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Look at me, timely and in on the new trends of one week ago. In case it isn’t painfully obvious, you should not take investment advice from me. Stronger yet, you should probably not take financial advice from anybody from the internet. I’m just here to laugh at people behaving trying their best to cement the Dunning-Kruger effect, whether that’s stock bros from Wallstreet Bets or bitcoiners.
So, this is about how the Gamestop pump and dump is exactly like bitcoin. To get there, let’s start from the beginning.
Investment is when you put money in the financial markets to get more money out. Investment is not gambling, it is putting money in successful companies, either directly via stocks or as loans via bonds. The money you get back origins from the underlying company creating value. Investments should be expected to give 5-7% interest per year seen over a long period and ignoring inflation. If something gives (or promises) more than 5-7% per year, it is either speculation or a scam. Speculation is the idea that it is possible to do better than the markets overall. When speculating, people think they can pick the right time or stock to buy, and therefore earn more than the value generated by the underlying company. If somebody makes more than 5-7% earning per year, they are 1) lucky, and 2) somebody else has to make less (because only 5-7% value is created). Much like a lot of the people involved in speculation, investiment <-> speculation is on a spectrum. Further along this spectrum is scams. This is the only way to reliably make much more than 5-7% per year, and if you thinkl you are not investing but getting more than 5-7% per year, you are involved in a scam. If you’re not the perpetrator, you’re the victim. Good ways to recognize a scam from speculation is terms like “timing the market,” “guaranteed return,” labeling something as an investment while mentioning returns. The whole Gamestop story is one of something starting as speculation turning into a scam.
Next, we need to discuss options and shorts. It is very important to realize that neither are instruments of investment. They are currently viewed as instruments for speculation, but in reality they were designed as insurance products. If I, an European, need to buy something from the US in two weeks, I’ll need some amount of USD. This leads to uncertainty, if something is $100000 today, according to Siri, it is €83420 today, but what will it be in two weeks? I might not have the €83000 to lock in the price by buying the USD today, and not want to take the risk of the rate going up and the price instead being €85000 or €100000. For that, I can buy an option. An option is a contract that says that in two weeks, I’d like to buy $100000 for today’s price. If the price goes up, I’m good: I can still get my $100000 for €83420 + whatever I have to pay for the option. This is a good thing that allows companies to insure themselves against market fluctuations outside their focus, and is like buying an insurance. Now what happens if the price instead goes down? Then I just throw away my options and instead buy the USD on the market. I get them cheaper but still have to pay for the options.
Short selling is another product that works similarly. When shorting a stock, you essentially borrow a stock from somebody and sell it in the market, e.g., for €100. You then hope the value goes down so you can buy it back for less, say €80, when you have to deliver it back. That way, you make €20 (minus what you had to pay to loan the stock). If the price goes up, to say €120, you lose €20 (plus what you had to pay to loan the stock). This can also work as an insurance like an option. If I need $100000 in two weeks, I can sell a short of €83000 (getting $100000). Now, in two weeks when I have to buy my $100000 worth of dildos or whatever, it no longer matters whether the price has gone up or down: no matter what happens, I spend the $100000 I got for my €83000 shorts on the dildos and use the €83000 I originally wanted to use for dildos to cover my shorts. All of this without needing to have the €83000 to buy the $100000 immediately, and with the only cost being whatever I have to pay to loan the $100000 initially.
Thus, both shorts and options are really useful instruments to insure against fluctuations in a volatile market. It is exactly an insurance against that. But they can be used differently as well. A lot of people try timing the markets. Heck, I’ve done that when I was younger and dumber. A classic trick is to buy stocks just before an earnings call if you expect it to go well. This is easy to do. But if you expect an earnings call to go badly, you can sell just before it. If I have 10 stocks in a company worth €100 today but expect it to be worth only €80 after the earnings call tomorrow, I can sell the stocks today, earning €1000, and buy them back tomorrow for €800. I now have the same 10 stocks plus an additional €200 I can spend on blow. This falls under speculation but can be a way to make a quick profits as a stock can fluctuate several % past an earnings call, sometimes as much as tens of percent. Now, if you don’t have any stocks in the company, you can instead sell a short, just like we did with our dildo-buying money above. Sell the short today for €100, buy the stock back tomorrow to cover the short for €80 and pocket the difference (minus the cost of borrowing the stock.
Selling/buying a stock before an earnings call is a more speculative version of trying to time the market, and selling shorts is even more speculative. Shorts and options are not bad, but using them for speculation is a bit like taking a life insurance on somebody else. That’s probably illegal because it’s extremely dodgy. A life insurance is a very useful instrument to secure your family or to take away risk of buying e.g., a house (I have a life insurance that covers my mortgage which means I get a lower interest as the bank doesn’t have to deal with the risk that I die before paying it back). At the same time, taking out a life insurance on somebody else is a bit dodgy. It gets even more dodgy if you start encouraging the person to take up sky diving or heading to COVID-parties, and outright illegal if you start messing about with the person’s car. So, shorts and options are not bad, but can be used for bad.
The entire Gamestop thing was that some hedge funds had sold a lot of shorts in Gamestop. Not because they wanted to hedge against fluctuations, but because they were betting on the company going down. They sold a lot of stocks, and they were definitely closer to encouraging Gamestop to going on some safaris near dangerous animals than making sure they could pay back their mortgage. They might even have been adding just a bit of poison to Gamestops drinks, but that is pure speculation and also largely irrelevant.
Now, some Redditors found that the Gamestop stock was undervalued. They looked at fundamentals such as earning but also future prospects and the amount of debt and such boring things. They were probably right? I don’t know nor do I particularly care. They therefore started buying up in the stock. It’s speculation but definitely closer to investment than scam at this point.
Later, other Redditors found that some hedge funds had sold large amounts of shorts in Gamestop. The hedge fund was looking at other facts: people do no longer buy physical games and COVID was shutting down much of retail. There’s a real risk that Gamestop could go bankrupt, netting the hedge funds a nice profit.
At this point, both are really fair takes. It could go either way. what set everything off was the discovery that the hedge funds had sold a lot of shorts, so many that it totalled more than there are stocks in total. They concluded that at some point, it would be necessary to cover these, and if they owned the stocks they could set the price: if a hedge fond needs to buy > 100% of all stocks, they in particular need yours and you can ask everything you want for it as they have no choice but to buy. Having more than 100% of the stocks shorted seems extreme, and is on the high end, but can easy happen (if you have enough money): simply loan 60% of the stocks and sell them in the market. Then loan the same 60% of the stocks, maybe even from the same people, and sell them again. You have now shorted 120% of the stocks. There are also other ways it could happen (basically, instead of actually loaning a stock to sell, you just make a bet and exchange money as if you did that; that’s the essentials of derivates).
Now, Reddit concluded, since they have sold 120% of the stocks, the price can only go up-up-up. Just buy the stock and you have guaranteed returns without any risk. This is when what was speculation turned into a scam. The people buying Gamestop at $20 or $50 could just make sure that everybody else were buying the stock, rocketing the price to $450. The
investor speculant scammer that had bought at $20 could sell at $450, making a 2150% profit. For those keeping track, 2150% is larger than 5-7%, so this is definitely no longer in the investment category, and as it is labelled as a safe investment, we’re in the scam category. This is a classical pump and dump scheme: buy some stock at a low price, then talk it up so the price goes up (pump), and finally sell of your initial stocks (dump them on the market). Now, the price goes down or remains the same; the scammer doesn’t really care: they already made their profit.
I don’t think the same people that initially bought in were part of the scam. some might have been, but some may just have been speculants with genuine analysis in the company. The pump and dump was the scam. The scammers used classical methods: talking up the company as if they had inside knowledge they were going to do well. While true, they were never going to do $400/sotck well. They used FOMO (fear of missing out): you have to buy now before the short sellers buy up all the stocks. They presented the return as certain: the short sellers have to buy from you. And they encouraged people to buy but never sell stocks; Reddit did a lot of memes about diamond hands, that $100 (and $69420) were not memes but realistic price targets. By discouraging others from selling, the scammers have a better chance of selling themselves and ensure the price remains high.
Normally pump and dumps happen with penny stocks that are being pumped using fake insider information, so the new thing here is that it happened with a real company. The fake insider information is that the short sellers had to buy the stocks. I’m absolutely no expert, but I can think of two ways they could avoid buying an over-priced stock from a Redditor: The first method is just the opposite of the trick we used to sell 120% of the stocks: first you buy 60% of the stocks and return them to cover your short. Then you buy the same 60% from the person you returned them to and use them to cover your remaining shorts. Now, you’ve covered 120% of the stocks in the company without ever touching 40% of the available stocks. The second is similar, but like derivatives just doesn’t involve the dirty real world: just pay the current stock price to whoever you got the stock from to cover. Sure, that’s not what the contract said, but as a lender, I’d rather get $300 for a stock that has a real price of $20 (or whatever, dunno what Gamestop is worth). Especially seeing as getting the stock and selling it would crash the market, netting me much less, and if I were to squeeze the short seller, they may declare bankruptcy, netting me no money at all. There are likely legal reasons this cannot play exactly these ways, but if I, a non-expert, can come up with two plausible ways to get around the short squeeze, surely a hedge fund manager, who is or employs experts, can come up with 20 ways, 10 of which are illegal and 5 of which a dodgy, but at least one fo which is workable.
The Redditors were laughing at how they were battling the establishment and fighting stock manipulation done by the short sellers. But they did not know, they were doing the exact same. Colluding to drive a price up is illegal. There’s a very moral argument about why it is illegal for individuals to do it in the open, but it is tolerated that large funds do so themselves or by colluding in secret, but that argument is not relevant here (it’s still relevant in general though). Furthermore, they were laughing at how the little guy was taking on the behemoth who were profiting of the individuals. Not noticing that throwing in a couple hundred memebucks for the LOL is exactly what large institutions profit from. Sure, the couple of hundreds is fine for most of the people participating. A lot of the loss port shared are likely false (student spending their tuition on memestocks and getting thrown out of university, a young couple spending their entire savings for a house and now having to live in a flat with their upcoming child and thinking of divorce, etc.), and even if not, they are not too important in the larger picture: all of the profit comes from millions of useful idiots throwing in a couple hundred or thousands for the LOL, going directly to the pump and dump scammers,. Each of them thinking: I know this is a scam, but I’ll outsmart them all and get out at the top.
This story is the exact same as the story of bitcoin. Bitcoin did not invent anything new, but it put existing technologies together in an interesting way. There was even a proof of concept. Like the first analyses were likely right, bitcoin also presented an interesting set of ideas. Much like the Gamestop asking the question of whether hedge funds should be allowed to collude and to which degree buying an insurance on your neighbour’s house and setting up a bonfire near the hedge should really be legal to the extent it is, bitcoin raised the question of whether some things should be thought of in a more decentralised manner, which is genuinely a good point when dealing with sensitive data.
But then came in the grifters and scammers. Bitcoin is not, nor will it ever be a technological revolution. The problem is that it just doesn’t work. Bitcoiners of course don’t believe that, but all of the problems solved by bitcoin are solved much better by other technologies, just in slightly different settings. Bitcoiners have to pump up the value, because that is the only thing it can. Gamestop will not be worth a $400 validation, just like bitcoin will not be worth a $38000 valuation. Or a $28000 valuation. Or a $18000 valuation. Or a $8000 valuation. Just like Redditors discouraged selling Gamestop (diamond hands), Bitcoiners discourage selling Bitcoins (HODL). Gamestop was predicated on short sellers having to buy their stocks, and bitcoin lives off the belief that Bitcoin has to take over real finanace. Bitcoiners completely overlook two simple ways that can just not happen: 1) classical finance is working fine as it is; bitcoiners always cite US-only problems like slow or expensive account-account transfers that simply don’t exist in EU, or 2) if decentralized finance was really a thing that anybody wanted, the US or EU could just make their own bitcoin rival. The source is open so they could base it on regular bitcoin (but take out some of the outright bugs bitcoin is stuck with and redesign some of the ways it is conceptually broken) or they could make something better building on the experiences. All the same, they keep deflecting any criticism with: have fun being poor, to the point that bitcoins is sometimes referred to as Dunning-Krugerands.
I predicted the crash of Gamestop Friday last week, which I’m of course immensely proud of. It was pure luck I was that right; it might also have been the ride would have continued for another week or two. I have in the past predicted the fall of bitcoin and Tesla as well, and the fact that they seem to be doing fine now does not change that opinion: they are overvalued and will go down in time. I don’t know when, which makes the predictive power useless. For that reason I stay the fuck out of them, both on the short and long side. My assessment about Gamestop will also not change if it goes up next week. That does not mean that it is possible to make money on them, but doing so is not investment, it is pure speculation at best, and more than likely outright scams. Never take advice from “somebody from the internet,” also not from me, and for all that is good in the world do not take the advice of bitcoiners to “do your own research,” because it is very difficult to decide what is worth taking into account and what is not.
Just take away this: if it gives more than 5-7% returns per year, it is speculation at best, and if it promises more than 5-7% return, it is definitely a scam. And if you are participating in a scam, you’re likely the one getting scammed, especially if you think you’re the scammer.
Time person of the year 2006, Nobel Peace Prize winner 2012.