Author | LatticeX CSO: Jennifer Jiang

The GameStop (NYSE:GME) saga has now become one of the most seminal events in the history of U.S. and global capital markets. The ever-evolving stories of GameStop and Robinhood have raised many challenges and thoughts for investors, Wall Street, regulators and the entire financial system. The key questions fall into two broad categories:

Macro risk management and crisis prevention. The events surrounding Robinhood and GameStop could be the first shot at deeper, more systemic financial market risks.

Micro-regulatory issues. The combination of technology, social media and finance has created unprecedented market weather and regulatory challenges.

Macro financial conditions usually pave the way for micro actions and distortions. The SEC and other financial regulators have reportedly stepped in to investigate. The US Congress held its first round of hearings on Thursday. However, it is unclear what regulatory measures should be taken for investors or intermediaries.

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On the American social networking site Reddit, Wall Street Bets (WSB-Wall Street Bets) is a stock market discussion forum for retail investors. In 2019, opinions on why GME would be valuable began to appear in forums. Although initially modest, it garnered enough attention during the lockdowns triggered by the US Covid-19 pandemic to spark interest in the stock from a new generation of retail investors (net natives) known as the "Gen of Millennials". Interest, participants surged.

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Facts and fundamentals don't matter for short-term stock price gains. All it takes is demand outpacing supply. Demand for stocks explodes when there is a sudden swarm of energetic and angry young retail investors buying stocks, and they buy not just stocks but stock options. It is worth pondering that when the market transactions reversed significantly, some quantitative funds and institutional investors also joined the feast.

At this time, Elon Musk (Elon Musk) tweeted support for retail investors on social media. By January 21, GameStop's rally had grown into an unstoppable force, with GME rising from a price of $18 on December 31, 2020 to a high of $483 on January 28, 2021, an incredible 2583% increase.

The development of events is often unexpected. GameStop, AMC and other stocks fell sharply on Feb. 1 when Robinhood Markets Inc. and Webull Financial LLC and other online retail brokers suddenly began restricting trading. The Robinhood-led move angered customers and sparked dozens of lawsuits against the Menlo Park, California-based startup.

Initially, many investors believed that Robinhood's decision to limit purchases of GameStop stock was dictated by hedge funds or high-frequency trading firms that later bet on the stock. But the reason is actually simpler — the Trust and Clearing Corporation (DTCC) required Robinhood to provide $3 billion in margin due to surging trading volume and increased market volatility. As an unlisted start-up company without a strong balance sheet support, Robinhood immediately faces high-pressure risks of default, liquidation, or even being forced to be merged or sold. Robinhood raised $3.4 billion from its private equity investors in two installments within a week, plus restricted transactions, which met its obligations to the clearinghouse, and at least transactions in the entire market were not interrupted by default.

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In many ways, the shift of financial activity to non-bank financial institutions presents new and little-known risks. These trends and challenges are exacerbated by the industry struggle between technology and finance.

For example, one of the triggers of GameStop’s short squeeze war is that according to the market disclosure, GameStop’s short position has reached 139% of the available stocks. In other words, nearly 40% of the stocks do not exist but are “borrowed to sell” . Known as "naked short selling," the practice is generally banned but rarely enforced. This happens because Wall Street's existing system of indirect ownership and delayed delivery doesn't instantly reconcile ledger records showing who owns what and when. In fact, the reason why the market is so angry with GameStop is that the market has understood Wall Street's operating routines for many years. This is just another example of many.

2. The financial policies of the Federal Reserve and the SEC in the past 13 years have created an environment of abundant monetary liquidity, which has led to distortions in the entire market and companies supervised by officials and industry self-regulatory organizations. Monetary liquidity via quantitative easing (QE) and near-zero interest rates favor momentum speculation and investors in GameStop's specific story scenario. In other words, once GameStop's price starts to rise, the stock price can easily skyrocket. The SEC and the Federal Reserve need to conduct a more thorough assessment of the impact of various policies implemented in the past on financial markets.

3. Investing vs shopping: With the development of emerging online financial technology companies and the decline in the product competitiveness of full-service brokerage companies in the original regulatory system, a large number of investors have transferred investment accounts to provide lower or even zero transaction costs. in fintech companies. But many new investors have limited understanding of regulatory and systemic risk, expect online broker/dealers to operate unregulated, and invest more like shopping services.

4. The business model of financial technology companies: Robinhood's zero transaction cost and payment to order flow (POF) business model has also begun to be examined with a magnifying glass. Legally, a broker-dealer is not obliged to accept trade execution, i.e. the trade must be executed as soon as the trade is actually accepted. Robinhood appeared to immediately reject deals it didn't want to execute. Are investors just part of the information product in the non-paying case? And the real customers are actually paying customers - wholesale market makers, similar to Citadel and so on. How do regulators assess fair dealing between retail brokers and wholesale market makers, and how do they assess transaction efficiency? Moreover, capital, liquidity and other requirements imposed by financial regulators and the central counterparty DTCC may from time to time prevent these companies from accepting unlimited transactions, or even drive these companies to conduct selective transactions.

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The smooth operation of the financial system has become a new hot topic in the context of the current integration of policy, technology, and social media.

The first is the modernization of financial infrastructure, especially the feasibility of using blockchain for real-time transaction clearing. Thursday's hearing in the U.S. House of Representatives lasted five hours and was the first of three hearings planned by the Financial Services Committee. Robinhood CEO Vlad Tenev (Vlad Tenev) reiterated his call for industry-wide changes to the trade settlement process at Thursday's hearing, "shorter settlement cycles and a transparent capital model." The opportunity to completely reform the settlement system of the securities industry may also be a new development opportunity for the real-time transaction settlement system based on the blockchain.

Under the current T+2 settlement process, it takes two days for trading systems to clear trades, so the DTCC requires companies to increase their deposits to compensate for this lag, and when stock volatility increases, so do deposit requirements. At the height of the GameStop frenzy, Robinhood’s deposit requirements for DTCC regulations related to stocks soared 10 times. This, Vlad explained, is what led the company to impose purchase restrictions on stock trading.

DTCC does not mind shortening the time it takes to settle transactions. According to Michael McClain, DTCC Managing Director and General Manager of Equity Clearing and DTC Settlement Services, in a published Q&A, DTCC has “long advocated for settlement cycles to enhance market resiliency, reduce margin requirements and reduce investor risk.” cost". But the DTCC cannot make the decision alone. Although the existing technology can already support certain T+1 or even settlement on the same day, market participants need to pay for such changes. This also means that major changes are required to the current complex market structure, original business and operational processes.

First, the government must support the move.

Secondly, in addition to the consideration of the modernization of financial infrastructure, supervision also faces a series of key policy problems.

• level playing field. Leaving aside the question of whether or what regulators should do about this recent event, it is important to recognize that broader financial stability problems that go beyond this event stem from the existence of inequalities in financial transactions question.

• More financial education is needed. In particular, a new generation of cyber natives understands financial risk and complexity.

• Examine the rationality and safety of Payment to order flow as a business model, and the audit and supervision of its effectiveness.

• The line between blockchain and fintech is starting to blur. As mainstream financial institutions develop stablecoins and the possibility of real-time payments using blockchain accelerates, most fintech companies are beginning to accelerate the addition of blockchain to their business models. This also places new demands on institutional oversight.

Putting GameStop in a larger context, the rise of digital finance is a real trend following the global COVID-19 health crisis in 2020. The epidemic has increased people's demand for "digital services" and "alternative" digital assets. Perhaps, this is a new opportunity for the development of native digital assets and digital financial infrastructure.

The follow-up is worthy of continuous research.