Login

Is this what they meant by democratization of finance? 02 February 2021

Opening up the stock market to retail investors is having extraordinary consequences.
“Take back control” was Brexit’s controversial slogan, appealing to people’s sense of lost democratic control. In a well-functioning democracy, people are supposed to be masters of their own fate, voting for leaders and laws that directly determine outcomes of the polity. Brexit represented an alleged opportunity to wrest back control from far off, unseen forces who weren’t accountable to any democratic process.

A similar sentiment, stripped of its political or racial connotations, is trumpeted in the fintech world. Consumer-facing fintechs have exploded in the past decade, promising people unprecedented control over their finances. Traditional financial institutions are no longer required. Nor are well-credentialed financial advisors. All you need is a smartphone and a driver’s license to get rid of unnecessary banking fees, regain control over your personal financial situation, and maybe even begin investing some money.

Fintech encompasses a wide range of companies and services. Some of the biggest names in the industry come from the retail investing space. Apps such as Robinhood, Acorns, and Wealthfront have caught fire in America, where companies are enabling access to the previously exclusive world of investing. They are part of a broader “finance democratization” sentiment that prevails in fintech circles. Robinhood is (was?) especially regarded as one of the most successful fintechs in the world. Valuation isn’t the only marker of success, but Robinhood’s many rounds of funding have valued the platform at over $15 billion. “Investing for Everyone” is their simple, democracy-tinged slogan. Everyone taking part in the stock market, what could go wrong?

Now, the “democratization of finance” is creating unprecedented market occurrences. The Reddit forum r/WallStreetBets, with its 2m+ users and penchant for memes, has fueled an astonishing rise in the stock price of GameStop. GameStop is not widely regarded as a strong company worthy of a high market valuation. Its stock price had languished around $4/share for years. It is a brick-and-mortar video game retailer whose best days belong to the distant past when people still went to stores to buy the newest Call of Duty. Or so we thought.

What started as a few online personalities conducting some due diligence on the company and making a bull case has turned into one of the most fascinating stock market phenomena in years. A cocktail of retail investing, online forums, gamer culture, and a desire to “stick it to Wall Street” has launched the stock into the stratosphere. GameStop went from a small cap stock to large cap in the span of two weeks, fueled by incredible options trading, largely on retail investing platforms like Robinhood. Retail investors turned into millionaires overnight. One hedge fund lost $8 billion, or more than 50% of its assets, in a single month.

Then, in a dramatic move last Thursday, Robinhood, and a host of other investing apps, made it impossible to buy $GME and other stocks that had caught the attention of r/WallStreetBets. Obviously, this did not sit well with the millions of people who woke up Thursday morning, hoping to continue buying stocks. Accusations of market manipulation and hedge fund meddling rocketed around the internet. Robinhood’s stated reason was that their clearing house could not handle the volume from the unprecedented amount of trading. A mismatch between customer-facing apps that promise instant trading and exchange pipes on the back end that still require actual money to be present and trades to be settled. A straightforward mechanical issue, nothing nefarious.

No matter, because finding another broker who will process your trades simply requires downloading another app. For a group of people that lives online, this is not a difficult task. A list of brokers who would still accept $GME purchases was widely shared. They picked up right where they left off on Friday, with the stock climbing back up again.

Now, everyone is asking themselves some form of the same question: Is this the dawn of a new investing era, where stock prices will be driven not by fundamental evaluations but by internet hordes? Or is it merely a flash in the pan that will get squashed by Wall Street money and regulatory agencies? In the heat of the moment, there is no way to definitively answer these questions.

What is certain is that what had percolated on Reddit for months has exploded in spectacular fashion. Wall Street has taken notice, with hedge funds getting in on the action, setting their algorithms to now follow the internet-driven investing flows. Regulatory bodies, always keen to rein in excessive financial speculation, are taking notice. Pumping and dumping stocks is illegal. So is giving unqualified financial advice. But millions of people online making memes and choosing stocks falls into a regulatory grey area. This phenomenon has largely taken place in America, where the “free market” reigns supreme. It would be un-American, not to mention un-democratic (the two words are synonymous), to lock people out of their God-given right to make and lose money picking stocks.

It is important to note this is not a sign of the market “breaking” in any meaningful sense. Stock exchanges are secondary markets that have minimal impact on the actual day-to-day operations of businesses. GameStop isn’t magically selling more games or opening more stores due to its sky-high valuation. Retail investors just decided to buy the stock (and its options) at never-before-seen volumes.

Instead of the market breaking, what might be under threat are traditional stock valuation models. A stock is worth what investors think it is worth. Previously, investors would arrive at a stock’s valuation using tried-and-true methods such as discounted cash flow or dividend discount models. Fundamentals – assets, liabilities, revenues, profits – determined stock prices. This is still largely the case. Now, however, with investing opened up to millions of everyday people, aka, democratized, fundamental-based models may mean less. A stock may just be worth whatever millions of people online think it's worth at a specific point in time. If this trend continues, it will have major ramifications for a market organized around fundamental-based methods of valuation.   

For now, it remains a fascinating phenomenon that is minting millionaire retail investors and causing prominent hedge funds to sweat. Where it goes from here is anyone’s guess. Big money and institutions have a way of winning these types of battles. Market exuberance gets reined in eventually. New regulations may be enacted under the guise of “protecting the consumer.” Hedge funds may second guess their big short bets. Or at the very least, restrain from publishing the stocks they are betting against.

Just as democracy in a political sense can take some unexpected turns, so too we are witnessing the messy reality of democracy in the financial world. Whether it's a paradigm-shifting event that changes Wall Street investing forever or a one-off stock spike, the GameStop saga demonstrates how when old shibboleths fall, the new form that emerges is by no means fixed. 

Keywords

Trading

Related Content

Death by a thousand digital wallets
Article
Patria Finance: Indigo roboadvisor
Presentation
UniCredit: Power 4 Advice in BVI
Presentation
Intesa Sanpaolo: Smart Save (Italian only)
Presentation
Neobanks and the next step
Study