GameStop and Coordination Problems
January, 2021
The GameStop story is so fucking interesting, and the more I read into it the more I realize that there's an entire side of this story that just isn't being told at all. Lemme try and walk through it.
Ok so let's start with the basics: what is a short? A short is when someone makes a bet that a company is going to do poorly in the future. The bet is structured as a loan. Alice thinks GameStop is going to do poorly in a week, and Bob thinks GameStop is going to do great. So Alice promises Bob 100 GameStop stock in a week, and Bob pays now. If Alice is right, she gets to pocket the difference between what Bob paid her today and what she has to pay in a week. If Bob is right, and GameStop stock goes up, Alice has to pay out of pocket to fulfill the promise she made to Bob.
So far that's pretty straightforward. But this picture is a bit simple, because actually there's a broker in between. The bank. So Alice is actually trading with CitiBank, and Bob is also trading with CitiBank, and CitiBank is connecting the two. Where all this gets really funky is that CitiBank can actually short GameStop itself. So let's reframe stuff a bit. Let's say Alice is holding 100 GameStop stock in CitiBank. Citi thinks that GameStop is going to go down, so Citi quietly shorts GameStop by trading to Bob. If Citi is right, they can buy back the GameStop stock that they owe Alice before Alice ever notices, and make a profit on the side at Bob's expense. Something interesting has happened here. If GameStop only has 100 stocks, Alice and Bob collectively own 200% of the total amount of stock in existence. And Citi is on the hook for 100% of the stock in existence. So when Alice wants to make a trade with her GameStop stock, Citi needs to scramble to fill the order by buying stock back from Bob. Who can now control the price, as much as he wants, assuming he knows that he has full ownership.
But this actually gets a bit more funky, because there's no limit to how many shorts there can be in the chain. Citi might short to Schwab who might short to Fidelity... Multiple banks and brokers can actually loan and short each other, which ends up in the situation we see with GameStop: altogether, the big hedgefunds owe 140% of all of the GameStop stock in existence. Obviously, they can't buy 140% of GameStop stock, because there is only 100% of stock available. So if anyone notices this glaring mistake, and manages to buy up 40.1% of the GameStop stock out there, they can jack up the price of GameStop infinitely high. Sorry hedgefunds. Shouldn't have gambled.
This isn't actually the interesting part (although for a systems person like myself it is fascinating to see this loophole play out in the financial markets). The actual interesting part is how to coordinate buying 40.1% of stock. See, if you're a big hedgefund with a lot of buying power, coordination like this is easy and also totally fucking illegal. But what if you're just like, 10000 random guys? This is where WSB comes in. WSB is trying a huge, massive experiment in solving coordination problems at scale with literal billions on the line, against an army of very highly coordinated agents who fucked up and are now trying to stop them. If everyone holds the line, everyone walks away with cash in hand. But if they lose the 40.1% hold on GameStop stock, it's all over, everyone is broke. And there is serious pressure for each individual person to cash out early, because the $$$ are real.
I also think this is a real failure of media reporting. The way this whole thing is being presented is as a pyramid scheme, a pump and dump. Basically, some people at WSB got the idea to meme a pump into existence, and if they sell first everyone else will be left holding the (now empty) bag. And there's certainly some part of this that is true. But the real story here is how everyone can win at the expense of the big funds if they can all just hold on together. Media, through negligence or malintent, isn't making this aspect of the plan clear at all. And it is a planned endeavor. These guys need to collectively hold 40% of the stock just long enough, need to make sure that everyone is on board for just long enough, for the shorts to come home to roost. Everyone walks away with money.
Cards on the table. I exited my GameStop position. I don't think it can happen that 10000 people can meaningfully coordinate in this way. Too many people have no idea what's going on, don't know the plan. Not sure if a meme can really last all the way. It's possible that there are enough folks on WSB who know what they are doing and who collectively have enough stock to drive up the price to the stars, but it's really unclear and I'm not that kind of gambler.
But I'm really rooting for them. And I will very gladly eat my words if it turns out that I missed on the biggest bottom-up overthrow of financial capital of the century.