You may have heard: Robinhood halted the ability of users to trade GameStop (GME) yesterday, amid a huge rise in stock and rising trading volumes. Chaos ensued. Retailers everywhere cried dirty, accusing the start-up brokerage of protecting hedge funds and the establishment at their expense. U.S. politicians across the spectrum, from Representative AOC to Senator Ted Cruz, have come together to glorify the move on Twitter. Venture capitalists and technologists questioned the morality of the founders of Robinhood and proclaimed that the moment for decentralization had finally arrived.
Robinhood did not trade with GameStop to punish the rebellious mass of retailers. Nor did it do so out of a paternalistic impulse to try to protect them. Robinhood stopped trading with GameStop because it had to, thanks to a set of standards set upstream in the market. Robinhood’s clearing house, the company that facilitates the settlement of the brokerage deal, could not hold the risk he was asked to take.
Jill Carlson, a columnist for CoinDesk, is co-founder of the Open Money Initiative, a non-profit research organization that works to guarantee the right to a free and open financial system. She is also an early stage investor with Slow Ventures.
Clearing firms exist in part to mitigate the consequences if a broker does not meet its obligations. Clearing firms must therefore keep a close eye on the risk. This means that they have to raise more money to make trading successful as markets get worse (that is, as volatility increases). The GameStop market was about as crazy as it gets. The cleaning company can no longer take risks. Robinhood could no longer hand over funds to the clearing firm. The music had to stop.
These are exactly the types of controls that became so important in the aftermath of the 2008 financial crisis: strict risk management, transparency, liquidity thresholds and capital requirements. These standards are designed to prevent reckless behavior and to mitigate the consequences if a financial venture is exposed. When retailers demanded 10 years ago that these rules be implemented in large institutions, they could not have imagined that the rules would one day block them outside the market.
Yesterday emphasized the importance of understanding all the tedious nuances of back offices and the standards, rules, regulations and protocols that go with them. The completion of a trade takes two days. Clearing firms therefore have two days of exposure to their counterparty firm.
See also: Jill Carlson – GameStop and the Real Market Manipulators
Why does it take two days? People like to say that it is a technological problem and that innovations like blockchains can solve it. The reality is, as with so many things people claim that blocks can fix, that this problem is almost entirely a process and regulation. Perhaps new technology could be a catalyst to revisit it, but it is certainly not the limiting factor.
The Securities and Exchange Commission gives a mandate for settlement periods for securities to smooth processes among counterparties. There are many short-term securities that are settled the same day, such as deposit certificates and trading papers. Equities last just as long as they do in part because of historical precedent, dating back to the times when technology was indeed the limitation. Each financial institution has become accustomed to the processes involved in multi-day settlement period. Financial institutions are usually slow-moving creatures, meaning that what they are used to is what they prefer. Because their processes are built around multi-day settlement, they continue to choose multi-day settlement. The solution to this is no longer a blockchain, but a centralized database.
Robinhood stopped trading with GameStop because it had to, thanks to a set of standards set upstream in the market.
It’s so tempting to turn these conversations into conversations about technology. If we only had a decentralized financial trading platform, we would be saved from the censorship imposed by Robinhood or clearing firms or the SEC. If we only had shares in a blockchain, we would be saved from two-day settlement periods and the risks and inefficiencies they pose.
But the problems do not lie with the technology. It depends on the way the protocols, processes, rules and laws around the market are designed. And these kinds of issues do not go away, no matter how decentralized your trading space is or how many blockchains you use.
Admittedly, there are many archaic and outdated practices that market managers continue to adhere to. But it is too easy to blindly incite against this or blame them for technology without examining where these practices come from or why they exist. In the most extreme cases, these processes apply for risk management reasons. In more harmless cases, these practices simply stemmed from the human behavior of those who trade in the market.
See also: Preston Byrne – ‘The Squeezening’: How the GameStop setback will thwart freedom
When XRP was deployed by Coinbase and many others earlier this month, there was not a sudden rush of liquidity and activity on decentralized exchanges calling the asset. This is because traders did not do it want to touch the asset given the regulatory issues surrounding the asset.
Also consider whether markets should be open and active 24 hours a day, 7 days a week, 365 days a year. This is another area where I often hear people say that new technology can solve it, and that points to cryptocurrency markets that are always open. But there are already many mainstream markets that are always open. All sales without prescriptions work on Wall Street so. If I want to do an over-the-counter trade, I could theoretically call a marketer at any time and ask for a price. In all likelihood, I do not want to do that. I want to wait for times when there is liquidity.
So much of how the financial market works is based on historical human behavior, whether it is codified in market standards or to set up leanings against their natural tendencies. To be sure, the developments of recent weeks and years show that many of these policies and procedures are worth revisiting. Currency markets have proven that there may be demand for 24/7 markets, at least in some asset classes. GameStop has shown that certain retail brokers need to be better capitalized to be able to provide the kind of good behavior we saw this week.
Innovations such as blockchains and decentralized exchanges may prove more and more of these assumptions and behaviors wrong in the 21st century. And for that purpose, it’s important. But technology itself is not the answer.