How does Robinhood stock broker make money?

Question

I recently downloaded the Robinhood app that states it charges $0 commission for its trades. If so how do they stay in business by doing this? Is there something they are leaving out?

Answer 1

Robinhood seems interesting. Some say it's a gimmicky site with a nice UI not an investing or trading platform.

From investopedia:

1. For now, the app stays afloat for mainly two reasons. First, the business itself is extremely lean: no physical locations, a small staff, no massive public relations campaigns and only one operating system platform to maintain. Robinhood also generates interest off of unused cash deposits from user accounts according to the Federal Funds rate.

2. Second, venture capitalists such as Index Ventures, Ribbit Capital, Google Ventures, Andreessen Horowitz, Social Leverage,and “many others” have invested more than $16 million in the app.

3. According to Barron’s, Robinhood plans to implement margin trading in 2015, eventually charging 3.5% interest for the service. E*Trade charges 8.44% for accounts under $25,000. Phone assisted trading will also be available at $10 per trade in the future.

4. Originally, Robinhood planned to make money off of order flows – a common tactic used by discount brokerages in the 1990s to generate revenue. According to the company's FAQ, Robinhood backpedaled on the idea because it executes orders through a clearing partner and, as a result, receives little to no payment for order flow. The company is willing to return to its original plan in the future if it receives order flows directly or begins to generate a lot of revenue from them.

Answer 2

Yes, there is a lot they are leaving out, and I would be extremely skeptical of them because of the "reasons" they give for being able to charge $0 commissions.

Their reasons are that they don't have physical locations and high overhead costs, the reality is that they are burning venture capital on exchange fees until they actually start charging everyone they suckered into opening accounts. They also get paid by exchanges when users provide liquidity. These are called trade rebates in the maker-taker model.

They will start offering margin accounts and charging interest. They are [likely] selling trade data to high frequency trading firms that then fill your stock trades at worse prices (Robinhood users are notorious for complaining about the fills).

They may well be able to keep commissions low, as that has been a race to the bottom for a long time. But if they were doing their users any actual favors, then they would be also paying users the rebates that exchanges pay them for liquidity.

Robinhood isn't doing anything unique as all brokers do what I mentioned along with charging commissions, and it is actually amazing their sales pitch "$0 commissions because we are just a mobile app lol" was enough for their customers. They are just being disingenuous.

2018 edit: Called it. Now with government mandated disclosures: https://d2ue93q3u507c2.cloudfront.net/assets/robinhood/legal/RHF%20PFO%20Disclosure.pdf Interpretation: https://seekingalpha.com/article/4205379-robinhood-making-millions-selling-millennial-customers-high-frequency-traders

2020 edit: I originally wrote that they were selling trade data and providing worse fill prices which is an incredibly obvious and common practice amongst brokerages and exchanges, the initial comment was that this was "unsubstantiated" because there wasn't a public source - as if that was ever needed except for gullible people that adored Robinhood. Robinhood now pays a kickback of $65m to the US Government over not disclosing this practice and being disingenuous to gullible people that adored Robinhood from 2015-2018 https://www.sec.gov/news/press-release/2020-321#:~:text=Press%20Release-,SEC%20Charges%20Robinhood%20Financial%20With%20Misleading%20Customers%20About%20Revenue%20Sources,Satisfy%20Duty%20of%20Best%20Execution&text=The%20order%20finds%20that%20Robinhood,from%20not%20paying%20a%20commission.

I also predicted they would offer margin accounts and charge interest, what really happened is more hilarious as they charge a subscription model for the privilege of using basic margin. The market can bear it.

Answer 3

Disclosure: I don't have an iPhone, so I don't use RobinHood. That being said, I have a less "they're-out-to-get-ya" view of what they're doing.

As a small business owner (2 businesses), employees cost the most. If you can create a solid business with few (or no) employees and let robots run it, you will drastically reduce your costs. Joe Polish said it similarly with sales letters, something along the lines of they never complain about a headache, need to take a year off to discover themself, or just need a personal day. Robots are the same; they do not have human limits. Most simple trading can be done and maintained by well written code and AI, there's very little need for humans to do anything other than build it. Think about the efficiency of bitcoin versus all the central banks combined; how many people are employed by central banks?

Robinhood states that they are using technology in these ways to minimize costs and they're using a system that doesn't need physical branches (this doesn't mean they will never have them, just that they don't need them). Robinhood does not indicate that they allow everything to happen for free; only stock trading. I worked for a large trading firm once and observed that stock trading wasn't the bulk of where they made their money anyway; trading options, futures, index funds, etc are where the big money was and Robinhood says nothing about those being free. Like the CQM mentioned too, they'll be charging for margin as well.

In a way, the individual stock trader is dead; many people - including this forum - prefer index funds, so more than likely, Robinhood will strike up a deal with an index fund company or create their own (this is just easy, passive income with an expense ratio). In this category, the markets are their playground, but they do need to attract enough people to their platform, thus free stock trading is a good way to do it.

As for selling your information for advertising, that is always a possibility, but they have quite a few other options that would be good for most investors (index funds, affiliating with financial fund companies, etc) where they can start before ever needing to dip their toe in selling information. This isn't to say they won't do it, but that there are few other options they have.

The major concern I have for Robinhood is ongoing security. Just building it and letting it run kind of assumes that there won't be major compromises in the future and as AI evolves, superior AI might be able to crush older AI.

Answer 4

Charging very high prices for additional standard services:

See Commission & Fees:

https://brokerage-static.s3.amazonaws.com/assets/robinhood/legal/RHF%20Retail%20Commisions%20and%20Fees%20Schedule.pdf

Link is down in the footer, to the left...