Bitcoin and the Reddit phenomenon - is there a shared explanation?

Daniel Dăianu (TRANSLATED BY COSMIN GHIDOVEANU)
English Section / 10 februarie

Bitcoin and the Reddit phenomenon - is there a shared explanation?

New technologies, the internet, as a support for social media, can act as a factor for the "democratization" of access to dialogue, to the social and political life, to decisionmaking. To use a concept of Albert Hirschman "Exit, voice and loyalty"'(1970), any citizen can make their "voice" heard, on any issue. Many of the silent ones can thus get such a voice. That can do good, but it can also favor cognitive dissonances, misunderstandings, division in society. Nor does it facilitate compromises in politics, if the public policies are not adequate. That is what has happened during the financial crisis, with the conflict between Wall Street and Main Street. This can lead to a rejection of the "elites" (with their bad and good parts), of the Establishment.

An example in the financial world furthers the aforementioned reasoning. Bitcoin, "other currencies", also express the rejection of the hierarchical structures; aside from the actual technical foundation (blockchain), they are largely the consequence of the financial crisis, and they have also appeared as a result of the drop in confidence in the authorities' ability to limit the effects of the crisis. The financial crisis has shaken the confidence that public goods and financial stability can be ensured. Bitcoin and other cryptocurrencies mirror this lack of trust, the desire to create "parallel markets", to offer an alternative means of exchange which is not subjected to the control of the authorities, of the central banks, and which would be in unison with the operating logic of some non-hierarchical structures.

As I have said on other occasions, the economic, social and political significance of "parallel currencies" goes deeper than it is assumed in the customary public debate. And this significance cannot be interpreted only through the libertarian mindset - the kind of discourse that there would be no more need for central banks, that we need to return to gold and free banking, or an "anarchic" interpretation, of total decentralization of relations in society. This meaning can be easily included among the arguments that speak about the need to rethink capitalism, to make it more inclusive. At any rate, cryptocurrencies are remble financial assets more, which attract those that bet on speculative gains. Crypto-currencies do not have a State behind them, as a borrower of last resort, they have a very high volatility (specific to financial assets), are limited in quantity (gold isn't yet limited in quantity, even though theoretically it is limited in terms of the volume that exists on the planet, alchemical fantasies aside), they do not serve the functions of money.

Another example in the financial world is the recent Wall Street "rebellion" (January 2021), the "Reddit" phenomenon - individual traders who produced a major short-squeeze with long positions and who beat hedge funds (e.g.: Melvin Capital) which had shorted GameStop. Hedge funds bet on the major drop of the prices of this company on the stock market by short-selling them and anticipating major gains by buying them at far lower prices. But they have lost a lot of money, after being forced to close their positions at very high prices due to the counter-strike by a large of number of investors from the Reddit movement who pooled their money together. Fundamental analysis shows that GameStop is in a difficult situation and a change in the business model was necessary. But a company's structural problems are one thing, and speculators' game is another. That short-selling can have positive effects when it unveils serious issues (such as for instance the Wirecard case) does not eliminate the controversies concerning these term-operations, which are not illegal, but are not necessarily beneficial. It isn't for nothing that short-selling funds have long been called "vultures".

The Reddit phenomenon can be considered as pertaining to the decentralization mentioned above - wider access to a market that is dominated by big players. It is the expansion of the possibilities of many (small individual traders) to do what was, until recently, only available to those who dominate the financial market. Since forever, this market has been exposed to rigging. Therefore, the financial market needs to be regulated and supervised. And that is why there are regulatory and supervisory institutions whose activity has been influenced over time by ideas, dominant paradigms in economic and social life, by powerful interest groups.

After the crisis of 1929-33 there was the regulation initiated by the Franklin Delano Roosevelt administration through the Glass-Steagall legislation, which essentially separated retail and investment banks and regionalized the banking sector - attempts were made to reduce the channels of contagion of a crisis, thesis reprised by Andrew Haldane (chief economist with the Bank of England) in 2009 after the outbreak of the financial crisis more than a decade ago.

In the last decades of the last century there was the Big Bang in the City of London (1986), the abolition of Glass Steagall in the US in 1999 and other initiatives that enshrined "light touch" regulation and created premises for increasing financial market speculation, the introduction of all kinds of derivatives of great complexity, which exacerbated systemic risks. Central banks have also fueled the frenzy of stock market speculation with very cheap money out of a desire to avoid recessions - which has affected the normal process of market exit and entry. Nor did what we now call macroprudential measures to reduce lending that feeds speculative bubbles exist then.

Speculation cannot be eliminated because it is part of the nature of financial markets and of human nature (acquisitive, unbridled desire for profit, in the logic of homo oeconomicus). But it is the role of regulation and oversight to ensure that systemic risks are reduced, to make the Stock Exchange more than a mere casino, but to fulfill the function of providing funding to some companies, as an alternative to bank loans. Capitalization through stock issuing can also be viewed from the perspective of the distortions created by the Modigliani-Miller theorem, which equates equity with loans to obtain additional gains through leverage.

The stock market, beyond the inherent fluctuations derived from rumors and temporary trends, from all kinds of unavoidable noise of all kinds, is designed to express the performance of listed companies, to promote transparency, better corporate governance. That is the big stake of the regulatory and supervisory activity.

And the experience of Gary Gensler, newly appointed as chairman of the Securities and Exchange Commission (SEC) will help the regulator be more skilled in uncovering irregularities. It is telling that leftist and right-wing politicians in Congress have had reactions to the Reddit/GameStop episode; some are asking for a revision of the regulations, in order to avoid abuse, dominant positions, others criticize the temporary shutdown of trading in some stocks (like it happened on the Robinhood platform), etc.

If hedge funds experience major losses, that will be a lesson for them and they will probably be more careful. What is essential for the stock market is for systemic risks not to be created (as was the case of Long Term Capital Management in 1998). Especially since the Fed (the US central bank) ended up buying even junk assets in 2020 junk to avoid the collapse of the financial markets, which would have led to repercussions all over the world. In other words, the Fed is the de facto lender (buyer) of last resort and on the stock market -a "market maker".

Is there a link between the bitcoin phenomenon and the Reddit phenomenon along the lines of "decentralization", of the protest against the dominant forces / positions on the markets, against the "elite", against a system that is considered by some to be manipulated (rigged) in favor of others?

"Parallel currencies" are part of the logic of total decentralization, which does not want a central authority; The Reddit phenomenon illustrates the need for good, fair regulation that gives equal opportunities to market participants. But what happened in January brings back the discussion on how to regulate the market in order to reduce systemic risks, so as to prevent favoring speculation to the detriment of the basic role of the capital market (financing economic activity). The latter message is even more relevant for Romania, where the stock market is still developing and should not be a mere field for speculation, for domestic and foreign players.

The moral is that the economic system must be captive, or manipulated, to as little an extent as possible; capitalism must work for the benefit of as many citizens as possible, for as many companies as possible. Otherwise, there are protests, rejection reactions, extremism, and democracy is eroded. The stock market needs to help change business models when necessary. Central banks also receive a message that large-scale money injection is fueling the search for yields at all costs, encouraging speculative bubbles. It should be noted that speculation is also made against weaker currencies, since we're speaking of the need for Romania to reduce its large imbalances (budgetary and external), which put pressure on the leu. Speculative operations span the whole spectrum of financial markets and had a turning point following the breaking the link between the US dollar and gold in 1971. It is that moment that can be considered as a key step towards financial liberalization, the invention of all kinds of financial products.

The stock market can also produce the illusion that money can be made easily - money out of money, not by creating ideas, or new products that help our lives, but through financial operations. That you can have a guaranteed living by simply being in front of a console, watching your mobile phone for hours and entering special trading apps. To most, this is obviously an illusion. Stock market operations cannot replace true human creation. And it is impossible to win on the stock market systematically. It's not a global casino that humanity needs. We need to be realistic.

The article " Bitcoin and the Reddit phenomenon - is there a shared explanation?" was written at the request of the BURSA editorial office, which saw these two processes as being extremely significance.

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