IMPACT OF CRYPTOCURRENCIES ON THE MONETARY POLICY
Impact of Cryptocurrencies on the monetary policy
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IMPACT OF CRYPTOCURRENCIES ON THE MONETARY POLICY
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Abstract
The rapid advancement of technology has ushered in the development of
cryptocurrencies. The innovation in the financial system and revolutionized the entire process
and made transactions simple. Although there are different types of cryptocurrencies globally,
Bitcoin is the most famous and notable virtual currency compared to others. In this research,
secondary resources will be utilized to explain monetary policies' role in the economy. The
research results indicate that Bitcoin does not influence the current monetary system, although
Bitcoin Cash has strong popularity. In future private publishers would create one or two types of
cryptocurrencies that would become accepted as a means of transaction. Alternatively, countries
may create their digital currencies based on blockchain or related technology.
IMPACT OF CRYPTOCURRENCIES ON THE MONETARY POLICY
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Introduction
The rapid advancement of technology has ushered in the development of
cryptocurrencies. Since 2008, different types of cryptocurrencies have emerged globally, some
being backed by the central bank. The massive growth in their usage and popularity recently
attracted more significant attention to different people, including legislatures. An increase in the
use of cryptocurrencies increases the competition of the government's fiat money. According to
Tomić, Todorović, & Čakajac (2020), cryptocurrency is a digital or virtual currency applied to
purchase goods and services, but it uses an online ledge. One characteristic of the cryptocurrency
is that it uses a strong secured online transaction. These virtual currencies attract interest from
most people as they are unregulated owing profits to speculators. Consequently, this pushes the
value of cryptocurrencies skywards. Most cryptocurrencies are decentralized network based
blockchain technology that is impossible to double-spend or counterfeit. Sauer (2016) defines
blockchain as a devolved and distributed ledger that records digital asset transactions. With
advancements in the current technology, various companies and countries have unleashed their
own cryptocurrencies, including Litecoin, Bitcoin, Cardano, Polkadot, Chainlink, Stellar and
others. The innovation in the financial system and revolutionized the entire process and made
transactions simple. Cryptocurrencies are providing tools for simplifying people's lives. Also, it
has promoted a new era of crowdfunding. According to Pfister (2017), crowdfunding is the
process whereby entrepreneurs accumulate money. Using blockchain technologies, people mine
Bitcoins. Consequently, there are some challenges attached to bitcoins. Unlike the US dollar,
cryptocurrencies lack scalability. It is difficult to change cryptocurrencies to purchase goods or
services. Also, there is an issue surrounding the use of bitcoins around the world. There are only
about 400,000 transactions, which are less than over 150,000,000 visa processing transactions
IMPACT OF CRYPTOCURRENCIES ON THE MONETARY POLICY
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per day. Cloyne, Ferreira, Froemel, & Surico (2018) elaborate that this is more likely to change in
the future, and central banks should find ways to operate collaboratively with cryptocurrencies.
They should establish a central bank cryptocurrency. Although there are different types of
cryptocurrencies globally, Bitcoin is the most famous and notable virtual currency. Bitcoin is a
form of the digital asset created to work as a medium of exchange applied globally. The
individual's coins are stored recorded in the encrypted computer system. Bitcoin is one of the
cryptocurrencies, privately issued and facilitates peer to peer transactions. It has the potential of
becoming the most reliable medium of exchange, and mode of payments and savings. Unlike fiat
money regulated by a country's monetary policy, cryptocurrencies like Bitcoin heavily depend on
the demand and supply market mechanism, making them very volatile. Although bitcoin is
considered highly volatile, it has a limited inflation rate. If there is a guarantee in its stability, its
usability will increase, threatening central bank effectiveness in regulating the currency. In other
words, it will reduce the demand of the central banks. This research evaluates the implication of
Bitcoin on the monetary policy. Bitcoin use has both positive and negative consequences for
monetary policies. Although Bitcoin Cash has a strong popularity, it does not influence the
current monetary system.
Overview
Monetary policy
According to Kiley, & Roberts, (2017) monetary policy entails the actions that the
country's central bank exercises to communicate and manage the supply of money in the
economy. The money supply includes forms such as checks, credit, cash, digital cash, and the
money market. In this case, the primary forms of money are credits, including mortgages, loans,
and bonds. There are three types of primary objectives of monetary policy. First, the monetary
IMPACT OF CRYPTOCURRENCIES ON THE MONETARY POLICY
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policy manages inflation in the country. Secondly, it aims at reducing the unemployment rate.
Lastly, it promotes moderation of long-term interest.
There are two types of monetary policies that central banks utilize to reduce to adjust or
correct various economic parameters. First, it can apply a contractionary monetary policy, which
reduces currency circulation in the economy. During inflation, the central bank may increase the
interest rate on the loans, which discourages borrowing. Reduction in borrowing reduces the
money circulation in the economy, which also reduces the aggregate demand. It makes the
aggregate demand go back to normal. Secondly, the government may use expansionary policy.
Central banks use expansionary monetary policy to lower unemployment and avoid recession.
They increase liquidity by giving banks more money to lend. Banks lower interest rates, making
loans cheaper. Businesses borrow more to buy equipment, hire employees, and expand their
operations. Individuals borrow more to buy more homes, cars, and appliances. That increases
demand and spurs economic growth.
Literature Review
Recently, cryptocurrencies have become more popular. The term cryptocurrencies were
popularized in 2009 when it became widely accepted by most people. The most known type of
cryptocurrency is bitcoin. Tomić, Todorović, & Čakajac (2020) outline that Bitcoin value
appreciated by 1,318 percent in 2017 compared to most equity indexes across the world. The
future of Bitcoin is contested by some authors, where some assert that it is doomed to fail in the
future. Cryptocurrencies significantly impact the world's economy. First, the cryptocurrencies
have challenged the US dollar, the Chinese yen, and Euro. According to Tomić, Todorović &
Čakajac (2020), the US dollar has been the most common currency used globally. It has been
IMPACT OF CRYPTOCURRENCIES ON THE MONETARY POLICY
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used as a reserve currency in the global economy. For many years, several attempts have been
made in an effort to de-dollarize the global economy. Most countries and governments needed to
end the dollar's reign in the global economy. However, cryptocurrencies have been used to
replace the dollar. It holds high ground with most transactions, thus making the US dollar lose its
popularity.
Secondly, cryptocurrencies like bitcoin have resulted in new payment methods.
Cryptocurrencies have introduced a new way of payment. Initially, people used to transact using
cash payment. Today, people cannot transact without their credit or debit cards. In other words,
debit and credit cards have made it easy to transact. In their study, Tomić, Todorović, & Čakajac,
(2020) found that the central bank has little or no influence on the private cryptocurrency usage
growth, which continues to endanger the traditional monetary systems. Therefore, Tomić,
Todorović, & Čakajac (2020) propose the establishment of national cryptocurrencies to counter
the influence of the privately-owned cryptocurrencies. However, Tomić, Todorović, & Čakajac
(2020) outline that cryptocurrencies have little capacity to endanger a country’s monetary
system.
In their report, Mandeng (2018) elaborated that cryptocurrencies challenge traditional
monetary systems' dominant position. They assert that cryptocurrency usage is feasible during
hyperinflation, political turmoil, financial crisis or any other situation that negatively impacts an
economy where it can substitute the traditional monetary system. However, their report Srokosz,
& Kopciaski, (2015) highlighted that financial regulators might not advocate cryptocurrencies
because of their anonymity and ability to circulate across the borders. Financial regulators tend
to believe that cryptocurrencies will facilitate tax avoidance, money laundering, the financing of
illegal activities, circumvention of capital controls, and fraudulent activities. Therefore, the
IMPACT OF CRYPTOCURRENCIES ON THE MONETARY POLICY
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available literature presents findings on the impact of cryptocurrencies on monetary policies.
Some studies argue that cryptocurrencies present a significant risk on the dominant monetary
policies. It highlights the gap in the current study, which requires deeper research in future to
address the causes of this gap.
Methodology
In this research, secondary resources will be utilized to explain monetary policies' role in
the economy. The Bitcoin and market cap websites were the primary sources of data, which was
used to give more detail on the representation of the cryptocurrencies in the global economy.
The analysis of the financial journals and peer-reviewed articles was conducted to determine
how cryptocurrencies fulfil the money function in the economy.
Findings
Table 1.
Bitcoin Annual rate of return in dollars
Opening
Year stock
Closing
Annual
Stock
Return
2011
0.3
4.72
1473%
2012
4.72
13.51
186%
2013
13.51
758
5507%
2014
758
320
-58%
2015
320
430
35%
2016
430
968
125%
IMPACT OF CRYPTOCURRENCIES ON THE MONETARY POLICY
2017
968
13860
1331%
2018
13860
6321
-54%
8
Source: https://bitcoinexchangeguide.com/bitcoin-btc-proves-to-be-profitable-when-measuringyearly-returns-for-investors-2011-2018/
Table 2
Top Cryptocurrencies by capitalization from 2014-2021
Market
No. Name
1 Bitcoin
Symbol Capitalization
BTC
2 Ethereum ETH
Circulating
Unit price
supply
Volume (24h)
$882,075,744,037.00 $47,239.82
$88,075,744,037.00
$18,626,425.00
$201,965,890,079.00
$38,893,332,012.00
$114,636,704.00
$1,758.20
3 Tether
USDT
$30,738,524,378.00
$1.00 $155,635,236,841.00 $30,727,705,082.00
4 Cardano
ADA
$28,179,591,933.00
$0.93
$10,319,114,361.00 $31,112,484,646.00
5 XRP
XRP
$25,213,958,914.00
$0.55
$10,750,229,281.00 $45,404,028,640.00
Source: https://coinmarketcap.com/
Table 3
Bitcoin market capitalization and price
IMPACT OF CRYPTOCURRENCIES ON THE MONETARY POLICY
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Source: https://coinmarketcap.com/currencies/bitcoin/
Analysis
Table 1 indicates how Bitcoin has been performing since its introduction into the
economy. Ideally, Bitcoin began as a concept currency, and it was not taken seriously by the
majority. From the data collected in the table, it is clear that Bitcoin is the most important
cryptocurrency across the world, and it seems profitable. Bitcoin has registered profits for six
years between 2011 and 2018. Table 1 indicates that the virtual currency recorded over 1000
percent gains in 2011, 2013, and 2017. It also recorded over 100 percent gains in 2011, 2012 and
2016 and only 2015 percent it recorded 53 percent proceeds. Moreover, it recorded negative
returns in 2014 and 2018. High profits records from most of the digital currencies attract
attention from most investors, thus pushing the prices of digital currencies skywards. The graph
IMPACT OF CRYPTOCURRENCIES ON THE MONETARY POLICY
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in table 3 indicates that the price and market capitalization of the bitcoin has been rising
significantly from 2014 to 2021. The Bitcoin price rose from US$754.57 in 2014 to US$
47,027.27 in 2021. Similarly, its market capitalization rose from $8,946,914,139 to
$877,160,630,819 in January 2021.
Table 2 shows the market capitalization of the top five virtual currencies including
Bitcoin, Etheric, Tether, Cardano, and XRP. Bitcoin leads with $882,075,744,037, followed by
Ethereum 201,965,890,079, Tether with $30,738,524,378, Cardano with $28,179,591,933, and
XRP with $25,213,958,914. By January 2021, the market capitalization for all cryptocurrencies
surpassed one trillion.
By 2020, there were 5,134 digital currencies recorded on the coinmarketcap.com website,
with the first 19 cryptocurrencies being less than a hundred billion US dollars. Similarly, the top
100 US dollars have a market capitalization of less than 120 billion US dollars, where more than
half of this amount belongs to bitcoin. Studies show that the market capitalization value does not
increase with the increase in the number of cryptocurrencies.
The implication of Bitcoin on the monetary policy
The recent advancement in technology has led to the development of cryptocurrency.
The massive growth in usage and popularity recently attracted greater attention to different
people, including legislatures. An increase in usage of Bitcoin increases the competition of the
government fiat money. Bitcoin being a privately controlled entity, its implication on the
monetary system becomes a necessary topic to address (Tomić, Todorović, & Čakajac, 2020).
The ability of the private entities to make automatic decision making concerning the money
supply diminishes the ability of the central bank to make monetary policy effectively.
IMPACT OF CRYPTOCURRENCIES ON THE MONETARY POLICY
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Theoretically, the automaticity of the private institutions' Bitcoin to make monetary supply
decision would interfere with central banks from implementing monetary policy efficiently.
Currently, Bitcoin's monetary implications remain extremely limited. This is due to the fact that it
has a low worldwide market capitalization when compared to the traditional currency. Bitcoin
market capitalization is below 2.0 percent, which is less than M1 and M3 of the euro area monetary
aggregates. Bitcoin has limited acceptance and high volatility, which makes it less monetary.
However, the low capitalization of Bitcoin in the market limits its impact on global
monetary movements. According to Tomić, Todorović, & Čakajac (2020), cryptocurrencies
capitalization currently constitutes a small proportion compared to world financial assets.
Currently, Bitcoin market capitalization is approximately $ 100 billion, which merely constitutes
1.3 percent of the $7.6 trillion in all global coins and banknotes. On the other hand, 1.3 percent
of the world's $7.7 trillion in gold, 0.11 percent of the world's broad money supply, which $ 90.4
and 0.13 percent of the $73trillion in global stocks (Sauer, 2016). It can be assumed that Bitcoin
is not in the capacity of endangering the traditional monetary system.
Some policymakers believe that Bitcoin thwarts the effectiveness of monetary policies.
An excellent example of a person doubting the effectiveness of Bitcoin is Randal Quarles, who
was the former US Federal Reserve Bank. Quarles argued that although cryptocurrency like
Bitcoin has no impact on the economy currently, it may pose stability issues in the future if they
attain wide-scale usage. Therefore, Bitcoin may frustrate the central bank's effort to counter
credit risk and price because the local currency exchange rate may become unstable (Nabilou, &
Prüm, 2019). For instance, the instability of the price of goods and services in the economy
results in inflation. The government's efforts to counter inflation by increasing the bank reserves,
IMPACT OF CRYPTOCURRENCIES ON THE MONETARY POLICY
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increase borrowing interest rates may be unfruitful. Bitcoins are not the liability of an identifiable
issuer. Like fiat money, Bitcoin currency has not attached intrinsic value. Bitcoin's price is solely
driven by the market mechanism. The supply of bitcoin is controlled by algorithms and rises at a
fixed rate.
Arguably, Use of Bitcoin will have a positive impact on a country with poor monetary
management. Some countries irresponsibly print fiat money, ending up hurting the economy.
Countries with the irresponsible monetary system do not escape a period of extreme inflation,
which worst hit people from those countries. Therefore, Bitcoin reduces the government's ability
to devalue money through printing money. In this case, it has positive implications on the
monetary policy. It promotes welfare gain for countries with high volatility. For instance, Bitcoin
will help to stabilize Venezuela, a country that experiences major fluctuations in the economy. It
will cushion Venezuelan people from government irresponsibility, which affect their living
standards.
Conclusion
The rapid advancement of technology has ushered in the development of
cryptocurrencies. Since 2008, different types of cryptocurrencies have emerged globally, some
being backed by the central bank. The massive growth in their usage and popularity recently
attracted more significant attention to different people, including legislatures. With
advancements in the current technology, various companies and countries have unleashed their
own cryptocurrencies, including Litecoin, Bitcoin, Cardano, Polkadot, Chainlink, Stellar and
others. Despite gaining popularity, cryptocurrencies pose no threat to an existing monetary
system. The changes brought by the cryptocurrencies indicate private electronic money systems
IMPACT OF CRYPTOCURRENCIES ON THE MONETARY POLICY
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could be long-lasting. In future private publishers would create one or two types of
cryptocurrencies that would become accepted as a means of transaction.
Future Research
After its introduction, Bitcoin has gained significant growth and success. Pieters (2017)
outlines that cryptocurrencies cannot diminish the ability of the central bank or government to
implement monetary policies. A ten-year existence of virtual currencies has influenced the
approach to managing electronic currencies. The changes brought by the cryptocurrencies
indicate private electronic money systems could be long-lasting. Based on its stability, and
efficiency in transacting there is no doubt that cryptocurrencies will be part of the future payment
systems. Currently, the cryptocurrencies do not have the capacity to influence the monetary, but
it can increase in future. In future private publishers would create one or two types of
cryptocurrencies that would become accepted as a means of transaction. Alternatively, countries
may create their digital currencies based on blockchain or related technology.
IMPACT OF CRYPTOCURRENCIES ON THE MONETARY POLICY
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References
Cloyne, J., Ferreira, C., Froemel, M., & Surico, P. (2018). Monetary policy, corporate finance
and investment (No. w25366). National Bureau of Economic Research.
Kiley, M. T., & Roberts, J. M. (2017). Monetary policy in a low-interest rate world. Brookings
Papers on Economic Activity, 2017(1), 317-396.
Mandeng, O. J. (2018). Cryptocurrencies, monetary stability and regulation. In Technical Report.
Nabilou, H., & Prüm, A. (2019). Central banks and the regulation of cryptocurrencies. Review of
Banking and Financial Law (Forthcoming).
Pfister, C. (2017). Monetary Policy and Digital Currencies: Much Ado About Nothing?. SSRN
Electronic Journal.
Pieters, G. C. (2017). The potential impact of decentralized virtual currency on monetary
policy. Federal Reserve Bank of Dallas-Globalization and Monetary Policy Institute
2016 Annual Report.
Sauer, B. (2016). Virtual currencies, the money market, and monetary policy. International
Advances in Economic Research, 22(2), 117-130.
Srokosz, W., & Kopciaski, T. (2015). Legal and economic analysis of the cryptocurrencies
impact on financial system stability. Journal of Teaching and Education, 4(2), 619627.
Tomić, N., Todorović, V., & Čakajac, B. (2020). The potential effects of cryptocurrencies on
monetary policy. The European Journal of Applied Economics, 17(1), 37-48.
Long-term investing strategies vs. short-term speculation
Long-term investment strategies are more efficient than short-term speculation. Longterm investing and short-term speculation are two different acts that are commonly confused as
the same. According to The Intelligent Investor, written by Benjamin Graham, the father of value
investing, and Jason Zweig, “An investment operation is one which, upon thorough analysis
promises safety of principal and an adequate return. Operations not meeting these requirements
are speculative” (Graham & Zwieg, 2005, p. 27). Speculation is commonly associated with
short-term investing is not different from gambling. Meanwhile, long-term investing is not
gambling but is a passive strategy that could help investors beat the market. Long-term investors
and short-term speculators also manage emotions differently when investing or speculating in the
stock market. Short-term speculators tend to sell off their stocks at low prices, while long-term
investors hold stocks and buy more cheap stocks while others sell out of fear. Short-term
speculators also use technical analysis to help them forecast stock price movements. However,
technical analysis is like a coin flip, and the previous prices of a stock do not reflect its future
price. Also, long-term investors tend to beat actively managed funds with passive investing
strategies. Most actively managed funds could not beat passive funds in the long term because
they actively buy and sell stocks. In addition, costs such as higher fees charged by actively
managed funds and commission charges on frequent buying and selling restrain short-term
speculators from beating long-term investors overtime.
Short-term speculation
Many people could not differentiate between speculating and investing. Short-term
speculation is risky and not a sustainable way to build one’s wealth. According to The Intelligent
Investor, “an investor calculates what a stock is worth, based on the value of its businesses” and
“a speculator gambles that a stock will go up in price because somebody else will pay even more
for it” (Graham & Zwieg, 2005, p. 40). Short-term speculators gamble that a price of a particular
stock will increase. They do this without valuing or fundamentally analyzing the stock.
Speculating in the stock market can be exciting and deliver high returns if a speculator gets
lucky. However, it is no different from “casino gambling or betting on the horses” and is the
worst way to build wealth. Similar to casinos, Wall Street “has calibrated the odds so that the
house always prevails, in the end, against everyone who tries to beat the house at its own
speculative game” (Graham & Zwieg, 2005, p. 40). These reasons prove that short-term
investing or speculation is not different from casino gambling and that long-term investing is a
more effective strategy.
Long-term investing
Long-term investors value stocks and determine whether their price is high, low, or fair.
They make investment decisions based on stock valuation, mostly buying stocks cheaper than
their actual value. Long-term investors stay away from expensive stocks. Expensive stocks are
valued more than their underlying value. Investing is described by Graham as “a unique kind of
casino” where one cannot lose money if you play by the rules. Long-term investors make money
for themselves in the long-term; whereas speculators make money for their brokers due to their
recurring buy and sell orders (Graham & Zwieg, 2005, p. 40). Graham explained that you should
only invest “if you would be comfortable owning a stock even if you had no way of knowing its
daily share price” (Graham & Zwieg, 2005, p. 40). A stock’s share price changes almost every
day; therefore, long-term investors are not worried about the price movements of a stock they
hold, knowing that it will grow in the long-term. Yet, speculators get carried away by the
volatility of the stock market. They gamble and predict whether the stock price will go up or
down and try to make trades to benefit from a stock’s potential price movement. Instead, a more
sustainable way of investing and not speculating in the stock market is to buy and hold stocks,
particularly value stocks, for the long-term.
Emotions in the stock market
Short-term speculators make poor speculative decisions in the stock market based on
their emotions. Speculators tend to fear losing their money when the market drops. Instead of
buying a stock for a low price and selling it when it becomes expensive, speculators often decide
to sell when the stock price becomes cheap due to a market correction. The stock market is “a
pendulum that forever swings between unsustainable optimism (which makes stocks too
expensive) and unjustified pessimism (which makes them too cheap)” (Graham & Zwieg, 2005,
p. 12). Long-term investors take advantage of unjustified pessimism in the market by buying
cheap value stocks. Graham explained how intelligent investors “buy from the pessimists”
(Graham & Zwieg, 2005, p. 12). Long-term investors should know how to control their emotions
and be patient in investing. They do not sell their stocks for a cheap price due to fear during
market corrections. If a long-term investor is patient, they could “take steady advantage of even
the worst bear markets” by buying cheap stocks when others are selling out of fear. Bear markets
tend to result in long-term investors buying cheap stocks while short-term speculators lose a lot
of money from selling stocks at a massive loss. Long-term investors should also develop
“discipline and courage” and “refuse to let other people’s mood swings” influence investing
decisions. Intelligent investors should sell out of fear as others do. They should not let emotion
dictate their investing decisions, but they should carefully analyze their stocks and decide
whether it still has value amidst the sell-off. On the other hand, when people are optimistic about
the stock market, investors should never overpay for a stock. Graham called the elimination of
the “risk of being wrong” the margin of safety. He insisted that investors should not overpay “no
matter how exciting an investment seems to be” (Graham & Zwieg, 2005, p. 12). The margin of
safety could help investors minimize the risks of errors or unexpected factors that could affect a
company’s financial performance in the long run. Short-term speculators tend to buy stocks at a
premium overlooking the concept of having a margin of safety. On the other hand, forecasting
short-term momentum or swings would not “allow you to beat the market” because “stock prices
don’t always underreact to the news—sometimes they overreact and price reversals can occur
with terrifying suddenness” (Malkiel, 2003, location 1855). According to Bogle, it is not possible
to accurately forecast short-term swings in the stock market. However, “forecasting the longterm economics of investing has carried remarkably high odds of success.” (Bogle, 2017, p. 60).
Therefore, short-term speculators lose overtime to long-term investors.
Technical analysis
Some short-term speculators use technical analysis to help them time and predict the
price movements of stocks. Technical analysis is a methodology that assists short-term
speculators or ‘technicians’ analyze “a stock’s past behavior” to “help predict its probable future
behavior” (Malkiel, 2003, location 1801). Technicians use the “sequence of price changes before
any given day” to help “predict the price change for that day” (Malkiel, 2003, location 1801).
Technical analysis could be compared to the wallpaper principle, “where the pattern of wallpaper
behind the mirror is the same as the pattern above the mirror” (Malkiel, 2003, location 1801).
Nevertheless, Burton Gordon Malkiel, an American economist; and author of A random walk
down Wall Street: the time-tested strategy for successful investing, mentioned how he “never
known a successful technician, but seen the wrecks of several unsuccessful ones” (Malkiel, 2003,
location 1781). He further explained that technicians blame their errors on not believing and
investing based on their charts. Short-term speculators who use technical analysis have to pay
transaction costs and taxes. Thus, they do not outperform a buy-and-hold strategy (Malkiel,
2003, location 1795). Technical analysis had been tested by “using stock-price data on the major
exchanges” dating back as far as the “beginning of the twentieth century” (Malkiel, 2003,
location 1807). The results revealed that the “past movements in stock prices could not reliably
foretell future movements” (Malkiel, 2003, location 1807). The stock market does not remember
its previous prices examined that the “persistence of this belief in repetitive stock-market
patterns is due to statistical illusion” (Malkiel, 2003, location 1825). A lot of short-term
speculators use technical analysis to profit off of the stock market. However, this methodology
could not help them beat long-term investors overtime.
Technical analysis and coin flips
Making speculative bets based on technical analysis is often compared to coin flips.
Malkiel examined how rising stock prices could occur several days in a row and that you can get
a “long string of ‘heads’ in a row” flipping a fair coin. You also “get sequences of positive (or
negative) price changes no more frequently than you can expect random sequences of heads or
tails in a row” (Malkiel, 2003, location 1813). Therefore, what technicians claim as persistent
patterns in the stock market “occur no more frequently than the runs of luck in the fortunes of
any gambler” (Malkiel, 2003, location 1813). In each coin flip, “as long as coins used were fair”,
there was a 50/50 chance of getting heads or tails. Heads imply an increase in the stock price and
tails imply a decrease in the stock price. Even when a coin flip resulted in “ten heads in a row,
the chance of getting a ‘head’ on the next toss was still 50 percent” (Malkiel, 2003, location
1842). According to Malkiel, the movement of daily stock prices could be compared to a random
walk because it does not occur based on previous movements. Short-term speculation of stock
prices is risky because they incur a 50/50 chance of the stock price rising or falling. Technical
strategies sometimes make money but “a simple buy-and-hold strategy (that is, buying a stock or
group of stocks and holding on for a long period of time) typically makes as much or more
money” (Malkiel, 2003, location 1861). Therefore, long-term investing is then more efficient and
sustainable than short-term speculation even with the use of technical analysis.
Actively managed funds
Fund managers who manage active funds buy and sell stocks actively to try to beat
benchmark indexes by timing their trades. Nonetheless, the trading activities of active fund
managers do not necessarily outperform benchmark indexes in the long-term. Most actively
managed equity funds charge higher fees making it harder for investors to make substantial
returns. When compared to benchmark indexes, actively managed funds do not beat these
indexes when “costs are taken into account” (Siegel, 2008, p. 357). According to John C. Bogle,
the innovator of index funds, the SPIVA report proved that index funds beat actively managed
funds in the long-term. The SPIVA report compared the performances of the S&P Indices with
actively managed funds by grouping actively managed funds by various strategies “with relevant
market indexes” (Bogle, 2017, p. 78). They evaluated the performances of the indexes and active
funds over 15 years from 2001 to 2016 and found that “90 percent of actively managed mutual
funds underperformed their benchmark indexes over the preceding 15 years” (Bogle, 2017, p.
78). This statistic proved that while possible, actively managed funds are a lot less likely to
outperform passive funds that focus on long-term investing. It also proved that indexes are more
superior and consistent in the long-term compared with actively managed funds.
Costs in investing
A significant aspect that prohibits speculators from making high returns from the stock
market is ignoring costs in investing. When a client makes a trade, buy or sell, stockbrokers
make money. Stockbrokers make money off of the commission of a clients’ trade. According to
Graham, no matter how the market performed on a particular day “brokers on the floor of the
New York Stock Exchange always cheer at the sound of the closing bell” (Graham & Zwieg,
2005, p. 40). When you trade stockbrokers “make money—whether you did or not” and by
“speculating instead of investing, you lower your odds of building wealth and raise someone
else’s” (Graham & Zwieg, 2005, p. 40). Bogle examined how investors “pay far too little
attention to the costs of investing” (Bogle, 2017, p. 67). He explained that it is easy to disregard
costs in investing because stock market returns have been high, there had been a focus on “shortterm returns, ignoring the truly confiscatory impact of costs over an investment lifetime”, and
costs are normally hidden from view. Costs such as portfolio transaction costs, front-end sales
load or commission charged on a trade, and taxes “incurred on fund distributions from capital
gains” are often ignored and disregarded (Bogle, 2017, p. 67). According to Bogle, an easy way
for investors to earn a “fair share of whatever returns—positive or negative” is to invest in a lowcost index fund (Bogle, 2017, p. 96). He further explained how we are “consigned to playing the
hyperactive management game that is played by the overwhelming majority of individual
investors and mutual fund owners alike” (Bogle, 2017, p. 96). Therefore, staying away from
short-term speculation and investing long-term could help you avoid costs that could hamper
your ability to make fair returns in the long run.
Long-term investors beat short-term speculators in the long-term because long-term
investment strategies are more effective than short-term speculation. Short-term speculation is
not different from gambling in a casino. However, long-term investing described as “a unique
kind of casino” where you could not lose if you follow the rules. Long-term investors also
manage their emotions to become successful at making investment decisions. On the contrary,
short-term speculators sell in market corrections due to fear of losing money. In addition, shortterm speculators forecast the movement of stock prices with technical analysis, a methodology
that analyzes a stock’s past behavior to predict its future behavior. Yet, technical analysis is like
a coin flip and is not efficient in the long-term because there is no real correlation between
previous stock prices to its future price. Additionally, actively managed funds do not beat passive
funds in the long term. Actively managed funds are also more costly because they charge higher
fees. Commission charges from recurring buying and selling also hinder short-term speculators
from beating long-term investors in the long-term. Investing is an important skill to help build
one’s wealth. It is especially important during this time for those who want to accumulate wealth
due to the current low-interest environment. Therefore, knowing how to invest long-term and not
short-term speculate will help build one’s wealth overtime sustainably.
References
Bogle, John C. The Little Book of Common Sense Investing: the Only Way to Guarantee Your
Fair Share of Stock Market Returns. John Wiley and Sons, Inc., 2017.
Graham, B., & Zweig, J. (2005). The intelligent investor: A book of practical counsel. New
York: Collins Business Essentials.
Malkiel, Burton Gordon. (2003). A random walk down Wall Street : the time-tested strategy for
successful investing. New York :W.W. Norton.
Siegel, J. J. (2008). Stocks for the long run: The definitive guide to financial market returns and
long-term investment strategies. New York: McGraw-Hill
1
The Argentine Financial Crisis and their Ongoing IMF Debt
2
Abstract
According to the International Monetary Fund, gross external debt is the amount of outstanding
contractual liabilities of residents of a country to non-residents to repay principal, with or
without interest, or to pay interest, with or without principal (IMF eLibrary, March 1988).
Countries can borrow money because they need to spend more than what they generate, or
because they find themselves in states of emergency due to phenomenon like famine, pandemics,
or other types of economic instability. Governments borrow loans from organizations like the
IMF, the World Bank, among others. They usually have a repayment date that is set once the
debt is issued. Argentina has faced several financial crises in the past century and has recently
found itself in another precarious situation, which has made them the biggest debtor out of all the
countries that take loans from the International Monetary Fund. Having a good relationship with
international organizations such as the IMF and the World Bank, among others is crucial for
countries because of many reasons. Currently, every country in the world was hit by the
Coronavirus pandemic in the past year and therefore went into different types of crisis.
Whenever this happens, governments turn to these organizations for loans in order to help the
economy recover by increasing the value of their currency, providing humanitarian aid to their
population, build more facilities, generating medical supplies, among other reasons. This is why
governments should keep a clean record with these organizations to prepare for these emergent
situations that can occur at any time.
3
Introduction and Overview
Argentina was once one of the richest countries in Latin America. In mid 19th century,
their extensive land allowed them to grow enough grains, corn, and livestock, which they
exported intensively during that time. Argentina had a strong economy and was one of the most
prosperous countries in Latin America. However, once the Great Depression hit in 1929, the
situation took a drastic turn. Tariffs increased to around 27% (CNBC) and their exports to
Europe fell, and the government manipulated exchange rates with the sole purpose of protecting
the country and keeping everything within borders. Their goal shifted from being global and
exporting their products to as many countries as possible, to becoming a self-sufficient economy.
In the process of doing that, like any other country would, Argentina’s foreign debt began to
increase. In 2001, Argentina was hit with massive political instability caused by the resignation
of President Fernando de la Rua and followed by more resignations of three presidents in a
period of two weeks. This led to violent riots, bank runs, and a default of nearly $100 billion in
debt.
In 2018, a currency crisis struck Argentina and they were experiencing once again, a lot
of financial instability. In order to try and fix the problem, President Mauricio Macri signed a
$50 billion Standby Arrangement with the IMF that had detailed regulations and purposes of the
agreement plan. One of the purposes of the plan was to restore market confidence by having a
detailed plan that would eventually lead to an Argentina that would require less financing from
foreign organizations. Another one of their goals was to relieve the pressure on the balance of
payments, reduce inflation, decrease debt, and increase employment opportunities. The plan also
includes protecting the Argentine society’s vulnerable people by keeping up social spending
(IMF press release). Part of the agreement was that the IMF was going to give $15 billion for
4
immediate purchase, from which half was going to be used budget support, and the other half
was going to be provided over the three years of the agreement duration. However, they agreed
on 4 quarterly reviews from the executive board of the IMF in order to supervise how the deal
was going and to measure if Argentina was keeping up with their side of the agreement. As the
IMF states in their initial report, Argentina has faced very high fiscal deficits, which means that
the government has been spending way more than what they are making. Among their main
goals as a result of the plan was to take inflation to single digits by the end of 2021. The IMF had
faith in the Argentine government because they showed strong interest and belief in the program
and said they would follow with its guidelines in order to help the economy recover from the
crisis.
In August of 2020, President Alberto Fernandez managed to restructure $65 billion of
foreign debt by striking a deal with two major creditor groups. However, Argentina’s sovereign
bonds plummeted as soon as the deal was signed, which was the opposite of what creditors
expected that would happen. As an effect, the debt relief restructuring deal was a failure and this
only caused more political and economic instability, and less transparency between creditors, the
government, and the International Monetary Fund. One of the main issues is that both President
Fernandez and Martín Guzman, the economy minister are publicly saying that Argentina is fine,
and that their exchange rates are stable. They have said that there is now need or rush to strike a
new deal just yet, because the economy is stable, and the government is handling it properly.
Review of the Literature
The Argentine financial crisis is an event that has occurred several times in history, which has
caused outsiders to think that the country somehow enjoys going through financial crises.
5
However, it is interesting and very intriguing to all researchers and news hubs to know as much
as possible about each crisis, why it happens, how it develops, and how the government gets out
of it eventually. There have been studies that have been carried out on the Argentine government
and its history on politics, as well as studies solely based on the economy and their financial
affairs both within the country and among other countries and international organizations. Some
of the weaknesses about this is that different sources sometimes provide different or biased
information depending on how they choose to portray the results of their research. For example,
the International Monetary Fund posts press releases to their website in regarding all of their
agreements and affairs with Argentina since starting from a century ago. Their press releases are
always published using a neutral tone, and stating only facts about what the agreements consist
of and how the reviews of the agreement have resulted in. However, when it comes to news
articles that have been released over time, these sources tend to add tones or biases coming either
from the Argentine government or the IMF. Because of this, this may give the wrong message to
readers who want to know facts about what has been happening with this specific country, its
government, and its economy. Therefore, the best way to carry out research on a specific country
and a specific issue is to look at data and graphs that portray only the results and numerical facts
on how the economy is doing in general. In regard to the Argentine financial crisis that the
country has faced more than one time in history and in the present day, there are endless types of
sources that have studied the situation.
Sources such as CNBC have released long documentaries explaining all the crises that
the country has faced and the effects that these have had in the economy and other sectors of the
country. Other news sources have released short clips explaining Argentina’s stance on external
debt and its relationship with the IMF throughout the years. Scholarly articles also exist
6
explaining the matter, and news articles are released almost every week explaining what is still
going on with their ongoing external debt and their unstable currency and government. Because
of the fact that they have faced and are still facing so many issues, outside sources will have a lot
of opinions on the subject and secondary sources can lack accuracy or relevance at this point.
Methodology
In order to find enough research about the Argentine financial crisis and their external
debt with the international monetary fund, several sources were used. Among the news
platforms, the main source used was the Financial Times. They have been publishing articles and
are up to date with what is happening in Argentina. Their articles are medium length and provide
information of what political authorities have said regarding the situation in Argentina.
Furthermore, the international monetary fund has a website in which they publish press releases
continuously regarding their affairs of each country that they have relationships with. For
Argentina, they have press releases that date back to many years ago through which they show
how their debt agreements and other affairs have developed, been issued, and evolved. For the
latest stand-by agreement between Argentina and the IMF, the contract stated that the executive
board of the organization was going to have 4 quarterly reviews in order to supervise how the
situation was going, and if the Argentine government was meeting with their end of the bargain.
For each of those four reviews the IMF released articles summarizing the organizations’ findings
and Argentina’s stance on the agreement. In addition, sources like Passport and Statista, which
are provided through the George Washington University Gelman Library were also utilized to
get data about many aspects of the economy in Argentina. Levels of unemployment, their GDP,
their external debt levels, and their presidents along with their political party affiliations were all
7
extracted from these websites. These are legitimate sources that provide updated studies and
research on every country globally.
Results and Analysis
As it has been stated several times, Argentina has in fact, faced more financial crises and
emergency episodes than many other countries in history. They have gone through constant
political instability, currency crises, devaluation of the Argentine peso, ongoing external debt
that they fail to repay, among many other situations that were already discussed and explained.
Most recently, Martín Guzman, the economy minister expressed that the deal struck in 2018 was
not effective because as most of the previous agreements, it was based on austerity (financial
times, 2020). He strongly believes that financial adjustments are not what is necessary to relieve
the economy from its crisis. The problem is that all other countries in the world have been able to
beat and come out of financial crises because of using those measures that the economy minister
in Argentina is so against. This raises concern coming from the Argentine population,
international organizations like the IMF and the World Bank, big creditors like the ones that
already tried to help the economy but failed, and other governments that would otherwise maybe
get involved to help. Because of this, it makes it even more difficult for Argentina to beat the
financial crisis once and for all. Firstly, in order to beat a crisis a government must acknowledge
that they need help. Secondly, they mus ne in agreement with whichever organization they will
ask for help in order to form a plan and carry it out properly, with enough contribution coming
from both parties. Otherwise, it will continue to happen again as it has been happening thus far.
Regardless of the repetitive times in which the country has found itself in an unstable situation,
its authorities are failing to make the right decisions and take the proper measures.
8
Conclusions and Future Research
With the Coronavirus pandemic, the Argentine government announced strict lockdown in
March 2020. All restaurants, stores, schools, and all types of businesses were closed. Everyone
was forced to quarantine in their homes which of course, only made the financial situation in
Argentina worse. The lockdown was not suspended until November 2020, making it one of the
longest lockdowns out of all countries in the world. In addition to the already existing and
ongoing economic crisis in the country, the lockdown caused violence and inappropriate conduct
coming from policemen as an attempt to reinforce the lockdown rules and regulations. It is clear
that the pandemic will only make matters worse for the Argentine economy to recover. The IMF
has been providing relief packages to more countries than in normal times because all countries
have been caught by surprise by the covid-19 pandemic. In order to survive, Argentina has to
commit to a plan or agreement in which they actually meet their side of the promise. Drastic
measures have to be taken in order to decrease external debt, stabilize their currency, decrease
unemployment, and provide wellbeing and protection for the population in general. After so
many critical episodes and failures to meet repayment dates, Argentina is in a precarious and
delicate situation in which they cannot risk failing again.
9
References
(Will be properly completed for final draft, didn’t have time)
The Economic Effectiveness of Curtailing Natural Gas for Renewable Energy
Author Note
Evan T. Rhee, Senior Majoring in International Affairs and Finance, George Washington
University.
Inquiries concerning this paper should be addressed to Evan Rhee, George Washington
University, 2121 I St NW, Washington, DC 20052. Email: etrhee6@gwu.edu
Abstract
The Biden Administration’s energy policy proposals are heavily influenced by limiting climate
change and transitioning towards cleaner power. Biden’s executive orders will specifically
suspend auctions of federal land and water to oil and gas companies, expand land conservation,
create civilian conservation corps, and provide economic aid to coal-producing regions damaged
by industry declines. Natural gas can be a critical energy source in reducing carbon emissions as
it provides 50% reductions in emissions when compared to fossil fuels. Therefore, greater numbers
of nations are embracing wider usage of natural gas. However, the extraction process of natural
gas involves fracking and flaring, two processes that cause notable environmental damage. The
amount the Biden Administration plans to rely on natural gas as a bridge fuel to mitigate climate
change could have wider economic implications for American markets. If there is lower production
as global demand increases the United States could see its market share decrease and be replaced
by nations such as Russia and Japan.
Prior to the Biden Administration, COVID-19 has derailed fuel prices as demand has dropped
significantly with people travelling and commuting less. An underappreciation for the potential of
natural gas in the reduction of carbon emissions, could prevent prices from fully recovering.
American energy markets could be dependent on natural gas production to remain competitive
with foreign suppliers. Another alternative that President Biden is committing to is striving
towards carbon neutrality and sustainability through renewables. Yet, the economic gains from
renewables must show enough promise to mitigate the losses from natural gas divestment. The
United States could either set itself up for long-term propagation through a renewable based
infrastructure or end up severely missing out on the financial boom of natural gas.
Keywords: natural gas, renewable energy, energy markets, Biden Administration
The Economic Effectiveness of Curtailing Natural Gas for Renewable Energy
As more Americans are increasingly demanding environmentally conscious
policymaking, the Biden Administration has responded accordingly with its plan for a “modern,
sustainable infrastructure” based in clean energy (joebiden.com). Specified within his plan,
President Biden emphasizes the commitment to embark on an irreversible path towards a netzero emissions economy by 2050 (joebiden.com). Moreover, Biden has set a preliminary
benchmark to reduce the carbon footprint of U.S. building stock by 2035 (joebiden.com). The
current administration’s devotion to renewable energy, implies an immediate need to begin
divestments within the fossil fuel industry. While President Biden has repeatedly claimed that he
does not intend to ban fracking, he has advocated for the opposition of new drilling licenses on
federal lands (forbes.com). The clean energy movement will provide economic opportunity and
growth, yet the United States could still economically suffer overall without continued
progression in the natural gas sector.
Natural gas is becoming progressively popular worldwide as it serves as a bridge fuel to
clean energy. With its availability and reliability, natural gas is also attracting attention for its
ability to emit half as much carbon when compared to coal (eia.gov). Many nations are pushing
to utilize natural gas in their respective modernizations into environmentally friendlier energy.
Therefore, the commodity is growing in value as a key export and import worldwide. The United
States has an abundance of natural gas, serving as the global leading producer (statista.com).
Limiting this production would carry notable economic consequences as the United States loses
market share. Despite these potential losses, renewable energy is gradually multiplying in value.
While natural gas will remain relevant for the next 20 to 30 years, a head start in renewable
energy would set the United States on a route for energy dominance in the long term.
Over the next 30 years, as the United States progresses towards a carbon emission-free
infrastructure the losses of missed natural gas opportunities must be mitigated by the economic
vitalization of the construction and dedication towards renewables. Without this balancing of
losses and gains, the Biden Administration’s plan could weaken the United States’ energy sector
and its economic prowess. Two major hypotheses are postured about the future of the American
energy markets. The United States could either continue its foray into natural gas dominance or it
can pivot towards renewables and mitigate their potential losses through the modernization of its
infrastructure and gain a long-term competitive advantage over other nations.
To understand the current influence of natural gas over the American energy economy,
several financial and economic measures must be taken into account. Through economic
projections and historical data relating to natural gas and renewables, an educated analysis can be
conducted to understand whether the energy sector void left by discontinued interest in natural
gas can be covered by the promise of renewable energy. The data utilized includes the
percentage natural gas and renewables comprise in the American energy infrastructure, the trade
balance of natural gas, and the potential market share of renewables. With these statistical
models a proper estimation can be made regarding the feasibility of a carbon free 2050.
Method (Need to Add Specific Findings Related to the Graphs and Data)
Coal consumption has been dropping significantly and in 2019 for the sixth consecutive
year to 11.3 quadrillion Btu (eia.gov). Additionally, coal electricity generation fell to the lowest
rate in 42 years (eia.gov). Filling the void in the electrical power grid, natural gas usage has risen
to 32% of U.S. primary energy consumption (eia.gov). However, the fall in coal consumption
has not solely been met by natural gas supply, as renewables have similarly surpassed coal for
the first time in 130 years (eia.gov). Renewables now provide 11.5 quadrillion btu in energy
provisions with the greatest strides being made in electric power and industrial sectors.
Results
The results from studies indicate that although natural gas is growing in importance to the
American energy sector and economy, advancements in natural gas development can still occur
even with less federal funding. Therefore, the Biden Administration’s plan to cease new leases
for drilling on federal lands would not blockade the United States from continuing its dominance
of global natural gas production and trade. Furthermore, the discovery that renewable energy
prices are dropping, and investment is increasing shows faith from the American population and
markets that renewables should be the infrastructural backbone of the future. Since President
Biden has solidified his position on maintaining fracking with more safety and environmental
regulations, the United States’ existing natural gas reserves would be able to hold the energy
market over throughout the global natural gas boom. A pathway to a sustainable energy sector
will allow the United States to modernize and stay ahead of the global community in relation to
energy production, security, and create a long-lasting growth within energy markets.
Conclusions and Future Research
Ultimately, the Biden Administration’s plan to focus on a net carbon emission by 2035
and zero carbon emission infrastructure by 2050 are economically feasible based off current
projections. The United States would be able to retain its high volume of natural gas production
during this administration, providing consumers with a reliable source of energy while
renewables are simultaneously being tested and developed.
Future Research would include continuous updates on the pricing of renewables and their
according investments. Moreover, projections may be altered as more is discovered about the
feasibility of a sustainable energy sector in relation to availability and pricing.
The Effects of the Retail-Investor Boom on the US Stock Market
i.
Abstract
The US stock market has experienced historic turbulence in the since the onset of the
COVID-19 pandemic, largely due to the influx of retail investors. This paper aims to
explain the retail-investor boom in the US stock market caused by a combination of the
eradication of brokerage fees and the COVID-19 pandemic. Additionally this paper aims
to analyze such effects on individual stocks, the stock market as a whole, and electronic
trading brokerages and firms.
To analyze the effect of the boom, this paper looks at stock trading volume, effects on
large and small cap stocks, and the increasing levels of dark trading created by high
frequency trading firms. Results of this information show that the historic increase of
retail volume in the market has not significantly impacted the market as a whole, though
the “Robinhood Effect” can be applicable to individual stocks. Additionally, the
increasing profits of HFT firms reveal the real winners of the retail boom: Wall Street.
These results confirm the need for increased regulatory action in the stock market.
Firstly, the ability of a Reddit page to initiate the manipulation of a stock price by almost
3,000% is quite alarming. Plus, HFT firm Citadel having almost the same volume as the
Nasdaq, and routing transactions in a disclosed dark pool generating enormous profits, is
more cause for concern. Overall, the evidence in this paper argues that the retail investor
boom has created the need for more regulation on Wall Street in order to protect
individual firms and investors.
ii.
Introduction and Overview
The slashing of online brokerage fees among trading platforms such as Robinhood
and TD Ameritrade has helped contribute to a massive influx of retail investors in recent
years. Combined with the COVID-19 pandemic leaving individuals sheltering in homes
with a surplus of savings, it is clear to grasp the reasons behind the retail investor boom.
Plus, the shutdown of most sports leagues in early spring led to many individuals looking
for a new way to “gamble.” Throughout the first half of 2020, retail investing accounted
for almost 20% of the US stock market, compared to around 10% in 2010. This inflow of
new traders and investors has many similar characteristics with the dot-com bubble in the
late 1990s, mainly technological innovation making it easier to trade stocks. With this
inflow of traders has come increasing volatility, as many traders seeking to make a quick
profit will inject their savings in riskier stocks, or potentially options.
This habit of retail traders buying stocks with no regard for the company’s financial
statements, resulting in irrational stock price movements, has been dubbed the
“Robinhood Effect.” Though the Robinhood effect is not proven to have a significant
impact on the market as a whole, it is clear that certain stocks can be easily manipulated.
For instance, recent surges in GameStop, followed by drastic declines in share price are
characteristic of a typical irrational movement. While this example is an extreme, the
development of zero-fee trading has led to market irrationality becoming a common
occurrence.
Despite being named after a storied outlaw who stole from the rich and gave back to
the poor, it is clear that Robinhood is creating the opposite effect. As inexperienced
Robinhood traders “herd” into buying the same risky stocks, institutional short-sellers
reap profits by taking advantage of the buy-sell imbalance. However, it is not just
institutional traders profiting off of inexperienced investors. Since Robinhood does not
have brokerage fees, their business model includes the selling of client transactions to
market makers such as Vandham and Citadel Securities.1 These market makers then place
these orders into dark pools, which are not transparent to the market as a whole. As a
result, it is nearly impossible to tell if these orders are in the best interest of the clients.
What is clear is that Citadel and Vandham are generating immense profits from dark
pools, and surges in volume only further contribute to such profits. Ultimately, it is
becoming increasingly dangerous for investors with little experience to enter the market
due to a lack of clarity, and lurking institutional traders looking for easy profit.
iii.
Review of the Literature
Many sources attempting to explain the risky behavior of new retail investors point
toward Robinhood’s simplicity and “gamification” of the stock market. For instance,
gifting new users a free stock claimed only after scratching off images resembling lottery
tickets clearly reinforces a pattern of investing in a fun, possibly dangerous manner. Such
tactics have even led to the state of Massachusetts filing a complaint, citing Robinhood’s
“use of strategies such as gamification to encourage and entice continuous and repetitive
use of its trading application.”2 While the slashing of brokerage fees in recent years was
immensely attractive to retail traders, the cancellation of sports from the COVID-19
pandemic also led to a large influx of traders. To gamblers, Robinhood’s sleek and simple
design combined with tactics to attract new investors became the next best thing. As a
result, trading per customer on Robinhood in the first quarter of 2020 was nine times that
of E-Trade, and 40 times that of Charles Schwab.3
While many investors familiar with the turbulence of the 2020 and 2021 market
argue that the impact of Robinhood customers is hurting the market, evidence supports
that it is in fact the other way around; the market and it’s key players are hurting
Robinhood customers. For starters, Robinhood itself is a business, and therefore needs a
way to make money. This is done in the form of selling their order flow to market
makers. While this is relatively new in the era of high speed online trading, this form of
1
“Stock Order Routing.” Robinhood, robinhood.com/us/en/support/articles/stock-order-routing/.
2
Barber, Brad M. and Huang, Xing and Odean, Terrance and Schwarz, Christopher, Attention Induced
Trading and Returns: Evidence from Robinhood Users (February 2, 2021).
3
Popper, Nathaniel. “Robinhood Has Lured Young Traders, Sometimes With Devastating Results.” The
New York Times, The New York Times, 8 July 2020,
www.nytimes.com/2020/07/08/technology/robinhood-risky-trading.html.
off-exchange trading already makes up approximately 47% of entire US stock market.4 In
the fourth quarter of 2020 alone, Robinhood was paid $221.4 million by market makers
to route the transactions of Robinhood clientele to these firms.5 While Robinhood’s
mission statement is to “democratize finance for all,” it is clear that every customer the
company attracts simply provides more orders for the company to profit on. In fact,
Robinhood’s website also labels market makers as generous institutions providing market
liquidity and executing orders at the best price.6 Further evidence will show this is most
definitely not the case.
Even though Robinhood makes hundreds of millions of dollars selling order flow,
market makers more than make their money back in the form of dark pools and high
frequency trading. Additionally, market makers profit a few cents on each trade by
pocketing the difference between the bid price and ask price on a certain stock. A dark
pool is essentially a private exchange that lacks public transparency, creating the
possibility of predatory trading from HFT firms. As a result, market makers can make
money by selling access to their dark pool to these HFT firms. These firms will then use
supercomputers and algorithmic trading to skim pennies off of millions of trades on a
daily basis. For instance, if a retail investor places an order, HFT firms can jump in front
of the order, buy enough shares to make the price jump, and then profit on the price
difference before completely exiting out of their position.7 Many financial institutions
argue that dark pools create additional market liquidity, and are necessary to place largeblock orders. Even institutions such as Morgan Stanley and Goldman Sachs have created
their own dark pools. However, it is clear that dark pools provide an advantage to high
frequency traders, and create a conflict of interest among owners of firms.
Robinhood plays a part in this by selling orders that are likely to enter dark pools.
Additionally, Robinhood actually hurts their clientele due to an unconventionally high
bid-ask spread. This essentially means that when Robinhood receives an order and sends
it to a market maker (for a fee), the market maker will match the order with an
unconventionally high price. This is done without the awareness of most users, and is
simply the hidden cost of zero-fee trading.
iv.
Methodology
In order to determine the effects of the retail investor boom on the stock market and
it’s various components, it is important to determine who the biggest players are. In the
age of electronic trading, it is clear that these players are the market makers and high
4
Detrixhe, John. “Citadel Securities Gets Almost as Much Trading Volume as Nasdaq.” Quartz, Quartz,
qz.com/1969196/citadel-securities-gets-almost-as-much-trading-volume-as-nasdaq/.
5
Ibid
6
“Stock Order Routing”
7
Lewis, Michael. Flash Boys. W.W. Norton & Company, 2015.
frequency trading firms, as these institutions are present in hundreds of millions of trades
every day. As such, this paper analyzes the performance of such firms after the retail
investor boom. Plus, this paper looks at the how this performance corresponds with
trading volumes. Research also includes market performance as a whole to determine the
impact of retail investors on market turbulence. Lastly, this paper will examine the case
of GameStop, and dissect the actions institutions, regulators, and investors.
v.
Results and Analysis
From 2019 to 2021, average daily trading volume has grown significantly from 7
billion shares per day to 14.7 billion, an increase of over 100%. Most of this boom is due
to the increase of retail investors, which accounted for an astounding 48.6% of all trading
in January 2021.8 Considering both market makers and HFT firms profit on virtually
every order they direct, a surge in volume results in a surge in profits. Shares of Virtu, the
only publicly traded market maker, are up 11% in 2021 alone, compared to 2% for the
entire market.9 However, the truly remarkable figures are derived from high frequency
trading firms.
Citadel, the same firm that receives almost as much trading volume as Nasdaq, earned
a historic $6.7 billion of net trading revenue in 2020, almost double their previous high in
2018.10 Not only do HFT firms such as Citadel profit from volume surges, but also surges
in volatility. The firm’s computing power and ability to front-run stock market orders are
immensely successful in volatile environments. Considering the firm commands 27% of
the equity volume market share in the United States, surges in volume are particularly
profitable.11
Recently, retail traders discovered that such volatility and turbulence in the market
can be beneficial for common investors as well. The most significant example of the
Robinhood effect in action occurred in January 2021 as the share price of GameStop rose
over 8,000% in one year (approximately 2,000% in January 2021 alone). While this paper
does not study the exact financial strategies of investors producing both a short squeeze
and gamma squeeze on shares of GameStop, it is evident that retail investors loosely
banded together in order to take advantage of the substantially high short-float that
GameStop was experiencing. Mainly through a Reddit page, “r/wallstreetbets,” retail
investors collectively decided to buy unusually large amounts of stock in GameStop (as
8
Pisani, Bob. “Trading Volume Is up from 2020's Breakneck Pace as Retail Investors Jump In.” CNBC,
CNBC, 22 Jan. 2021, www.cnbc.com/2021/01/22/trading-volume-is-up-so-far-from-2020sbreakneck-pace-as-retail-investors-get-even-more-active.html.
9
Kasumov, Aziza, et al. “High-Speed Traders Reap Windfall from Retail Investor Boom.” Financial
Times, Financial Times, 3 Feb. 2021, www.ft.com/content/e4f9100e-7ef6-4807-89f9-4015db1750fd.
10
Maloney, Tom. Bloomberg.com, Bloomberg, www.bloomberg.com/news/articles/2021-01-22/citadelsecurities-reaps-record-6-7-billion-year-onvolatility#:~:text=Citadel%20Securities%20brought%20in%20%241,in%20equity%20distributions
%20last%20year.
11
Ibid
well as calls). This resulted in a skyrocketing share price, and left many hedge funds
stunned with losses. Specifically, Citron Capital Fund exited their GameStop short at a
100% loss.12
On the other hand, many retail investors were left with immense gains. It seemed
clear that retail investors had won this battle, and had proved that retail investors can
have an impact on certain stock prices. While the latter is absolutely true, actions taken
by hedge funds, makers, and online brokerages such as Robinhood also took action in the
GameStop case. Clearly, Robinhood’s payment in the form of order flow from market
makers creates a conflict of interest when dealing with clients’ orders. This was seen in
full force as Robinhood restricted the buying of GameStop stock in January. Many
investors and regulators speculate that Robinhood’s ties to investment firms and market
makers heavily influenced the company’s decision to restrict trading of GameStop, in
order to prevent more hedge fund losses. After the GameStop squeeze dried out, many
institutions then entered into short positions, many fully covering their losses and even
profiting off the situation. Whether true or not, the actions of both Robinhood and
institutional firms supports the idea that at the end of the day, large booms in trading
volume and in volatility mainly benefit Wall Street, even if institutions need to bend the
rules in doing so.
vi.
Conclusions and Future Research
This research reinforces the need for further regulatory action taken in the US stock
market. On February 18, 2021, CEOs of both Robinhood and Reddit will be testifying
before Congress regarding the events unfolded during the GameStop price manipulation.
Already in December 2020, Robinhood paid $65 million by the SEC to settle an action
involving misstatements in Robinhood’s payment in order flow. In this case, Robinhood
did not act in the best interest of its clients in making transactions, resulting in an
aggregate $34 million loss for Robinhood users.13 Additionally, Congress and the SEC
will further look into the gamification of the Robinhood app, and its success in attracting
young risk-oriented investors. Whether or not Robinhood faces extreme punishment, it is
likely that many clients will leave their platform for a more transparent online brokerage.
On the other hand, it is unlikely hedge funds and HFT firms will face serious
repercussions. It is likely however those hedge funds will take a closer look in their
investment strategies to ensure that retail cohorts are not capable of significantly
impacting their investments. For instance, Citron Research has already decided to no
12
Nagarajan, Shalini. “Citron's Andrew Left Says His Firm Covered Most of Its GameStop Shorts at a
100% Loss - and Tells Reddit Traders to Pay Taxes on Their Recent Profits.” Business Insider,
Business Insider, markets.businessinsider.com/news/stocks/citron-gamestop-reddit-short-positioncovered-loss.
13
Domm, Patti. “GameStop Traders Outsmart the Smart Guys, Leaving an Indelible Mark on Wall Street.”
CNBC, CNBC, 30 Jan. 2021, www.cnbc.com/2021/01/29/gamestop-traders-could-force-hedgefunds-to-change-investing-tactics.html.
longer publish research on their short positions, which the firm had done for 20 years.14
Overall, the retail investor boom will have long lasting effects on the stock market, likely
to cause significant regulatory action. The effects of retail investing have open the eyes of
many to the power of high frequency trading firms, and the existence of extreme market
inefficiencies that can be manipulated to produce enormous profits.
14
Ibid
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