GameStop signals a new, destabilizing collision between social media and the real world

(Tiffany Hagler-Geard/Bloomberg)

This column has been updated.

On Jan. 6, misinformation propagated on social media helped motivate a crowd to attempt an insurrection at the U.S. Capitol. On Jan. 23, social media was instrumental in driving tens of thousands of Russians into city streets to protest the Putin regime. In the past few days, social media has wreaked havoc in the financial markets, producing dramatic price surges in the stocks of GameStop and other companies.

In the past, social media has occasionally impinged on real-world events, as with the Arab Spring a decade ago. But now the online power of crowds is crossing over into the real world as never before.

The GameStop phenomenon is a new chapter in this story. The company’s stock has jumped more than 1,700 percent, with a big role in the run-up played by retail investors relying on the no-fee trading app Robinhood and coordinating over Reddit and other social media sites. Small investors, egging each other on through social media, employed a classic Wall Street tactic to put a “short squeeze” on hedge funds that had bet big on a drop in GameStop’s stock.

This isn’t the first time that social media users have inflated stock prices and caused bubbles. The “hack crash” of 2013 was triggered by a viral false tweet from Syrian hackers who had infiltrated the Associated Press Twitter handle to claim that President Barack Obama had been injured in an explosion. About $140 billion in equity value was wiped out in a matter of minutes. Pump-and-dump schemes also used social media, posting fake news on Facebook and Twitter to hype stocks.

But what has transpired lately with the stocks of GameStop, the AMC movie theater chain and the BlackBerry tech company breaks fresh ground. The problem is that the world is witnessing this plane crash in real time: Right now, the plane is still at 30,000 feet, but countless small investors could be wiped out when the inevitable crash comes — when the market tries to find the appropriate prices for stocks that are untethered to companies’ underlying value.

The Securities and Exchange Commission said Friday it is reviewing the recent volatility in GameStop and other stocks. Good. Not nearly enough is known about the perverse incentives and feedback loops driving these market movements. For example, who is in this “crowd”?

During the Jan. 6 Capitol riot, there were some who showed up in military gear, armed with weapons, zip ties and a plan. But many others just held up their cellphones, recording videos as if they were strolling through Disneyland. In the GameStop run-up, have there been crowd instigators on Reddit with undisclosed ties to institutions that have a financial stake in the outcome? The SEC might like to know.

And what role has been played by hedge funds standing to profit from the dizzying price increase? Yes, some hedge funds were short-squeezed and lost a fortune, but other institutions — such as BlackRock, owning 9 million shares of GameStop — likely made more than $1 billion on the madness.

There are also perverse incentives created by Robinhood and other retail investing sites that purport to give the little guy a seat at the Wall Street table, but that actually earn large swaths of their revenue from institutional investors by processing trades through market makers, including Citadel Securities, that provide the other end to the trade.

This phenomenon doesn’t exist in isolation. It’s coupled with systems that sense, mine, analyze and trade on sentiment expressed on social media in real time. Dataminr, RavenPack and other companies are constantly sifting through social media data to find the signal in the noise. When they find that signal, they seize on it and relay instructions to automated trading algorithms and their institutional clients to buy or sell ahead of market trends.

The past week’s events exposed several potential sources of economic instability. If investment decisions are completely unmoored from the economic realities of the companies involved, the potential for destructive volatility rises. If the social media crowd’s opinion alone drives market value, the market goes where the herd takes it, without the constraints of economic reality.

Perhaps most important, if social media can disrupt markets, it creates an incentive for economic terrorism and provides an opening for America’s enemies. If Russia saw an opportunity to disrupt U.S. elections with disinformation on social media, imagine what Moscow must be thinking about the prospects for interfering with the U.S. economy. The results of the SEC’s GameStop review cannot come fast enough.