Cryptocurrency's Robinhood effect

by Molly White on Thursday, February 17, 2022
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On Sunday, a hundred million people gathered to watch the American Super Bowl. Throughout the event, they were treated to something new compared to previous Super Bowls: ads for cryptocurrency platforms including Coinbase, Crypto.com, and FTX. Each of these companies offers an easy on-ramp into cryptocurrencies—in fact, Coinbase’s whole ad was about making it simple for people to scan the QR code that bounced around their screen for an entire minute. This took them to download the app and sign up for the product. The sign-up flow is quick and relatively painless, at least for a finance product: username and password, email, name, and an attestation that you are over 18. Then verify your email address and identification, connect your bank account, and you can buy and sell cryptocurrencies to your heart’s content.

The sign-up flow, while certainly more involved than non-finance apps that don’t require KYC¹ or bank account connections, is orders of magnitude less complicated than getting set up to buy cryptocurrencies was ten years ago. In the past, people either had to mine cryptocurrency themselves, engage with risky exchanges, or do peer-to-peer trades. While by 2015, cryptocurrency trading had made huge strides from what was in 2010 (a nightmare even to the tech-savvy), huge improvements in user experience and simplicity have been made in the past few years. Every day it seems like cryptocurrency becomes more accessible to the layperson: crypto wallets take the form of browser extensions and integrate with various dApps,² so you can connect your wallet in just a few clicks. Much of cryptocurrency trading is done from mobile phones, with user-friendly apps that aim to make the process as simple as possible. And, increasingly, these apps are being marketed aggressively to the types of people who may not know much about either computers or finance, but think Matt Damon’s a cool guy or can get a chuckle out of Larry David being curmudgeonly.

This trajectory is not unlike the advent of Robinhood, which “democratized finance” by bringing activities like options trading and margin loans to the average Joe, no longer largely only accessible to finance experts on Wall Street. Robinhood offers cryptocurrency trading now too, of course, and with a UI just as slick as its competitors. But Robinhood initially focused on the traditional financial market, and its name was based on the premise that they would “provide everyone with access to the financial markets, not just the wealthy”. And so they did: no longer did someone have to pay a fee for each trade, sometimes $5 or more per transaction. They even popularized fractional shares, so people who didn’t have the money to pay hundreds or thousands of dollars for a single share of companies like Google and Amazon could still get in on the action. And people no longer needed to use the clunky, often somewhat indecipherable online interfaces of traditional desktop e-trading platforms: they now had a slick, minimalist interface from which they could day trade anywhere they liked.

And day trading they did: Robinhood was an enormous driver in popularizing retail participation in options trading—that is, buying a contract that allows, but does not obligate, the buyer to buy or sell shares at a specific price on a specific time, essentially betting on the future price of the stock. Although much of the traditional advice around stock investments involves buying shares of stock and holding it for a long time, counting on the long-term prospects of the company and the trajectory of the market increasing the share value—options trading was its daredevil cousin. Robinhood handwaved at having users attest that they were making an informed decision to enable options trading, allowing users to answer a few questions about their assets, income, and investment experience without any verification, and then attest to reading a 100-page document. Robinhood would later pay a record fine of nearly $70 million to settle accusations including that they irresponsibly approved thousands of unqualified users for options trading using automated systems.³

Retail investors piled into the options market towards the end of 2019 as Robinhood was followed by other platforms who cut trading fees for not only stocks and exchange-traded funds (ETFs), but options as well. A few things fueled the frenzy. Robinhood offered investors a free stock—sometimes even pricey blue chip stocks like Facebook—just for signing up. They ran ads showing young men riding the bus, or taking a lunch break in the stock room of a supermarket, holding the “power of the stock market in the palm of [their] hand[s]”. They gamified the experience, showing animated confetti when people made their first trade. Also fueling the frenzy was outside hype: r/wallstreetbets showed people—also largely young men—making enormously risky trades, and having it either pay off in spades or blow up in their faces. It was tantalizing to scroll through the “gain porn” and see a presumably average person make hundreds of thousands of dollars in no time at all, often starting from fairly little. Add in the financial uncertainty in early 2020 with the COVID-19 pandemic, then sudden available cash from stimulus checks, and things really took off.

But the true impact of Robinhood, and its democratization of not only options trading but margin loans, is not all windfalls and wallstreetbets-fueled meme stock short squeezes.⁴ People have lost their entire savings in a single trade. People have taken out credit card advances and home equity loans to pour into options trading, making it big and then losing it all.⁵ Stories of incurring more debt to try to pay off debt—a general strategy known to gambling addicts as “chasing losses”—abound. Robinhood’s margin investing feature, which allows people to borrow from Robinhood to make trades, has left people owing money they don’t have. One young person, likely misunderstanding a confusing account balance stemming from the complex options trades they’d performed, died by suicide after believing he’d incurred $730,000 in debt.⁶

The same trend is repeating with cryptocurrency apps. Free Bitcoin is offered to people who create an account on Coinbase, or recruit friends and family to do the same. Crypto advertisements appear on the walls of the London Tube, on athleticwear worn during boxing matches that pulled in millions of pay-per-view customers, and during the Super Bowl. Exchanges and other crypto finance apps offer services far beyond standard trading, often with mind-bending mechanics: average users are invited to stake, yield farm, or lend, not to mention speculate on assets like NFTs. Services offer eyewatering returns on investment, often with little or no disclosure of associated risk. If they do comment on risk, sometimes even fairly mainstream products just outright lie.⁷

Adding to the brewing disaster is the absolute Wild West nature of the cryptocurrency space. With Robinhood’s stock trading offerings, the company was at least nominally subject to the same strict financial regulations as its more legacy competitors, even if it played things pretty fast and loose. In crypto, regulation is nigh on nonexistent. While traders are still subject to the uncertainty that their trade might go pear-shaped, just as they were with the stock market, they also face the risk that their exciting new defi⁸ project might just take off with all the funds, never to be seen again, and with no insurance or regulatory failsafes to protect them. There’s also very little identity verification in crypto. While Robinhood and other stock trading apps require a social security number, and can verify that the person checking the box to say they are over 18 is telling the truth, there is no shortage of crypto trading apps that allow people to operate completely anonymously. In fact, stories of underage traders making fortunes in crypto abound on otherwise reputable news websites.⁹¹⁰¹¹ The stories of underage traders losing funds, of course, tend to not make the news.

Much like options trading, engaging with cryptocurrency is often described as “investing”—a responsible-sounding word that tends to invoke ideas of 401ks or mutual funds. The reality can be much more like gambling—except sometimes people might actually face better odds pulling the lever on the slot machine. And with the increasingly low barriers to entry, combined with aggressive marketing campaigns, poor understanding of various project mechanics and the associated risk, and irresponsible outside reporting on cryptocurrency projects, more and more people will be risking far more than they can stand to lose.

Notes

Disclosures for my work and writing pertaining to cryptocurrencies and web3 can be found here.