Overstock's Blockchain and the War Against Naked Shorting

Jacob Dienelt
Nov 9, 2016 at 13:30 UTC
OPINION

Jacob Dienelt is the Managing Director of Brian Kelly Capital Management's Digital Asset Group. He is also an eight-year veteran of Morgan Stanley.

In this opinion piece, Dienelt looks at Overstock's planned blockchain stock offering, speculating on how this new technology will impact the company ahead.

Bullet hole in glass

Sometimes called the "Pariah of Wall Street", Overstock CEO Patrick Byrne has spent decades fighting against a suspect practice known as "naked short selling".

Naked short selling, or a naked short, occurs when a trader sells a share of stock without first procuring a "borrow" – an assurance that the shares are available to be delivered. This can lead to more shares being shorted than can actually be delivered to the buyers.

Banks could leave these unsecured shares short, as record systems are opaque, and despite risking severe penalties, the banks are not always completely honest.

During the financial meltdown of 2008-2009, naked shorting came into focus, and as a result, selling short bank shares was banned. The Salt Lake Tribune summed up the change in an article that later stated: "These days, when people talk of Byrne, the word 'vindication' comes up a lot."

But, Byrne wants more than vindication – he wants to win.

Byrne is a remarkable man. A doctor of philosophy, a Marshall scholar, a savant who can remember the order of a deck of cards years after seeing them, Mr Byrne has made it a personal mission to end naked shorting.

Surviving three bouts with cancer, several clinical deaths and recently returning from an "indefinite leave of absence" due to complications from Hepatitis C, it is clear – nothing will deter him.

If Byrne could find a way to expose what was hidden by the opacity of the legacy system, shorts would panic as they would be forced to immediately cover. The naked shorting Byrne has railed about would come to light.

Overstock could rally in a manner reminiscent of Volkswagen when Porsche made a takeover bid and several hedge funds were caught short. The resulting short squeeze briefly made Volkswagen the most valuable company in the world.

At Money 2020, Byrne took the stage last month and announced his solution to the shorting problem.

Overstock will issue a special rights offering for preferred shares of stock on Overstock’s own transparent blockchain platform, tØ, a subsidiary of their blockchain investment holding corporation, Medici.

Notably, a week after the Money 20/20 announcement, Overstock delivered a mammoth quarter and jumped 15%.

Exposing the cheaters

Why the interest? Overstock’s blockchain does exactly what blockchains do best – stop people from cheating.

Blockchains are shared ledgers designed for a specific purpose: transparency. Naked shorting is impossible on Byrne's tØ as an "unborrowed" short would be easily identified.

When a special rights offering is made, shares are tendered to establish a record of ownership. For a period of time, these shares go "in the box" and cannot be moved.

While Byrne has long fought the battle against naked shorting, there may be more to this move. The offering documents are not yet public, but when the shares come “out of the box”, they could be reassigned to Overstock’s broker dealer. Further, Overstock itself could change its corporate registration to the in-development Delaware blockchain.

This option, which will likely be available this spring, would give back title in shares to shareholders instead of the DTCC. Byrne, as the largest single shareholder of Overstock, likely wants to wrest back title to all of his shares – not just those impacted by the rights offering.

If he’s been fully vindicated, reclaiming title surely is his next goal.

Knock-on effects

The rights offering is for 1 million shares of preferred stock and an equal tranche of common stock – bringing the offering to 2 million shares. After the announcement, a senior Overstock executive speculated that they may see an 80% shareholder acceptance rate – that would be 1.6 million shares, or about 6.3% of the float.

If Byrne manages to move all of Overstock’s issued shares onto the tØ blockchain, and it turns out there are naked shorts, it will be hard to predict what will happen.

Even if shares return to the regular system after the offering, Overstock could later decide to do a 95% rights offering – boxing in more than the even reported available float.

This would make Byrne and Overstock holders happy and could also have interesting knock on consequences. For example, the banks' most important customers (public companies) might demand that the trading of their shares be moved to transparent ledgers.

In this way, buying shares of Overstock could well prove to be the best way to profit from blockchain technology without buying cryptocurrency.

Bullet in glass image via Shutterstock

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OverstockPatrick ByrneMedici

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