Decentralized Ponzi

The operation of the “bull pool” at wallstreetbets resembles a Ponzi scheme. There are five things that make it different:

  • It is decentralized.
  • Because it is decentralized, there is no single party that controls it and rakes off some of the money for himself, at least not directly.
  • The assets can be freely sold in a somewhat liquid, but chaotic market. Most Ponzi schemes have time barriers for redemption.
  • They caught a situation where shorting was so rampant, that triggering a squeeze was easy. Situations where the shorts are so crowded are rare.
  • Gamestop [GME] and other companies whose stock prices get manipulated above their intrinsic value can take the opportunity to sell more shares, as can less than 10% holders of the holders of the stock, and even the greater than 10% holders once six months have passed since their last purchase.

You have to give wallstreetbets credit for one thing, and only one thing: wiping out the shorts. It was an incredibly crowded short, and they identified an easy squeeze. But now it is harder to short, margin requirements have been tightened for both longs and shorts, given the market volatility, and even more so for options. That not only applies to individuals but to brokerages, because with the volatility, there is a greater probability of settlement failure, and broker failure. Robinhood faced possible failure and raised capital. What shorts remain are better financed than previously. When volatility goes up, so must the capital of intermediaries, including brokerages.

Ponzi schemes typically need ever-increasing flows of money to satisfy the cash need from the money being raked off. But there is no sponsor here, so what plays the role of the rake? I can think of three rakes for the money:

  • Most fundamentally driven longs have sold. Notable among them is MUST Asset Management of South Korea.
  • Some companies like AMC Entertainment and American Airlines (AAL) are issuing new shares to take advantage of the artificially high price. Maybe GME will do it next week.
  • And, those who are more intelligent at wallstreetbets know that GME is overvalued, and have booked their gains. This is definitely a place where the old Wall Street maxim applies: “Can’t go broke taking a profit.” or “Bulls can make money, Bears can make money, but Hogs get slaughtered.” (The Hogs in this situation are the ones who buy and hold GME. Buy-and-hold only works for undervalued assets.)
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