​​Blockchain fixes all of Wall Street Bets’ and Robinhood’s problems 10-Feb-2021

OK, it can fix a very good chunk of their problems.

Wall Street Bets suspects Robinhood of foul play in cancelling trades. Robinhood emp
hasised investor protection, but that just made people more suspicious of Robinhood.

Perhaps Robinhood’s PR or lawyers thought that investor protection was easiest to explain in simplest terms. They’re probably right but it isn’t the full story, or even a good and interesting part of it.

Robinhood was pushed to the max. It’s unreasonable to expect it to be prepared to handle such an unusual and volatile amount of trading in shares which were usually quiet. It has had to borrow $3.4bn to meet the increased collateral requirements from the DTCC (WSJ 01-Feb).

Brokers like Robinhood, and other parts of the financial system, are themselves at risk in a trade. They put up costs and take certain risks when trades happen - if a buyer or seller falls through they can be left in the lurch. Additionally, some of the biggest warning signs for financial crime are unusual volumes, in unusual products, by people who don’t usually trade, and in unusually high amounts. I wonder how many people saw an opportunity for spoofing and layering, for example? Even if many in r/WSB have a point, and are totally legitimately pressing an opportunity, at least some will be bad with only their own interests at heart, and others just taking advantage of the chaos.

These are problems which go all the way back to 2008 and beyond. A big problem in the 07/08 financial crisis was that markets stopped because banks didn’t believe trading counterparties would deliver and the collateral they’d posted wasn’t enough to cover the risk of failure. Before Covid-19 there were still armies of lawyers on entire floors of skyscrapers in world financial centres trying to unpick Lehman nonsense about who owns and owes what. In 1995 it was thought Nick Leeson had a real client with real money. He made trades the bank couldn’t back up and it collapsed. The risks are real.

Financial market infrastructure is segmented, slow, and risky. It just hasn’t evolved with memeing diamond-handers in mind. It costs a lot of money because the overall trading process actually takes a few days (e.g. T+2, T+3) in the background. Money has to be put up to cover the risks of some people not following through on the trades they say they’re going to make.

See the diagram below for approximately what today’s capital markets infrastructure looks like.

Upgrading to blockchains will vastly improve on the current system.

When a cryptocurrency, token, or other blockchain-issued instrument is traded, that also acts simultaneously as the registry, clearing, settlement, etc. In today’s capital markets system those are all separate. Where a process is not covered, blockchain technology at the very least streamlines it. At the same time, it dramatically reduces that wide spectrum of risks inherent in today’s capital markets infrastructure. (Other/new risks and their seriousness are a discussion for another piece).

See the diagram below for approximately what a blockchain-based capital markets infrastructure would look like.

Why not pre-fund the trade? Buyers and sellers put up their assets and cash. When there’s a match, the trade takes place entirely on-chain, and both sides get what they expected.

A blockchain-based financial market infrastructure delivers t+0. We can eliminate huge amounts of counterparty and collateral risks.

Robinhood won’t have to find huge amounts of money to cover the failure risks of trades it isn’t prepared for. It won’t have to cancel the trades of Wall Street Bets guys because it doesn’t want to risk whether or not it can handle them. The Wall Street Bets diamond-handers can keep going.