The Economist - USA (2021-02-06)

The EconomistFebruary 6th 2021 Finance & economics 59

1

“L

ike 4 chanfounda Bloomberg

terminal.”ThisishowWallStreet-

Bets,a forumwith8.5mfollowerson

Reddit,a social-mediasite,describes

itself.4chanisanoldersitewitha looser

moderationpolicythatresultsindis-

cussionsrangingfromthehilariousto

theillegal.Bloombergterminalsare

expensivecomputersusedbyprofes-

sionaltraderstoaccessfinancialdata.

Theself-descriptionisaccurate.The

worldsofonlinediscourseandfinance

havecollidedinspectacularfashionover

thepasttwoweeks,dominatinghead-

linesandswingingmembers’fortunes

upanddown.

Theforumhasalreadybecomea

subjectofstudy.A paperpublishedon

January28thbysociologistsattheGeor-

giaInstituteofTechnologyconcludes

that,despiteappearingchaoticand

offensivetooutsideobservers,toits

membersWallStreetBetsrepresentsa

realandvaluableonlinecommunity.

Theresearchersspenthundredsof

hoursreadingpostsandinterviewing

members.Theysaythattheforum’sfoul

languageandcrassmemes,mostlyinthe

formofhumour,serveasa barrierto

entry—newarrivalswhoarenotcommit-

tedtolearningthecommunity’sme-

meticlanguageareswiftlydrivenout.

Theyalsoactassocialglue.ElonMusk,

theworld’srichestman,whohasex-

pressedsupportfortheforum,features

heavilyinitsmemes,accompaniedby

statementsofdevotion,suchas“Daddy

MuskistakingusalltoMars.”

Financialmarketsaretheperfect

focusforthecommunitybecausethey

areever-changing,constantlyoffering

newmaterialforcommentary.AsThe

Economistwenttopress,theforumwas

comingtotermswiththecrashingprice

ofoneofitsfavouritestocks,GameStop.

The“degenerates”,asitsfollowerscall

themselves,urgedeachothernottosell

theirholdings,callingonthecommunity

tocontinuestickingit tothehedgefunds

short-sellingthestock.Thosewhohold

are“diamondhands”andheroes.Those

whosellarepathetic“paperhands”.

It istemptingtodismissWallStreet-

BetsandtheGameStopsagaasa one-off

outburstfromthemurkycornersofthe

internet.Thatwouldbea mistake.The

researcherssaytheforumisanexample

ofa “thirdplace”,a terminsocialscience

fora hubthatisnothomeorwork;

churches,cafésandbarbershopsareall

examplesfromthephysicalworld.It may

bebaffling,butunderstandingthecom-

munityisworththeeffort.Notleast

because,asoneuserpointedout,evenif

thecollectiveholdingofstockshasn’t

workedthistime,it canalwaystryagain.

Memeteam

WallStreetBets

HowtheRedditcommunityof8m“degenerates”works

F

rom oneperspective, retail stock trad-

ers have never had it so good. There is

fierce competition among brokers, includ-

ing the likes of Charles Schwab and Fideli-

ty, for their business. This broke out into an

all-out price war in 2019 when these firms

cut stock-trading commissions to zero,

four years after Robinhood, a startup pro-

mising commission-free trading, came on

the scene. Retail participation in stock

trading is at a new high.

This happy picture is somewhat mud-

died by the practice of payment for order

flow (pfof). Instead of charging users for

each trade, brokers are paid by marketmak-

ers to direct users’ trades—or “order

flow”—through them. Marketmakers take

small profits on the difference between the

price that a broker’s user pays and that at

which a share is offered for sale in the mar-

ket. The mania around GameStop, a seller

of video games, has put the practice, and its

practitioners, in the spotlight.

On January 28th Robinhood decided to

suspend buy orders for GameStop, after the

retailer went viral in a forum on Reddit, a

social-media site, and its shares spiked in

value. The decision outraged users and was

condemned by lawmakers on both sides of

the aisle. Robinhood contends the decision

reflected its obligations to the dtcc, a

clearing-house that settles most equity

trades. There is a two-day lag between an

equity trade and its settlement, when the

buyer gets their share and the seller re-

ceives their cash. In the interim, brokers

must post collateral for users’ trades.

Vladimir Tenev, one of Robinhood’s

founders, said he received a “nerve-wrack-

ing” call from the dtccas GameStop prices

surged, asking him to post $3bn in collater-

al. To meet these demands, the firm drew

down its credit lines with banks and raised

$1bn in capital. (It has since raised a further

$2.4bn.) And to limit the amount of collat-

eral it would have to post, it also temporar-

ily halted buy orders for certain stocks.

Users decried the decision. Robinhood

earned around $200m from pfofin the

fourth quarter of 2020 (see chart). Last year

most of its orders flowed through Citadel

Securities, a marketmaker run by Ken Grif-

fin, a Chicago-based billionaire. The same

parent company owns Citadel, a hedge

fund. It had bailed out Melvin Capital, one

of the funds short-selling GameStop,

which had been targeted by the army of re-

tail investors.

Users have questioned whether these

links played some part in Robinhood’s de-

cision to halt buy orders. (As has Elon

Musk, the boss of Tesla, who nicknamed

Mr Tenev “Vlad the stock impaler” when he

interviewed him about the decision on so-

cial media on January 31st.) Mr Tenev has

said “we absolutely did not do this at the di-

rection of any marketmaker or hedge

fund.” And Citadel has said it is not in-

volved in, or responsible for, any retail bro-

ker’s decision to stop trading.

But questions about the ethics and

prevalence of the practice, which is banned

in Britain and Canada, are likely to linger.

The GameStop episode has drawn atten-

tion to a group of tech-savvy high-frequen-

cy marketmakers, notably Citadel, that has

largely replaced banks as the main inter-

mediaries of stockmarkets. They stand in

between market participants and stock ex-

NEW YORK

The rise of high-speed marketmakers

and payment for order flow

The new intermediaries

Pay-per trade

The pecking order

Payments for order flow, Q4 2020, $m

Source:Companyreports

Marketmaker Broker

Citadel

249.4

Charles Schwab 44.5

E*Trade 97.4

Fidelity 16.9

Robinhood

196.5

TD Ameritrade

128.3

Dash Financial

Technologies 25.3

G1X 49.4

Global Execution

Brokers 84.8

Virtu 37.9

Wolverine 37.0