Robinhood Reiterates Costs of Centralization — DeFi Offer a Different Path

Robinhood Reiterates Costs of Centralization — DeFi Offer a Different Path

Patrick Tan 12/02/2021 6
Robinhood Reiterates Costs of Centralization — DeFi Offer a Different Path

One of the key features of cryptocurrencies is largely permissionless access, unlike what is being witnessed with trading platforms like Robinhood.

Anzio Ancelotti didn’t notice anything amiss right away. It was subtle things at first. Perhaps a credit card transaction that would take longer than everyone else’s to clear, or a bank loan that wouldn’t be approved.

Then his paychecks would bounce at his bank, but clear on reissue. Eventually, the bank closed his account and refused him banking services altogether.

And then one day, while walking home from work, an unmarked van pulled up and a two barrel-chested men bundled him into the back gruffly.

Panicked, Ancelotti tried to shout, but a gloved hand clasped firmly around his mouth meant that he could barely even breathe.

“Now now Mr. Ancelotti, there’s no need for drama. Now I’m going to calmly remove my hand from your mouth and if you so much as try to be smart, I guarantee you will regret it.”

Ancelotti nodded in agreement.

The balaclava-wearing man removed his hand,

“Do you know why you’re here Mr. Ancelotti?”

Shell-shocked, Ancelotti shook his head uneasily.

“No worries, let me do the talking then. You see Mr. Ancelotti, you have had a good life no? Albeit a quiet one. You tend to your little herb garden, your daughter Misha, she’s quite the handful isn’t she, and your loving wife.”

“It would be such a shame if anything were to happen to them don’t you think.”

“What did you do them! Who are you?” Ancelotti snapped back angrily.

“Now, now, Mr. Ancelotti. You are in no position to be asking the questions,” the man now tapped the inside of his jacket where the butt of a pistol could clearly be seen.

“It would be better if you just listened.”

“Now you are not an opinionated man, I know that. But you have an alter ego. Now that alter ego is plenty opinionated.”

“I don’t know what you’re talking about,” Ancelotti struggled in the back of the van which was rumbling around the streets of the city at great speed.

“Now you and I both know what we’re talking about. Your blog postings as your alter ego about our President have generated quite a degree of interest and we believe we have ways of changing your views of our dear leader.”

“You will find we have ways of making you see our point of view. It’d be shame if your paychecks kept on bouncing wouldn’t it? How would your lovely wife and Misha afford any of the nice things that they have now?”

“Oh you could try with another bank of course, but you’ll find that that would be an exercise in futility.”

“What do you want from me?” Ancelotti, his eyes alit with rage and back stiffening felt defiant.

“Nothing more than for you to consider a different point of view. Till then, you may find that your money isn’t as useful as you thought it was.”

And with that, the van pulled to an abrupt halt and Ancelotti was thrown out onto the sidewalk, before the sliding door of the van slammed shut, the man called out,

“We’ll be watching Mr. Ancelotti. Do think about it.”

In the weeks that followed, Ancelotti couldn’t cash any of his paychecks as no bank would open an account for him, nor could he cash out any of the stocks he had in his trading account.

For all its veneer of commercial freedom, Ancelotti realized that he still very much lived in an economic dictatorship.

Locked out of his country’s financial system, there was little that Ancelotti could do, but comply.

And while Ancelotti’s circumstances may sound extreme, the recent controversy surrounding GameStop shares and the move by retail-trading app Robinhood to curb trading in those stocks reiterates the dangers of centralization in the financial system.

If the financial markets are intended to serve everyone (like Hard Rock Café), then they have arguably failed miserably in their role.

But perhaps that was never their goal to begin with.

Democracy for the Few, Dictatorship for Everyone Else

Because when a mob of retail traders who organized on Reddit, a popular internet message board, bought call options and bid up the price of GameStop stock, punishing the hedge funds that bet against the firm, their pathway to make those trades was abruptly halted.

Just as retail investors were causing peak Wall Street pain, Robinhood and some of its retail-oriented brokerage peers restricted users from buying any more shares in GameStop as clearing houses — which ensure that cash and securities change hands in an orderly fashion — demanded the brokerages post more funds as collateral.

GameStop.jpeg

The outcry from the Redditors was almost instantaneous, with even lawmakers such as Democratic Congresswoman Alexandria Ocasio-Cortez and Republican Senator Ted Cruz carrying their torch and alleging this demonstrated a basic unfairness in the markets.

Retail investors cried foul, alleging that Wall Street insiders were protecting each other by preventing “outsiders” — read “retail investors” — from “bullying” the hedge funds who were shorting GameStop.

But was that really the case?

Go Ahead, Make My Market

Possibly not. Market makers want to encourage trading activity because that’s how they make money.

In 2008, an average of just 10.9 billion shares changed hands across all of U.S. exchanges every day, while during the height of the GameStop frenzy, a whopping 24 billion shares were traded in a single day — the most ever on record.

But Robinhood’s success meant that it needed to play by the same rules as the bigger brokerage houses and needed to scale up (rapidly in this case) to meet the post-financial crisis rules that aim to make the financial system safer.

As retail investors bid up the stock price of Robinhood, the brokerage had to rush to find liquidity to ensure that it had enough collateral to post to clear those trades.

And when volatility spikes, that liquidity can come at a higher cost, as the retail-centric brokerages found out the hard way.

But whatever the reason, whether conspiracy (to protect the hedge funds) or collateral (because of lack of liquidity), the Robinhood-GameStop episode revealed how access to the markets can be arbitrarily removed from a segment of the investing population.

Retail investors who found that they had tremendous power to move markets suddenly found themselves hamstrung when their brokerages shut off their flows.

But could the same thing happen in the arguably more decentralized markets such as cryptocurrencies?

Decentralize This

Robinhood.jpeg

While greater institutional interest and adoption of cryptocurrencies has been welcome, that participation has come at the risk of higher regulatory burdens and once again, rent-seeking gatekeepers.

Right now there’s nothing stopping anyone from starting up a liquidity pool to trade any digital asset on one of the many decentralized exchanges.

There’s no clearing house, there’s no brokerage and an automated market maker (a software program) helps to match buy and sell orders.

Even loans are facilitated autonomously.

Part of a new suite of services which started gaining popularity in the summer of 2020 known as decentralized finance, or DeFi, the Robinhood-GameStop episode should invite closer scrutiny of this nascent market model.

Whether one subscribes to the view that Robinhood moved to protect the powerful hedge funds from further losses or that the firm had run low on collateral to put up to support retail trades, the fact of the matter is that a retail brokerage unilaterally and arbitrarily stopped its users from making purchases.

The same way a store can refuse a purchase and a restaurant refuse service, brokerages, as retail investors are soon finding out, can refuse execution of orders.

And that puts tremendous power in the hands of a the few, the same way that social media giants can ban certain users from accessing their platforms.

Therein lies the dangers of centralization when it comes to democratizing access to markets.

If the goal of the market is as an economic good intended to serve the many, then arguably Wall Street has done a poor job of that.

Perhaps DeFi can pick up where markets have left off.

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  • Mark Hamilton

    I want Amazon Prime to make a special documentary about the Robinhood-GameStop saga.

  • Paul Lewis

    Excellent article

  • Andy Mather

    Robinhood isn't neutral.....

  • Glen Schumann

    When poor people lose money, the poor people are "irresponsible". When rich people lose money, the poor people are "responsible".

  • Tom Morrison

    Robinhood has stopped the buying of a particular stock, but not the selling. This is what market manipulation actually looks like.

  • Tom Morrison

    The app should be called "Robin." They are robing everyone.

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Patrick Tan

Crypto Expert

Patrick is an innovative entrepreneur and a lawyer passionate about cryptocurrencies and the business world. He is the CEO of Novum Global Technologies, a cryptocurrency quantitative trading firm. He understands the business concerns of founders and business people helping them to utilise the legal framework to structure their companies to take advantage of emerging technologies such as the blockchain in order to reach greater heights. His passion for travel, marketing and brand building has led him across careers and continents. He read law at the National University of Singapore and graduated with Honors in the Upper Division and joined one of Singapore’s top law firms, Allen & Gledhill where he was called to the Singapore Bar as an Advocate & Solicitor in 2005. He created Purer Skin, a skincare and inner beauty company which melds the traditional wisdom of ancient Asian ingredients such as Bird's Nest with modern technology. In 2010, his partner and himself successfully raised $589,000 from the National Research Foundation of Singapore under the Prime Minister’s Office. He has played a key role in the growth of Purer Skin from 11 retail points in Singapore to over 755 retail points in Singapore and 2 overseas in less than a year. He taught himself graphic design, coding, website design and video editing to create the Purer Skin brand and finished his training at a leading Digital Media Company. 

 

   

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