Fox Business Followup: Ex-Citadel employee reveals rigged trading game of “Market Battleship”, argues “DeFi” blockchain tech will #ChangeTheGame
The following article is written by Patrick McConlogue. All statements, conjectures, and opinions, are his own.
You’ve probably heard there’s a war on Wall Street right now between hedge funds and retail investors over GameStop ($GME) stock and a few others such as AMC Theaters ($AMC) and Nokia ($NOK) in a new category of stocks whose value climbed as a result of the power of social media. They are being called “meme stocks”.
This David and Goliath saga has already come close to bankrupting one hedge fund and caused others to lose billions overnight. Just as a brigade of Reddit-influenced investors was about to fly a victory flag, Wall Street peeked over the Battleship board and changed the rules, in real time, to give themselves an unfair advantage.
The game is not fair and it never has been. Individual investors, even when operating in a swarm, are destined to lose.
How do I know? I helped design the game.
A few years ago, I worked at the massive hedge fund Citadel. The multi-billion dollar fund was caught up in this week’s scandal for bailing out hedge fund Melvin Capital after everyday traders on Robinhood appeared close to liquidating the fund through mass buying of the GameStop stock $GME.
My role at Citadel was as an engineer in Long Term Quantitative Strategies. The entire department, filled with programmers and compliance officers, is dedicated to something called ‘alpha’ which determines the buying strategy of the fund. I was responsible for innovative proprietary technology that capitalizes on public data faster than any other hedge fund. It’s a classic situation of machines against humans. I respect many of my colleagues, the problem isn’t the people, it’s the rules of the game which heavily favor the funds.
With this in mind let’s return to what just happened.
A group of traders on the r/WallStreetBets Reddit thread, now consisting of over 8.6M members, noticed that someone had overly “shorted” the GameStop $GME stock. They decided it was the perfect time to buy. It was only around $18 per share and easily affordable for the common investor who kept buying, driving up the price of the stock.
As the buying frenzy continued the hedge funds who had taken the opposite position started to hemorrhage money.. BIG money.
The small investors celebrated their success online as news broke that the hedge fund Melvin Capital Management had lost so much on the $GME short position that they had to be bailed out by bigger hedge funds. While the markets were closed Melvin Capital’s sinking battleship received an emergency infusion of $2.75 billion from Citadel and Point72.
As Melvin Capital attempted to recover, the situation became a cause célèbre for the likes of Elon Musk, AOC, Chamath Palihapitiya, and Dave Portnoy. Using their huge online platforms they cheered on the small investors, who by then had identified and invested in other stocks to try to beat the hedge funds at their own game.
That drove millions to join in buying GameStop in bulk, pushing the price of $GME up astronomically to more than $400 a share. Now a $100 investment at $18 a share was worth $2,200! That’s a lot of money to individual, small and dare I say inexperienced investors. But not so fast. Remember, the game is rigged.
On Thursday morning, Robinhood — the commission-free stock trading app used by small investors — suddenly shut down buys on $GME and a few other stocks that were under siege.
Only sell orders went through, reversing the trend, driving the stock prices back down and shoring up the hedge funds’ sinking ships. Remember, when the stock price goes down, the people who hold the “shorts” make money.
This started a chain reaction. Other retail trading platforms like E*Trade and TD AmeriTrade began freezing the stock for individual investors. But hedge funds own supercomputers. They have direct access to stock markets. While small investors were frozen the hedge funds traded massive positions and quickly earned back the billions in losses from the past few days. The rules of the game had been exposed, in broad daylight no less.
Robinhood users, when signing up for the popular trading app that offered “free trading” were likely unaware of their role in the hedge funds’ ability to reap huge profits.
Like Facebook, Twitter, and TikTok, if the platform you are using is free then YOU and YOUR DATA are the products being sold. Robinhood makes money by selling what is called “Order Flow” and “Level 2” data. This treasure trove of your data is handed over to the same hedge funds that benefited from Robinhood freezing the GameStop stock trades.
While there is not yet proof that these parties colluded to halt trading, the lawsuits have already commenced and Robinhood has not stopped freezing stocks. At the time of this writing more than 50 stocks have been frozen while 34 lawsuits have been filed by small investors including a class action suit of more than 26,000 Robinhood users. Investigations may lead to changes that could level the playing field for the very first time. Foul play or not, millions of regular investors were hurt by the freeze. The wealthy few who could still trade unfairly benefitted.
The system is broken. There is a financial technology that’s been poised to solve this long standing inequity epidemic and has been waiting in the wings to calm the waters and empower small investors.
The solution is Decentralized Finance or “DeFi”. And traders are flocking to it in droves.
DeFi is not just a new kind of technology. It’s a movement to make trading more transparent. It circumvents centralized control in exchanges like Robinhood and even crypto exchanges like Coinbase to ensure your trades can never be frozen. DeFi defies prioritization of one trader over another because there is no middleman who can change the rules or make any decisions. DeFi is an open source market where middlemen do not exist.
When you press the “Buy” button on Robinhood or other trading apps, literally hundreds of middlemen stand between you and the end stock purchase. There are market makers like Citadel, clearing houses, brokerages, dark pools, and simple technological limitations. Any one of those middlemen complicates the trade to the disadvantage of small investors.
I left Citadel for decentralized finance and co-founded a new technology called Overline that takes the philosophy of DeFi to the extreme. Not only is Overline unable to freeze any of your assets but it can’t even turn off the exchange; it’s not possible.
This is because Overline is not an exchange at all. You trade directly with other peers without any middlemen. If you know Bitcoin, you know that it removed the need for banks by introducing mining power. With Overline, we removed the need for exchanges by doing the same thing.
Beyond Overline, the DeFi ecosystem has significantly matured over the last three years. So much so that billions of dollars from regular investors flow through it every day. The blockchain technology ensures that every trade is fully transparent. Projects like Uniswap, 1inch, and Solana all driving the space forward and improving the trading experience.
GameStop got it right with their tagline, “Power to the players.” This week has proved that the people hold the real power in the market, not the hedge funds, and DeFi levels the playing field once and for all. Let’s change the game.
Patrick McConlogue
#ChangeTheGame
