look at their 1 month price charts (then ignore the past two days).
- Everyone got in on it, and I mean it. When a lot of people buy a single stock, the price rises.
- It turns out, this was hurting a lot of Hedge Funds and Institutional Investors that were taking short positions (i.e. they were betting against) these companies. They tried to fight back. It didn’t really work.
Of course, the people quickly turned their anger towards the platforms that had locked them (and others) out of the ability to buy more shares, which had caused the share price of their currently held stocks to plummet. The main platform that the anger was directed towards was Robinhood, which is arguably the face of retail investing. Rumors quickly swirled on Reddit of financial relationships between Robinhood and market makers like Citadel, which had issued large loans to hedge funds that had issued large short positions against GME and faced bankruptcy if the stock price continued to rise. Claims of market manipulation were thrown. Congress got involved — the usual players voiced their displeasure with Wall Street and implied an investigation was forthcoming. Some unusual players did too.
- Wall Street sucks (again, on this, I would know). There’s no two ways about it. There was some collusion and market manipulation here. The big bad hedge funds forced the hands of Robinhood et. al. and said we’re going to ruin you if you don’t stop this right now and that was that, and all of us regular people were left holding the bag.
- Robinhood decided they had some sort of fiduciary duty to protect their users from entering into such volatile and overpriced stocks (and believe me, they were overpriced — do you really think I should have invested in Blackberry in 2021?). On the other side, they felt they had a duty to allow their customers to close out their positions and exit the market safely. It seemed like a somewhat reasonable surface level argument.
What Probably Happened
Then I stumbled upon an interview with the CEO of one of Robinhood’s competitors, Webull on Twitter. I listened and decided to do some digging to verify for myself (it was surprisingly buried on the internet). Here’s what I found:
- There’s one central securities depository called the Depository Trust Company (DTC).
- When you buy a stock on Robinhood they take the order to the DTC (usually through an intermediary called a clearinghouse). The DTC fills the order by finding a seller. The same thing happens when a hedge fund wants to buy securities, or a bank.
- But. There is associated risk with matching a buyer to a seller. To resolve this, there is something called the settlement cycle wherein there is a 2-day holding period where the buyer puts down a clearing fund deposit to collaterize the transaction. The transaction is guaranteed otherwise, though.
- After the two days, they get the deposit back.