Robinhood has become a central player in the story of r/wallstreetbets and the rise of “meme stocks” like GameStop and AMC. If you’ve been online this week, you know that a group of Reddit users turned amateur traders coordinated on social media to explode the share prices of low-valued companies, losing billions for hedge funds who were profiting off betting against them.
Wallstreetbets largely made their investments through apps like Robinhood, TDAmeritrade and CashApp. GameStop and AMC’s share prices sunk this morning as Robinhood and other apps blocked users from buying the stocks boosted by Reddit and even hiding search results for them, “in light of recent volatility.” Naturally, given Robinhood’s steal-from-the-rich branding (their mission statement is “to democratize finance for all”), the company is now under fire for putting Wall Street’s interests over users’ and manipulating the market themselves.
What's Robinhood's origin story?
Robinhood was a pioneering no-commissions trading app, on which users can invest in stocks, ETFs, options and cryptocurrencies. The company was founded in 2013 in Menlo Park by Vladimir Tenev and Baiju Bhatt, who’d both previously worked on finance software for Wall Street. The pitch was that Robinhood would eliminate the bar of entry to the world of investing, by eliminating pricey brokers fees.
The app paved the way for a wave of free online investing platforms like Acorn, Webull, Stockpile, Invstr and more. Retail stock-trading has been booming during the pandemic, as bored quarantiners picked up stock trading as a hobby, with Robinhood picking up the most growth of any online broker. Robinhood’s valuation hit $11 billion in August, up 50% from before the pandemic.
How does Robinhood make money?
Since Robinhood doesn’t charge users to place trades or make any kind of comission, their business model relies on something called “payment for order flow.” Payments for order flow are the fees that Robinhood receives for executing their orders through third party firms called market-makers — high-frequency trading firms that hold a wide inventory of shares, serving as a kind of middle man between investing apps and the actual market. These firms pay public-facing broker platforms for the right to place their trades.
Robinhood also has a $5 per month premium service called Robinhood Gold, that gives users access to a $1,000 margin for trading, however, the company hasn’t revealed if the feature turns a profit.
How does “payment for order flow” work?
Every time a Robinhood user places an order, Robinhood sends the order one of their market-maker partners, who then pay Robinhood for the right to execute the order. Robinhood might only make a few cents off each order, but with 13 million users and 4.3 million trades on average per day as of August, the cash adds up, hence the $11 billion valuation.
In the case of Robinhood, they make nearly half their revenue from just firms, Two Sigma Securities and Citadel Securities. Robinhood takes in one of the highest payment for order flow rates in the industry, at 17 cents per hundred shares for equity trades, and 58 cents for options, outpacing rivals like Charles Schwab which brings home 11 cents and 37 cents per hundred shares, respectively, for the same categories.
The business model of farming out client trading orders to high-speed, high-volume trading firms dates back to the very beginning of electronic trading. It was invented by none other than Bernie Madoff, at his securities firm back in the 1980s, which would pay Fidelity or Charles Schwab to make their trades for them.
“Payment for order flow” is the backbone the retail stock trading industry — nearly every free investment app’s bottom line depends on it. However, perhaps unsurprisingly given its founder, Bloomberg calls it “one of the most controversial practices on Wall Street.” The system has been criticized for a lack of transparency and potential conflicts of interest, since broker platforms make more off some trades than others, specifically options trading. Robinhood made more than $111 million of its $180 million second quarter revenue off options trades. Tim Welsh, a CEO of wealth management firm Nexus Strategy, told CNBC that retail trading apps “without a doubt” steer customers towards options trades. The company, however, put more checks on its options trading this summer, after a 20-year-old Robinhood user committed suicide, after believing he’d lost $730,000 (the interface made it confusing to tell the difference between his negative buying power and his actual account balance, which was positive).
Understanding the backlash
Since some see “payment for order flow” as anti-consumer and Wall Street-friendly, the app’s “for the people” ethos was already under scrutiny.
Now, the app’s mission statement is coming back duly to haunt them. Robinhood says in banning GameStop trades, that it was simply trying to tamp down a speculative frenzy. But Reddit investors — who frame themselves as class warriors, who are literally redistributing wealth from hedge funds to regular people and teaching Wall Street a lesson about market manipulation — claim the company is doing Wall Street’s bidding.
Soundbites and screenshots of interviews in which Robinhood’s founders recount their origin story of being disenchanted with Wall Street and inspired by Occupy Wall Street are circulating on Twitter. High profile figures as diverse as Alexandria Ocasio-Cortez, Ted Cruz, entrepreneur Mark Cuban and rapper JaRule have called out Robinhood for undermining free trade
While many other investment apps made the same call, Robinhood is taking much of the heat. Within hours of blocking GameStop trades, Robinhood was hit with a class action lawsuit, filed in New York on Thursday, alleging that the company “deprived their customers of the ability to use their service,” in an effort “to manipulate the market for the benefit of people and financial intuitions.
In the meantime, Reddit investors are boycotting Robinhood on principal — and desperately seeking any alternative platform that will let them hit “Buy” on Gamestop, AMC and others. As of late this afternoon, Robinhood competitors WeBull and Public have removed restrictions and are freely trading the “meme stocks” once again.
Over on the Apple App Store, despite reports on social media that users were bombarding the app with one-star reviews, Robinhood's rating (and total rating count) remain up and to the right:
It's a different story on Google, where the app has tanked in the Google Play App Store:
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