There are several ways to answer the question of “how does Robinhood make money?” Robinhood charges users a low flat fee up front. Second, it takes a percentage of money borrowed by users for margin trading. Finally, Robinhood makes money from market maker rebates, cash management and stock loan income. But the largest portion of Robinhood’s revenue is, by far, is from payment for order flow.
Robinhood: User Friendly Investment and Trading Platform
Robinhood is an investment platform application where users can trade electronically traded funds (ETFs), stocks, options and cryptocurrency. Specifically, Robinhood is revolutionary because of the low rates they offer to retail investors and how easy it is to trade. They have gained popularity because they have made it easy for anyone to have access to investing opportunities.
How Does Robinhood Work?
Using a simple, user-friendly phone app, Robinhood traders and investors can trade stocks, options, cryptocurrencies and electronically traded funds (ETFs). Trades are relatively quick and fees are the lowest the financial industry has ever seen.
With a Robinhood brokerage account, trades are sent to market makers where trades occur.
How Does Robinhood Make Money?
Robinhood Makes Money from User Fees, Margin Trading Fees, Market Maker Rebates, Earning Interest from Cash Management and Stock Loans, as Well as from Payments for Order Flow
First, Robinhood’s website states that they offer a range of inexpensive financial products including commission-free trading. This sounds great to younger traders and investors who are on a budget. But, there’s always a cost. Let’s explore more about how does Robinhood make money.
Second, Robinhood fees start at $5 per month. At this price, Robinhood provides investors with market trading tools. Tools include research reports and margin investing. Namely, margin investing equates to borrowing money from Robinhood to trade with. Robinhood then charges you interest (approximately 5%) for borrowing their money.
Finally, some smaller sources of income for Robinhood are market maker rebates, cash management and stock loan income. Market maker rebates are like special discounts for Robinhood for using a market maker instead of an exchange. Likewise, income from cash and cash management is interest money paid from using cash as a deposit or from payments. As well, stock loan income is money collected when Robinhood lends stocks to counterparties.
How Does Robinhood Make Money with Payments for Order Flow (PFOF)?
Big Quantitative Market Makers on Wall Street Pay Robinhood $ Millions for User Data
The most lucrative part of Robinhood’s business model is payments for order flow (PFOF). For example, Robinhood makes trades on behalf of users with large liquidity trading firms called market makers. Market makers like Citadel Financial, GTS, Virtu Financial and Two Sigma Securities provide liquidity and high frequency trading services to smaller retail outlets like E-Trade and Robinhood.
As trades between Robinhood and the market makers are conducted, Robinhood sells its users data to the market makers. Moreover, according to the October 2020 Forbes Magazine article entitled “The Barons of Casino Capitalism,” Robinhood made approximately $270 Million in the first half of 2020 selling user data to the big firms. As a result, this profit was more than 70% of Robinhood’s revenue in 2020.
“The big firms [market makers] would feed Robinhood customer orders into their algorithm and seek to profit executing the trades by shaving small fractions off bid and offer prices.”-Forbes Magazine, October 2020 “The Barons of Casino Capitalism”
The Wall Street Casino
Deregulation and User Friendly Apps Have Turned Investing into Gambling
Buying and selling stocks and cryptocurrencies like Bitcoin in the 21st century has become like the wild west. Because of deregulation of the financial industry in the 1990s and 2000s, opportunities are now available for retail traders or anyone with a smart phone to trade in the market.
As a result, many retail investors believe that the new found power to trade can make them rich quickly. College students and soccer moms who watched a YouTube video on trading can now trade options on margin. Unfortunately, investing and gambling have become almost intertwined. As a result, many people have lost money in the market. In addition, the risky environment encourages even more risky behavior with scams.
Making Money with Robinhood
Are You a Long Term or Short Term Trader or Investor?
One question you want to ask yourself prior to using Robinhood is, what kind of trading you plan to do.
- Are you a long term investor who buys investments and holds them for years?
- Do you trade cryptocurrencies?
- Are you a short term trader who buys stocks and sells them the same day?
- Do you want to trade on margin?
Answering these questions will help you determine if Robinhood is right for you.
Advantages of Using Robinhood
Robinhood is Easy to Use, Inexpensive to Start Trading and You Can Trade Cryptocurrencies Like Bitcoin
The advantages of trading or investing on Robinhood are two-fold: Robinhood is easy to use and it’s the very inexpensive to start. If you have a smart phone and a social security number, you can get started today. Investing less than $1,000 to start can be done with very little headache and within hours of account activation. Only have $5 to start? No problem. Robinhood allows you to own fractional shares of equities.
One additional bonus is that Robinhood allows cryptocurrency trading like Bitcoin, which is unusual. Cryptocurrencies have struggled to find mainstream adoption. However, this may be changing with a younger generation of investor who uses Robinhood.
Disadvantages of Using Robinhood
Robinhood Suffers from Slow Customer Support, Lack of Options for Long Term Investors and Ethical Dilemma
Customer support is an area that needs improvement at Robinhood. The help center is primarily online and conducted through email. This can be frustrating for those who like to speak to a human about their issues.
Long term investors looking to place their money in mutual funds or retirement accounts lack options with Robinhood. Instead, Robinhood is tailored more for retail investors who have small amounts of money to invest or trade on a shorter timeline.
One other disappointment is the payments for order flow model used by Robinhood. Although other brokerage firms like E-Trade also allegedly use this model, it sets up some interesting ethical dilemmas. When firms like Robinhood sell user’s data to the big market makers, they are able to use the data as a financial advantage over the Robinhood traders. It’s kind of like going to Las Vegas to play poker and letting the dealer see your hand. If the dealer tells the other player(s) what hand you have, you can never really win.
Final Thoughts on Robinhood and Investing
Overall, Robinhood is a great place to start investing and trading if you are ready to begin your financial journey. Investing and trading is a life-long learning opportunity. Frequently, learning about finance through experience is the best way to learn. Just prepare yourself to lose some money when you start. And remember, don’t play with more money than you are willing to lose.
It is important to note that Piggy Bank Coins does not provide financial advice. We do not endorse or recommend any financial investments. Instead, we provide information for educational purposes to those seeking knowledge regarding personal finance. However, in the spirit of transparency, note that the author is an investor in cryptocurrencies, precious metals, and some equities.
In addition, The Federal Trade Commission (FTC) requires that Piggy Bank Coins disclose to readers that we may receive commissions when you click our links and make purchases. However, this does not impact our reviews and comparisons. Moreover, we try our best to keep things fair and balanced, to help you make the best choice for you.