Ethical Technologist Issue 17: The Game Retailer, the Hedge Fund, and the Living Room of the Internet

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This week we’re doing things a little differently. The big news of the last week is GameStop, or more specifically, the fact that large numbers of people engaged in a coordinated effort to artificially inflate the price of GameStop stock, with…difficult to comprehend consequences.

So, in lieu of our regular curated content, our own Chip Hollingsworth has stepped up to help us navigate this complex and multi-faceted situation with a detailed primer to the players and moves in this astonishing game.

If you have a recommendation for a theme, or an article you’ve seen recently that you think I ought to share, please do let me know. You can reply to this email, or hit me up on Twitter

As always, you can find back issues of The Ethical Technologist in the archives. And if you found this issue thought-provoking and informative, please share with your friends and colleagues!

[ 📈 A GameStop Primer ]

One of the biggest and strangest tech stories of the past week has been the ongoing battle between scrappy investors on Reddit and multi-billion-dollar hedge funds over stock in a failing video game retailer. Depending on whom you ask, this is either a feel-good David-and-Goliath story of small investors getting revenge on the Wall Street titans who profited off the 2008 crash, or a cautionary tale about the vulnerability of the market to a bunch of meme-posting millennial edgelords with usernames like roaringkitty and deepfuckingvalue. In order to help us make sense of this bizarre story, and its implications for technology ethics, I’ve put together a brief list of the players and events.

GameStop is a chain of brick-and-mortar video game retailers trading in new and used video games and accessories. As physical video game media have all but ceased to exist, and COVID-19 precautions have hit in-person retail hard, the company finds itself quickly losing money and relevance. Recently, a number of amateur investors on the wallstreetbets subreddit decided to start buying GameStop stock in bulk. I haven’t been able to track down the exact post that started this phenomenon, so I’m not sure whether the primary motivation was to help out GameStop by increasing their value, to get rich quick in a pump-and-dump scheme, or just as a prank, like last year’s rush on joke cryptocurrency dogecoin. It soon became clear, however, that at least some investors had another motive.

Enter Melvin Capital. This is a $13 billion hedge fund that was heavily invested in GameStop short calls. Essentially, these are bets that a stock will fail: a company sells a contract to buy a number of shares for a particular price, typically more than the stock is currently trading for. The call seller is then obligated to sell those shares at that price at a later date. If the value of the stock goes down, the call seller makes a profit by selling the shares for more than their (later) market value. If the value of the stock goes up, on the other hand, the call buyer stands to make a profit at the call seller’s expense. Selling short calls for stock that everyone believes is doomed is relatively low-risk; buying short calls is higher risk but potentially higher reward.

Some Redditors saw the pumping of GameStop stock as a way to destroy hedge funds like Melvin Capital. See the Reddit post screencapped in this tweet (the Redditor has since deleted their account): by increasing the value of GameStop stock, they guaranteed that hedge funds who were heavily invested in GameStop short calls would lose millions. Proponents of this strategy argue that it shows that common investors, united through the Internet, could exercise power over the billionaire class that just a few years ago had profited off those same common investors’ losses. And Reddit made it all possible, kind of like the Arab Spring, but with stonks.

There seems to be a widespread fear, both among libertarians and those more concerned with income inequality, that these events will lead to more regulation of small-time stock traders. The former fear this because they oppose most regulation of the market; the latter argue that Wall Street firms have gotten away with this behavior for years, and that action is only taken when “the little guy” stands to benefit. (At least one proposal, by Senator Elizabeth Warren, tries to thread the needle by questioning whether either giant hedge funds or online message boards might have violated existing securities laws, and whether any regulatory gaps might have permitted the GameStop fiasco to happen.)

Even if you see this particular outcome as a good thing, and are glad the giant hedge fund was punished and some smaller investors made money in the process, it should be clear that these “flash mob” investments can be dangerous. If this strategy can be used to punish Melvin Capital, it can also be used for a regular pump-and-dump scheme. And it’s probably still too early to know what the long-term consequences of this will be; just because the big hedge funds are losing money now doesn’t mean smaller investors won’t catch some of the fallout as well. Leaving aside the question of market regulations, what should Big Tech’s response be?

There are a couple of ways tech companies enabled this to happen. One is by providing communications forums at scale such as Reddit. The other is by enabling individuals to trade stocks easily via apps like RobinHood. Neither of these things are inherently bad, but they combined in unexpected ways with startling results. RobinHood have already provoked controversy by banning trades of GameStop stock in an attempt to put the brakes on the buying frenzy. Users soon retaliated by leaving negative reviews of the RobinHood app en masse, which Google deleted. Both RobinHood and Google have rightly been criticized for their responses, but at least they acknowledged that tech companies bear some responsibility.

Perhaps the biggest contributor to the GameStop bubble, however, is high-speed trading. This is trading carried out at high volume, in real time, by algorithms that are designed to respond within milliseconds to market signals. Without high-speed trading, it is unlikely that a bunch of trading being carried out by a Reddit flash mob who never sought to conceal their motives would have had the effect it did. Instead, the rapid buying of GameStop stock triggered momentum-based algorithms to do the same, and the whole thing fed on itself. Perhaps the real lesson here is that too much attention is being paid to the visible hand of hedge funds, Reddit, and RobinHood, when the invisible hand of the high-speed trading algorithms deserves more scrutiny.

– Chip Hollingsworth

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So much for Issue 17! If you have insight you’d like to share on the unfolding GameStop situation, please do reach out and share by either replying directly to this email, or pinging me or Chip on the Twitters. Thanks for subscribing and reading, and thanks to the many folks who have continued to share content with us! If you enjoyed this issue, share with your friends!

Until next time, yours, Chip Hollingsworth & Don Goodman-Wilson