What does the Gamestop case show about tokenizing securities?

After several stock trading services in the US were forced to restrict trading Gamestop’s stock due to high risk, prominent voices from the Tech sector are proposing that all securities in the stock market should be tokenized in order to ensure everyone freedom to trade 24/7. This sounds fantastic in theory, but it also neglects the fact that, while imperfect, risk prevention regulation exists for good reasons. 

How the Gamestop stock became a worldwide sensation

Gamestop is an American video game company that, for the last decade, has found itself in a similar position to that of movie rental companies after piracy and Netflix came along. Gamestop operates 5.500 retail stores in several countries and business is not booming, as video game sales increasingly take place in online stores.

In August 2020, entrepreneur Ryan Cohen disclosed he holds a major stake in Gamestop (12.9% of shares). Cohen was the founder of Chewy in 2011, a pet supplies online store that he later sold to PetSmart for $3.35 billion. Early this January he was appointed to the Gamestop board of directors, with the mission to turn the company around into a digital store. Shares had nearly doubled a few days after the announcement. 

The news galvanized users of an online message board called WallStreetBets around the Gamestop stock, while high profile personalities like Elon Musk cheered them on. For many, this was an opportunity to go against the wealthy hedge fund managers shorting the stock. Short sellers make money if a stock goes down but the more it goes up the more money they lose. Millions of people flocked to the WallStreetBets group while a Gamestop buying frenzy raised its stock value by 1.600%. As a result, short sellers have accrued an estimated $20 billion in losses. 

Several trading services restricted trading Gamestop stock and angered users

They had to do so because they have to comply with their clearinghouse’s regulation (a third party that settles transactions in batches). To reduce risk, the clearinghouse imposes deposits to the trading services, based on how much of a stock its users have, and how volatile the stock is. 

This means that the more users of a trading service wanted to buy Gamestop, the more the required deposits increased. Some services saw their deposit requirements raise by hundreds of millions. They were forced to either restrict its users from buying or declare bankruptcy. 

Is the solution to tokenize the stock market?

Many prominent voices on social media are now claiming that, if the stock market was tokenized, people would have been free to buy Gamestop’s shares as much as they wanted. Decentralization would enable the liberty to trade at any time, as well as self-custody for individuals, eliminating intermediaries such as the trading services. 

This sounds great, but it’s an irresponsible proposition. Bubbles like this not only hurt the speculators involved, they affect the entire market, where our pensions and savings are invested. As the Wall Street Journal puts it: The stock market is like an online dating site. If too many profiles are fake, the real users will go away. 

What is being proposed by high profile individuals is to use tokenization in a way that, while increasing liberty to trade, would also facilitate the proliferation of bubbles and market manipulation. The justification that it would eliminate intermediaries and would be a freer market is not good enough. 

When the time is right, the tokenization of public securities should be used to increase transparency, improve transaction speed if ever possible, and facilitate more efficient consumer protection, not less.