This week’s edition of wNews unpacks how Redditors managed to bankrupt a hedge fund and inflict serious losses to others.
The mechanics of a Robinhood-fueled short squeeze has made headlines globally. And while many crypto enthusiasts are calling for a paradigm shift, finance may just be experiencing the growing pains of Internet-scale communities. Only time will tell.
Bitcoin and Ethereum traded sideways for most of the week, at least until the world’s richest man decided to endorse BTC on Friday.
Finally, weekend hobbyists can learn the ropes of one of the most interesting projects in crypto. Badger DAO is bringing Bitcoin to Ethereum, with a twist.
All that and more, below.
Occupy Wall Street 2.0
So, let’s talk about what seems to be the only story in finance these days: The WallStreetBets revolution.
It has all the makings of a great story. There are elements of David and Goliath, Robinhood, populist revolution, and sheer mass boredom. Indeed, the narrative is eternal; this edition is just steeped in financial jargon.
This week’s column will create a timeline of events, unpack the two dominant narratives, and, most importantly, reveal how the crypto industry will likely benefit.
But, first, a quick explainer on the mechanics behind the GameStop (GME) short squeeze.
The Big Short (Squeeze)
In laymen’s terms, shorting a stock means you borrow an asset with the expectation that the asset will drop in value. Then you sell that borrowed asset on the open market, repurchase it with your profits once the asset drops, then return the loaned asset and keep the difference.
Here’s a quick theoretical example.
Stock A is trading at $10, but Kaye thinks it’s going to crash soon. So, she borrows the stock from a brokerage and quickly sells it for $10. Don’t forget, Kaye still needs to return the borrowed stock to the broker eventually.
The price then drops to $5 because Kaye is an excellent market guru. She then quickly repurchases the stock at that price using the $10 she made from her earlier sell, returns the stock to the broker, and keeps the extra $5.
Remember, she borrowed the stock, not the value of the stock at that time.
As a side note, when an investor asks their broker to short a stock, the broker is essentially just asking another investor who holds the stock to lend it out. Sometimes this arrangement is buried in the fine print, however.
Now, let’s unpack what happens when the stock doesn’t do what it’s expected.
Kaye has just sold the stock for $10, expecting it to plummet eventually. Instead, though, the stock rises to $12, and she still needs to repay that stock loan. She has two choices: She can either repurchase the stock and take the $2 loss and return the loan, or she can wait and see if the stock eventually falls to a point where she makes a profit.
The latter option is perilous because there is no limit to how high a stock can rise. This means that Kaye’s losses could also be unlimited.
Here’s how this is related to GameStop.
Back in September 2019, a character named r/DeepF*ckingValue (name adjusted for press) began posting about GME on Reddit and his prayer bets on the stock. At that time, the company was also doing quite well, but the stock was underperforming relative to its health.
Josh Gross has an excellent thread on this undiscovered backstory.
Gross began digging into these posts and soon discovered an “insane” level of short interest (i.e., hedge funds like Kaye from above) banking on the fall of GameStop. These funds were, in fact, borrowing more shares than were actively being traded.
They did this because they were convinced that GameStop’s bankruptcy was inevitable, so they went all-in with max leverage.
r/DeepF*ckingValue doesn’t start looking like a genius until Michael Burry, the key figure from the 2008 financial crisis, joined them and began buying boatloads of GME.
The price then slowly began to rise as people joined the trade. “And then more people,” wrote Gross.
The short bettors saw this and quickly bought more shares to cover their positions. This, in turn, puts even more buying pressure on GME, lifting the price even higher. Funds thus need to buy more cover. Thus pushing prices higher. And so on.
Soon, this reached a pitch once a subreddit of millions of users, r/wallstreetbets, caught on to the game. Then Elon Musk and Chamath Palihapitiya joined in, adding fuel to the flames.
— Elon Musk (@elonmusk) January 26, 2021
This is a short squeeze, albeit of epic proportions.
Soon, Melvin Capital, the largest short bettor on GameStop, crumbled. They even earned a $2.75 billion bailout to help close their positions.
And Then There Were Two
Two narratives have since emerged from this debacle.
The first is the story of the little guy against the big bad Wall Streeters. The average joe versus the establishment and so on. This narrative is currently capturing hearts and minds around the world. Some compare the events to a renewed Occupy Wall Street, others to the Capitol riots at the beginning of the month.
“I think that the narrative is romantic, and will likely stick as a kind of justice, a Robinhood type of arrangement,” Thomas Kuhn, an analyst at Quantum Economics, told Crypto Briefing.
Assuming that the GameStop short squeeze is a revolution, it also assumes that an ideology drove the events. And though there have been samples of ideology, one must realize that personal greed, stimulus checks, and the sheer boredom of lockdown are far more logical conclusions.
Jamie Powell of The Financial Times wrote:
“So what is going on? The simple answer is: people have found a way to get rich quick, and are doing so. Nothing more, nothing less.”
What’s more, these Redditors likely didn’t operate alone. Surely, various funds and trading desks saw the same trade and joined en masse. Kuhn added that:
“The reality is probably more complex, where, for example, on Robinhood, the free trading app has been selling its order flow to Citadel, where perhaps High-Frequency Trading also participated in this.”
It’s difficult to call these events a clear-cut paradigm shift.
Instead, a more accurate description would be that greed, when scaled to the size of the Internet, looks an awful lot like ideology.
When so many micro forces are performing a singular, cohesive task, onlookers will have difficulty seeing each component. Thus, what was probably just a bunch of millennials trying to make a quick buck on a trading app, now looks like the French Revolution.
However, that doesn’t mean that these same millennials aren’t perfectly primed for a coup of sorts. Just so long as they get rich along the way.
1-year chart of Bitcoin vs. Gamestop percentage gains pic.twitter.com/OIx5VkUpF6
— Joe Weisenthal (@TheStalwart) January 25, 2021
Market Action: Bitcoin (BTC)
Bitcoin’s price has maintained a horizontal range for the past couple of weeks. Before the next big move, the consolidation phase has primarily held within the range of $33,900 and $30,700.
Bulls attempted a breakout above the range on Monday; however, they failed at highs of $34,900.
The bears also had a go on Wednesday, causing a strong pullback below $30,000. Fear in the market rose to levels not seen in this bull market.
Bitcoin’s Spent Output Profit Ratio (SOPR) is a robust on-chain indicator for gauging long-to-medium term market sentiments. The SOPR shot up significantly last week to levels not seen since the 2017 top.
The metric, nevertheless, touched the pivot value of 1 after Wednesday’s correction. In an uptrend, the market rejects values below 1 and vice-versa.
The ratio has started to pick-up again, suggesting strong hands.
Bitcoin’s peak price of $42,000 is the most critical resistance, beyond the all-time high market’s bullish expectations will rise considerably.
“If BTC reaches $42,000 then a massive inverted head and shoulders pattern will form, which points to $55,000. Additionally, bears failed to closed the daily candle under a large broadening ascending wedge earlier this week, signaling bulls appetite to test higher. Again, this pattern points to $55,000 as an upcoming target.”
Market Action: Ethereum (ETH)
Ethereum’s native token ETH logged a new all-time high of $1,477 on Monday. The surge blindsided the market’s focus towards ETH. However, buyers failed to push it higher.
ETH has since followed Bitcoin’s price action, plunging 9.29% on Wednesday and increasing by 4.8% this morning.
The daily ETH chart is textbook bullish, forming an ascending triangle pattern with higher lows and horizontal resistance. ETH seems to have a clear pass above $1,390 and a high probability of bullish confirmation above the peak value of $1,480.
The support levels for Ethereum are at $1,200 and $1,040.
Still, the funding rates for the top two cryptocurrencies on derivatives exchanges are surging, which is a negative signal.
A funding rate of 0.1% every eight hours on derivatives exchange amounts to more than 100% annual percentage rate (APR). Such high rates make shorting a lucrative option.
The last updated funding rate on Binance, for example, is 0.2% for BTC and 0.19% for ETH.
While traders and investors are getting comfortable with the new hyperactive regime, risk management and avoiding over-leveraging has become more important than ever.
Crypto To-Do List: Bring Bitcoin to DeFi
Decentralized Autonomous Organizations (DAOs) have been a major talking point in the crypto space since 2016, with varying degrees of success.
To date, DAOs have typically run on the Ethereum blockchain. The earliest and best-known DAO was launched in April 2016, less than a year into Ethereum’s lifetime. A vulnerability in the code enabled some users to steal the DAO’s funds, however, and a controversial decision was reached to hard fork Ethereum. It’s what led to the creation of Ethereum Classic.
Though the idea of launching a DAO during Ethereum’s infancy was arguably short-sighted, the blockchain has seen significant development since then. The driving narrative is undoubtedly DeFi, with almost $28 billion locked in protocols such as Aave and Uniswap.
NFTs are also booming. But less attention is paid to DAOs, despite their huge promise.
One of the most promising DAOs on Ethereum is BadgerDAO. Its aim is to usher in Bitcoin as collateral across other blockchains.
Ownership of BadgerDAO is shared, and there are several ways to participate in the project.
BadgerDAO’s products are focused on Bitcoin. One of them is called Sett, a DeFi aggregator that takes inspiration from Andre Cronje’s venerated Yearn.Finance vaults.
Sett offers DeFi users strategies for optimizing yield on tokenized Bitcoin. It currently uses the following strategies:
- Curve_sbtc_lp tokens: Compounding strategy
- Curve_renbtc_lp tokens: Compounding strategy
- Curve_tbtc_lp tokens: Compounding strategy
- Badger <> wBTC Uniswap LP: Compounding Strategy
- Badger: Stake Badger and earn Badger
Sett can be used to earn BADGER, BadgerDAO’s native token. Besides a 10% supply for the founders, which will be released on a slow emission schedule, BADGER has been allocated for the community only. This encompasses liquidity mining, developer mining, the DAO treasury, Gitcoin owners, and the token airdrop.
Rewards are paid based on how long users stake the funds for. Similar to Bitcoin, the supply is hard-capped at 21 million. The funds will be used to govern the DAO.
BadgerDAO’s second product is called DIGG, a synthetic Bitcoin that runs on Ethereum with an elastic supply.
The supply adjusts across all holders according to the value of DIGG relative to BTC. Users’ wallet balance increases when DIGG increases in price and decreases when the price of the token does.
BadgerDAO says DIGG is intended to create a non-custodial version of BTC that relies on elastic parameters.
DIGG has a supply of 6,250. It was recently airdropped to users who bootstrapped the DAO.
Though it’s early days for BadgerDAO, it’s an interesting project that’s helping the growth of Bitcoin on Ethereum. There’s already over $1 billion locked inside the DAO. As demand for collateralized Bitcoin grows, this could well increase in the future.
For anyone familiar with popular tokenized Bitcoin options like WBTC and RENBTC, joining the BadgerDAO could be a nice opportunity to earn yield while joining one of the first functional iterations of a DAO on Ethereum.
However, it goes without saying that many of these protocols are nascent and could fall to bugs or hacks at any time. Proceed with caution at all times.
That’s all for this week’s edition of wNews, readers. Stay tuned for next week’s dispatch.