Millennial investors have been flocking to easier ways to invest for cheap. And with the accessibility of online or app-trading for younger investors, investment apps seem to be the way of the future.
In fact, investment app Robinhood doubled its growth from the previous year to 6 million users in 2019 - trumping online brokerage E*TRADE (ETFC) with their 3.7 million (as of last year). With its commission-free model, Robinhood has attracted investors who are looking for a cheap, easy way to invest on their mobile devices. But, the question begs - how does Robinhood actually make money?
What Is Robinhood?
Robinhood is an online investment and trading app launched in 2013 that boasts a commission-free model and keeps costs low for investors to trade stocks, ETFs, options and even cryptocurrency without paying commissions. The app was originally developed for Apple (AAPL) phones and tablets but has since launched an Android version as well.
In the wake of the 2008 financial crisis, Robinhood was conceived out of a desire to "democratize America's financial system" and disrupt online investing by providing a platform for the younger generation of jaded investors to trade commission-free. Named after the fictional character Robinhood - who robbed the rich to feed the poor - the investment app was designed to give the next generation inexpensive access to trading that could help them get involved earlier in the market. Taking on a proverbial "not like the other guys" mentality, Robinhood has attracted a large millennial base to use the low-to-no-fee app - especially for high-frequency traders.
As of 2019, Robinhood offers a variety of investment vehicles including stocks, ETFs, cryptocurrency and options. The company has been valued at around $5.6 billion, following a recent Series-D investment round influx to the tune of $363 million, according to CNBC.
And, according to a recent report by JMP Securities in 2018, Robinhood is estimated to have around $1,000 to $5,000 in average assets per account - still way behind those of their competitors like Fidelity and TD Ameritrade (AMTD) . Still, according to the company as of May 2018, Robinhood has allegedly saved customers over $1 billion in commission fees.
But as a company boasting no commissions for trades, how does Robinhood actually make money to earn their near $6 billion valuation?
How Free Investing Works
Naturally, apps like Robinhood or even Acorns offer lower-cost investing with minimal or nonexistent commissions on trades - but how do they do it?
Commission-free investing might sound like a free (or at least very minimal cost) venture, but the reality is that apps like Robinhood make money through a variety of other means - including through interest, rebates and making customers pay for premium accounts to gain access to exclusive investment options.
How Robinhood Makes Money
Given its commission-free model and free account set up, how does the investment app actually make money?
According to one the co-founders of Robinhood, the app makes a large portion of its money from interest made by lending out investor's idle cash - basically making money off of uninvested funds in customer's accounts. According to their site, Robinhood makes money from "interest from customer cash and stocks, much like a bank collects interest on cash deposits" as well as "rebates from market makers and trading venues."
Additionally, Robinhood charges for some other services - including live broker trading via phone (which will put you back $10 per trade) as well as some foreign stock transactions for around $35 to $50.
But Robinhood also reportedly makes a decent bit off of trades in other ways - including making money off of orders.
According to the Wall Street Journal in late 2018, "If a customer buys 100 shares of Apple for $200 each - a $20,000 purchase - Robinhood could get up to $5.20 for routing that order to electronic-trading giant Citadel Securities LLC, according to calculations based on a recent Securities and Exchange Commission filing," the article reads. According to The Journal's analysis of SEC filings, that's compared to some 9 cents that Schwab (SCHW) would make for the order, and 16 cents that TD Ameritrade would make.
2. Premium Accounts
Robinhood Gold, the company's premium account, allows investors up to $1,000 of margin - allowing them to trade with more than they have in their cash balance on the app.
This is accomplished through margin lending.
3. Marginal Interest and Margin Lending
A major source of income for the investment app is the company's margin trading service via Robinhood Gold - which starts at $6 a month, according to their site. The margin account's minimum portfolio value is $2,000 - however, there are different tiers.
If you want additional margin loans, you can pay $6 a month for an another $1,000 - and can continue borrowing money as the margin will be 50% your account balance (which is unusual for brokerages).
According to Robinhood's site, for a "$200/month Gold tier, you'll receive a charge for a 5% margin fee. For customers borrowing over $50,000 there's an interest rate of 5% APR. For example, if you borrow $125,000, you'll be charged interest on $75,000 ($125,000 - $50,000). The daily rate for borrowing $75,000 will be $10.41 ($75,000 x 5% /360)."
However, if users wish to switch their Robinhood account to another broker, they will need to pay $75.
4. High Frequency Trading and Order Flow
The app has attracted some criticism over its dependency for revenue on high-frequency trading and a strategy called payment for order flow.
Bloomberg reported in 2018 that Robinhood makes nearly half of its revenue (more than 40%) from high-frequency trading and payment for order flow - a controversial practice used by many online brokerages. According to their site, Robinhood sends "your orders to market makers that allow you to receive better execution quality and better prices. Additionally, the revenue we receive from these rebates helps us cover the costs of operating our business and allows us to offer you commission-free trading."
Instead of orders being processed on a public exchange, companies like Robinhood can make money off of processing (or directing) trades through behind-the-scenes parties that provide the other end to the trade. According to Robinhood, they use market makers Citadel Securities, Two Sigma, Wolverine, and Virtu - which the company has disclosed due to SEC Rule 606.
Although the payout is reportedly minimal, Robinhood does make some money from rebates. According to co-founder and co-CEO Vlad Tenev in a statement issued in 2018, "Robinhood earns ~$0.00026 in rebates per dollar traded. That means if you buy a stock for $100, Robinhood earns 2.6 cents from the market maker."
However, according to the company's website, "[Robinhood] report[s] our rebate structure on a per-dollar basis because this accurately reflects the arrangement we have with market makers" - an unusual new move for comparable operations.
Because of the company's boundary-pushing revenue streams, some suggest its reliance on rebates may someday be to its detriment.
"Robinhood's revenue model could easily disappear," Tyler Gellasch, executive director of Healthy Markets (an investor advocacy group), told Bloomberg in 2018. "They've made it clear that they are comfortable living on this regulatory edge."
Is Robinhood Safe?
The big question with any online trading or investment app is (or should be) - is it safe?
As a brokerage firm dealing with securities, Robinhood is regulated by the Securities and Exchange Commission (SEC). In addition, the app has a membership with the Financial Industry Regulatory Authority (FINRA), which is a self-regulated organization that relies on voluntary participation from companies like Robinhood.
And, the app is protected by the Securities Investor Protection Corporation (SIPC), which protects up to $500,000 (or $250,000 for cash claims).
Bank masquerade controversy
However, Robinhood was recently in hot water when the company announced plans to launch savings and checking accounts with unusual interest rates. According to CNBC, Stephen Harbeck, the president and CEO of the SIPC, had "serious concerns" about the release, causing widespread criticism among regulators and users alike.
The company's checking and savings account, which boasted a 3% interest rate (an industry-leading rate), would not have been protected by the FDIC - the bank standard. Instead, money in checking and savings accounts not intended to be used for trading would have been covered by the SIPC - which is not allowed. For many, this made Robinhood look as if it were masquerading as a bank.
"If there's any uncertainty about regulatory protection, there is serious potential for people to be misled," former Rep. Barney Frank told CNBC in December. "There needs to be certainty - if there's stuff that isn't covered it needs to be in big bold [letters] on the top of the page."
Just a day after the announcement of their new product, the Robinhood co-founders posted a blog post in December, announcing a re-branding and re-working of the product that would "work closely with regulators as we prepare to launch our cash management program, and we're revamping our marketing materials, including the name."
Cryptocurrency on Robinhood
Notably, Robinhood has recently ventured into offering cryptocurrency as a trading option - which has apparently already boosted users.
"Crypto has certainly added to our growth," Baiju Bhatt, co-founder and co-CEO of Robinhood, told CNBC. "In the next couple of years I think you'll see Robinhood looking like a full-service consumer finance company."
Currently, Robinhood cryptocurrency is available in 37 states - reportedly with more on the way.
Options Trading on Robinhood
Additionally, you can trade options on Robinhood.
The company touts no base fees, no exercise and assignment fees, and no per-contract commission. And, you don't need a premium membership to trade options - the Instant account allows no-commission options trading (although Robinhood will instantly transfer you to an Instant account if you currently have a Cash account).
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