The democracy in Robinhood’s mouth is a nightmare for retail investors

Free is the most expensive

“Our mission is to democratize finance for all.”


On July 1, Robinhood formally submitted an IPO application to the US SEC. It plans to be listed on the Nasdaq under the stock code “HOOD”. Underwriters include Goldman Sachs, Citigroup, JPMorgan Chase, etc., with a valuation of at least US$40 billion .

Robinhood entered the capital market with a resounding zero commission slogan. Its rapid rise instantly released the trading needs of small investors, and at the same time subverted the entire brokerage industry. However, this is the base camp of retail investors with mixed reviews. Is it to rob the rich and help the poor or to cut the leeks?

How does a zero commission broker make money?

I believe everyone is no stranger to the short-selling incident of retail investors in US stocks at the beginning of this year.

A large number of retail investors gathered in Reddit’s popular forum Wall Street Bets to compete fiercely with many well-known hedge funds in GME and AMC stocks. In the end, Poin72 lost 750 million US dollars, Citadel lost 2 billion US dollars, and Melvin Capital announced the liquidation. The big bears were annihilated and surrendered one after another.

The democracy in Robinhood's mouth is a nightmare for retail investors

Image source: Internet

The democracy in Robinhood's mouth is a nightmare for retail investors

Image source: Internet

But we must know that in the mature capital market of the United States, institutional investors account for as high as 90%. Where did such a large number of retail investors spring up?

According to Robinhood’s prospectus, as of March 31, 2021, the company has accumulated 18 million users and 17.7 million monthly active users. It is worth noting that 5.5 million new users will be added in the first quarter of 2021. It seems that everyone wants to make a fortune in this retail battle.

The democracy in Robinhood's mouth is a nightmare for retail investors

Sure enough, the per capita income of Robinhood users increased by 65% ​​year-on-year in this quarter.

The democracy in Robinhood's mouth is a nightmare for retail investors

According to the prospectus, from 2015 to 2021, more than half of the users on the Robinhood platform opened stock accounts for the first time. Why are most novice investors willing to choose Robinhood as their first trading platform?

Unlike traditional brokerage trading software, Robinhood’s trading interface is intuitive, elegant, approachable, and easy to use. Since its establishment in 2013, Robinhood founders Vlad and Baiju have known what kind of product they are going to do. Adhering to the concept of “everyone is an investor”, the design of the app is naturally suitable for the general public and won the hearts of the people.

The democracy in Robinhood's mouth is a nightmare for retail investors

Image source: prospectus

The most important thing is that Robinhood, which takes so much care for its customers, is actually free to open an account and does not charge commissions. Is there really a free lunch in this world? Not really.

Let’s take a look at how Robinhood, dressed in a zero-commission coat, cut off retail leek.

1. Buy and sell order flow

2. Net interest income

3. Other income

The prospectus shows that Robinhood’s revenue in 2019 and 2020 will be 278 million U.S. dollars and 959 million U.S. dollars, respectively; the revenue of the first quarter of 2021 will be 522 million U.S. dollars, an increase of 309% from the revenue of 128 million U.S. dollars in the same period last year. .

The democracy in Robinhood's mouth is a nightmare for retail investors

The strong income is indeed impressive, but a closer look will reveal that Robinhood’s revenue source accounts for the bulk of the purchase and order flow (PROF: payment for order flow), which is as high as 80%. In other words, the company’s main revenue is to send user orders for stocks, options, and cryptocurrencies to market makers, and then earn rewards from them. The simple understanding is that an investor’s order could have been traded on the exchange to find the best price, but Robinhood was resold to the market by high-frequency market makers to match and execute it. However, the transaction speed is so fast that it is difficult for individual investors to find the spread, so the wool is smashed by Robinhood and market makers.

The democracy in Robinhood's mouth is a nightmare for retail investors

Selling order flow usually only earns a penny per share , but for a company with a large order volume like Robinhood, it is a significant income, which is why Robinhood can provide zero commission transactions.

In addition, Robinhood also earns interest from lending transactions and margin loans provided to users. Net interest income in the first quarter of 2021 increased by 160.2% to 62.5 million US dollars, accounting for approximately 12% of total income.

Other sources of income mainly include Robinhood Gold membership fees. This is a paid subscription service that provides users with advanced features: professional research, Nasdaq secondary market data, and more.

80% of Robinhood’s revenue comes from order flow payment, and excessive reliance on a single business will adversely affect the company’s operating performance. In particular, the US SEC has focused on this business and will continue to pay close attention to it. Any modification of relevant regulatory rules may affect the company’s future direction.

Repeatedly bombarded and accused

It can be said that there are many popular rights and wrongs. Robinhood, which is stealing the limelight in the capital market, has actually been criticized by many people. Buffett and Munger have called it “a casino disguised as a decent business.”

The democracy in Robinhood's mouth is a nightmare for retail investors

Image source: Internet

When it comes to zero-commission platforms, Buffett and Munger have repeatedly stated that the low cost and low threshold of transactions have caused investors to frequently conduct intraday transactions and lose large amounts of funds. This is different from the investment philosophy they have always advocated. It is not to guide investors to hold for a long time, but to allow them to speculate with higher risks.

Faced with the bombardment of the two predecessors, Robinhood fought back that “transactions should be democratized and investors themselves should be respected.”

Many investors talked about this time and again. But “playing for fun, for fun,” Robinhood really paid a heavy price for multiple accusations from the US Securities and Exchange Commission and the Financial Supervisory Authority.

The huge order flow payment finally attracted the attention of the US Securities Regulatory Commission. In December 2020, Robinhood was accused of inducing users and imposed a fine of $65 million. The company failed to provide users with the best transaction price on the platform, resulting in a loss of 34.1 million U.S. dollars.

Misfortunes never come singly. In June of this year, the US Financial Supervisory Authority FINRA issued the largest financial penalty ever to Robinhood-a $70 million fine. Among them, 57 million US dollars are fines, and 12.6 million US dollars are compensations to customers. A series of problems with this ticket include interruption of the trading system, conveying misleading information to customers, and ineffective control over option trading .

The democracy in Robinhood's mouth is a nightmare for retail investors

Image source: FINRA official website

It’s such a “wicked door”, Robinhood can always have system failures at critical moments. In March last year, U.S. stocks fluctuated sharply for several consecutive days, and the Dow Jones Industrial Index recorded the largest single-day gain in history . As a result, Robinhood went down! In May of this year, after the skyrocketing Dogecoin suddenly fell by more than 30% , Robinhood went down again! If the profit is not earned, and the stop loss cannot be taken, the user is extremely dissatisfied.

The democracy in Robinhood's mouth is a nightmare for retail investors
The democracy in Robinhood's mouth is a nightmare for retail investors

However, when investors tried to organize rights protection, they discovered that it was clearly stated in the user agreement that Robinhood was not responsible for losses caused by technical failures. This user agreement is the main reason for the 57 million fine.

The democracy in Robinhood's mouth is a nightmare for retail investors

Image source: Internet

Similar misinformation and “whatever you want” platform services have caused a large number of users to suffer huge losses.

Competitor corner overtaking

Robinhood by constantly boasting zero commission gimmick to attract users, but in fact zero commission voucher providers already not fresh, TD Ameritrade, Charles Schwab, Webull and other companies have traditionally provided a commission-free trading , is a little nibble Robinhood cake.

For example, in the retail war at the beginning of the year, when Robinhood and other platforms restricted the trading of GME and AMC stocks, Webull did not. After the incident, the average number of new users of Webull in the seven days soared by 1548% , and the number of users transferred from other US brokers every day was as high as 850, and about half of them came from Robinhood. Webull has become the second most popular free app in the financial sector in the United States, second only to Robinhood.

Both Webull and Robinhood are zero-commission, no-threshold trading platforms, but Webull has done more thoroughly in the matter of no commission, and also does not charge for option trading . At the same time, Webull’s stock research, community functions, and platform interface are more professional, making it easier to attract senior investors.

The democracy in Robinhood's mouth is a nightmare for retail investors

Image source: Internet

Each platform has its own merits, and the future competition will become more intense.

Concluding remarks

The advent of zero-commission brokerages has indeed attracted many new users to participate in investment, but one of its major features is that order flow payment is the main source of income. To achieve business diversification, the road behind will become more and more difficult to follow. In addition to expanding its business, Robinhood needs to continue to maximize the user experience and regain the trust of retail investors in order to gain a firm foothold in the emerging brokerage field.

Posted by:CoinYuppie,Reprinted with attribution to:
Coinyuppie is an open information publishing platform, all information provided is not related to the views and positions of coinyuppie, and does not constitute any investment and financial advice. Users are expected to carefully screen and prevent risks.

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