The remaking of the financial system

Society’s grievances against Wall Street, festering since the GFC, are starting to boil over.

In an interesting quirk of history, the war over GME has come at the same point that autonomous financial protocols – self-driving banks – are starting to pick up serious momentum. The stage is set for a seismic shift, where the young and tech-savvy start to migrate to this new world of autonomous finance.

It’s fair to say that the subreddit ‘WallStreetBets’ is an unlikely protagonist for this story about profound change in the global financial system. Subreddits are subject-specific online communities of Reddit users, and WallStreetBets – a group of mostly young investors – is as rowdy as they come.

The WallStreetBets subreddit, now nine million strong (at time of writing), is dominated by viral memes and maverick characters with pseudonyms like u/DeepFuckingValue. The rag-tag and chaotic appearance of the subreddit obscures a surprisingly close-knit and powerful community of young investors.

The strength of this collective was on display last month, with the subreddit successfully executing a short squeeze against the gigantic hedge funds shorting the failing retailer GameStop (GME).

Screeds and screeds have been written by journalists around the world about GME and the showdown between the foul-mouthed Redditors and the Wall Street bankers.

It’s a fascinating story (and will make a great movie) but the real takeaway has little to do with GameStop, and everything to do with the surging undercurrent of frustration driving WallStreetBets to enter the fray in the first place.

What started as a long-shot bet on a written-off stock rapidly turned into an ideological crusade, with millions of young investors upvoting posts about “how to fuck the bankers”. Some of the most popular posts were investors confessing that they were buying GameStop stock even though they knew it was overvalued, in order to keep “hedge funds bleeding”.

This saga is not about retail investors actually thinking they will get rich from squeezing the GameStop shorts (WallStreetBets investors are well acquainted with the reality of risky stock speculation) — instead, it’s about the compelling framing of the ‘little guy’ winning a rare victory in a financial system loaded in favour of wealthy bankers and hedge funds.

This collective sense of grievance proved to be globally unifying, whether judged from the huge virality of anti-banker memes or the number of small investors piling in to buy GME (setting records all around the world, including in New Zealand).

It is not difficult to see where the frustration against the financial institutions is coming from. Widely seen as responsible for the 2007–2008 global financial crisis, banks avoided significant legal liability and have gone on to set record profits in the years since. JPMorgan Chase, America’s biggest bank, posted a revenue record in the middle of the last year, notwithstanding the Covid-driven recession. Hedge funds like Melvin Capital cop the most flack of all, with their propensity to make money by betting on the failure of other companies, like GameStop.

Even Robinhood, with both a name and an app tailored for smaller investors and young people, came in for extreme scrutiny during the GME saga.

Robinhood suspended the buying of GME stock at the height of the share’s skyrocketing ascent, to the incandescent fury of Reddit. For a period of days, most investors were only able to sell the stock, not buy it, and so the GME price unsurprisingly cratered. WallStreetBets accused Robinhood of conspiring with hedge funds, and tens of thousands of people tried to join a class-action lawsuit alleging the company of market manipulation.

Whether or not the allegations of market manipulation are true (and they do not appear to be, at this stage), the community’s gut instinct was righteous fury. A message from a friend echoes the sentiment online: “it’s exposing how rigged the system is… pick which side of history you want to be on, I reckon.”

The Rise of Self-Driving Banks

At the same time that a maverick group of Redditors unified an unprecedented number of people against Wall Street, a niche type of blockchain protocol entered a period of exponential growth.

These blockchain applications, like Compound and Aave, belong to the category of emerging tech known as of ‘decentralised finance’ and they have the potential to turn the world of traditional finance upside-down.

While the term ‘blockchain’ usually has the effect of making people yawn and close an article, you don’t need to have any understanding at all about the technology to appreciate what these new applications can do.

These applications, or protocols, were approvingly described as ‘self-driving banks’ by the acting US Comptroller of Currency, Brian Brooks. Much as self-driving cars need no human operator in order to drive, self-driving banks are designed to work without any human involvement. Instead, they use algorithms to do the heavy lifting.

The developers who design these applications remove their private access to the back-end code when releasing it to the public, making them ‘decentralised’ — controlled by no single party.

The last twelve months have seen a Cambrian explosion of these kinds of financial protocols. There are money markets with algorithmically derived interest rates, determined by supply and demand, not a committee of bankers. Other popular applications include lending protocols and derivatives platforms, all driven by code.

Because these protocols are all built on public blockchains like Ethereum, they are completely transparent: the code running the application is visible to anyone. You can track exactly what happens to your money on a borrowing or lending protocol, for instance.

The simmering discontent of the Reddit and other GME investors illustrates exactly why self-driving banks might take off. If a completely decentralised financial application runs without human input, there is no scope for collusion or conspiracy. Hedge funds and bankers might dominate the traditional financial world, but they have zero influence on an algorithm designed purely to reflect supply and demand. By having no humans involved, self-driving banks should be free from any risk of fraud or corruption. They also have no capacity to discriminate against users based on their ethnicity or gender, a serious problem in the traditional financial system.

Finally, by cutting all the traditional overheads for a bank, like employees or buildings, these protocols can pass cost savings on to their users.

With the GME saga revealing a massive global hotbed of younger people discontented with the shadowy operations of the traditional financial system, there could be no better springboard for a new financial system that eschews people altogether. As many as 28 percent of Americans were willing to join in with the Redditors by buying ‘meme stocks’ like GME, which is staggering.

If a new wave of financial technology can capitalise on this meme-powered energy, this combination of forces might remake the financial system altogether.