How Does Robinhood Make Money [2021]: A Detailed Analysis

Anyone can open a business, but owners should address three critical things for it to be successful. These three factors can be summarized into questions that anyone looking to open a company should ask themselves first before doing it. They are;

  • What problem are you trying to solve?
  • Is there money in that problem?
  • Can you scale the solution?

If you are solving a real problem and your target customers are willing to pay for that solution, and you can quickly scale it across larger markets, then the chances are high that your business will be successful. These are what form the basis of any business model.

Today we look at many companies globally and wonder how they make enough money to sustain operations. This piece will break down one popular trading platform, Robinhood, and uncover how it makes money. Read on;

Overview of Robinhood

Robinhood is a fintech company that offers customers a platform to trade stocks, ETF’s, options, and cryptocurrency. They don’t charge a fee for this service. Most of the customers on this platform use the mobile application, but they can also check the status of their portfolio on the company’s website.

On sign-up, Robinhood gives users a free stock off a popular traded company such as Facebook or Amazon.

Users need to fill in both their data and Social Security number when signing up to this platform. After their account is approved, they can transfer funds into the accounts and start trading immediately.

One of these platforms’ main advantages is simplicity. Users can get a bird’s-eye view of the account’s performance after logging in, and with a few clicks, they can trade.

In addition, the trading platform Robinhood offers a cash management service that lets users earn interest on funds.

This service comes with a debit card issued by Sutton Bank and can transact in over 75,000 ATMs across the United States for free. Both these platforms are insured by the SIPC and FDIC to a tune of $500,000 and $1.25 million, respectively.

History of Robinhood

Robinhood was established in 2013 by two individuals who are the current CEOs, Vlad Tenev and Baiju Bhatt. It has its headquarters in San Francisco, CA. Both the CEOs are immigrants who met up at Stanford University.

After a few years of analyzing the flaws of legacy financial institutions, the two launched their first company in 2009 called Celeries.

This was a hedge fund that used algorithmic trading to make investment decisions. It didn’t quite pick up, and after two years, they moved on. In 2011 they launched Chronos Research, a startup that sold trading software to other financial institutions. This one wasn’t successful either.

They picked up a brilliant idea after studying a few things in the current financial market.

  • People were slowly adopting the use of smartphones and comfortably used them to manage their finances and contacts.
  • Trust in Wall Street was very low.
  • Access to stocks and other investment instruments was left for the elite in society. Companies like E*Trade and Charles Schwab were charging an average of $8 to trade, making it unsuitable for the average person.

The business case made sense, but the main challenge was raising capital. They pitched the idea to over 75 investors who rejected it.

Eventually, they got their eureka moments after convincing Tim Draper of index ventures and Mark Anderson to invest $3 million into the startup’s seed round. The website went live in early 2014, and the iOS and Android applications were launched in December 2014 and August 2015, respectively.

By the end of 2014, Robinhood had over 800,000 people waiting for it to launch. This interest prompted the founders to raise another $13 million before the launch. Everything was finally released to the public with the financial backing of $16 million.

One year after launch, Robinhood got over 1,000,000 users and processed over $1 billion in transactions while raising another $50 million in funding. In 2016 the company launched two features that would be the bedrock of its growth.

The first one was Robinhood instant which lets users borrow $1000 for trading while waiting for their deposit to be cleared. In addition, users could trade using the profits they made, which was new since they usually took a few days to reflect.

The catch to customers was that they had to be on the waitlist to enjoy this feature, and the more they invited others, the higher they climbed up the waitlist, which accelerated the platform’s growth.

The second service was Robinhood Gold which is a premium subscription service. For $10 a month, users with at least $2000 in their accounts could borrow twice that and use it to trade immediately.

These two features took Robinhood to a whole new level, and in that year, it hit a record $2 billion in transactions, which was the fastest in the brokerage industry.

Building on this growth, Robinhood ventured to Australia. It opened a different waitlist for this country, and within a few days, its waiting list had over 50,000 people on it. Robinhood was almost guaranteed to succeed in Australia since people had to pay over $50.00 for placing one trade before they entered this market.

In January 2018, the platform allowed users to trade cryptocurrencies when Coinbase was charging between 1.5 and 4% for each trade. This decision was arrived at when the founders discovered that over 100,000 users were always searching for crypto news on the application.

After conducting a survey, 95% said they would be interested in investing in crypto. It only took Robinhood two months to allow users to trade in cryptocurrency, and it almost doubled the number of users on the platform.

In the same spirit, they launched a banking product called Robinhood checking and savings in December 2018. Robinhood gave its customers a checking and savings account with a 3% interest rate and a significant SIPC insurance with this product. Note that the average rate at that time was 0.10% and 0.08%.

The caveat was that this product was not a banking product but an extension of its brokerage platform. It appeared that they had skipped some necessary steps when developing this platform and received a lot of public backlash; this forced them to change it to a cash management service which was released ten months later in October 2019.

This time Robinhood had done all the due diligence to ensure the product was OK.

In 2019 Robinhood’s entry into the niche had forced all the other players to change tact, and competitors like E*trade and Charles Schwab dropped their trading fees.

The history of Robinhood gives a little context of how the company operates before we dive into the specific ways it makes money.

How Does Robinhood Make Money?

Robinhood does not charge users to place a trade. This would have been the most obvious way to make money. However, the company uses this as its selling point and makes money in other ways, such as;

Payment for Order Flows

When you make a trade on any platform, the request is sent to a market maker who pays the platform a small fee in exchange for the deal. In most cases, these market makers give better offers for them to compete with stock exchanges.

Robinhood partners with multiple market makers, including Citadel or Two Sigma, to provide customers the best sales prices. In turn, the market maker makes a profit on the difference between the quoted price for a bid and ask. This process is done by computer, which allows the market maker to execute thousands of trades instantly.

This model of making money has received criticism from different stakeholders since it lacks transparency. In addition, it only takes milliseconds which can result in market swings that always favor institutional traders as opposed to small day traders on Robinhood.

The real investor loses out on some of the profits. The advantage is that this is what allows Robinhood to offer trades free of charge. Comparing these downsides to the 10% commissions that other platforms like E*trade and Charles Schwab were charging customers, many will lean towards the commission-free trades.

The authorities recently directed all brokerage platforms to disclose the amount of money they make from this order flows and Robinhood mid approximately $270 million in half one of 2020.

Premium Subscription Service

Robinhood Gold is a premium service that gives users a couple of privileges on their platform, including;

  • Level 2 marketing data
  • Access to investing on margin
  • Larger instant deposits
  • Unlimited access to comprehensive stock research on about 2000 companies

This plan starts at $5 per month and can go up to $50 per month. The difference depends but how much traders can borrow on margin. Any interested users can try it out for free for the first 30 days and cancel the subscription at any time.

Trading on Margin

Margin in the trading world is a feature that lets people borrow money from the trading company to invest. Robinhood offers this feature on its premium platform and gains interest from what users pay back. They pay 5% annual interest for any margin above $1000.

The platform looks at a user’s account balance to determine how much they can get in margin. This is key for risk control. If a user’s account balance drops below a certain amount, they will receive a margin call. They can either add more money to the account or sell off any property they must maintain the balance needed.

Interest

Robinhood loans money to institutions where it collects interests. This is done through its securities division which has a lot of uninvested cash.

Some of the profits gained from interests are distributed back to Robinhood users through annual percentage yield on their balance. Robin Hood also gets its cut from these interests.

Interchange Fees

It was mentioned that Robinhood has a MasterCard debit card hosted by Sutton bank. Whenever a user transacts using this card, an interchange fee is paid to the merchant.

It ranges between 0.1 and 1%, depending on the type of payment. The revenue is split between the card issuer, Mastercard, the bank, Sutton Bank, and Robinhood.

Frequently Asked Questions

Question: Is Robinhood Suitable for Beginners?

Answer: Robinhood is an excellent option for beginners, and this has been one of its key selling points from its inception. It was formed when trading was left to the seasoned professionals and, its concise and straightforward interface allowed just about anyone to trade.

It charges no commission on trading, lets users see their account status in a snapshot, and even place a trade within no time. While there are other equally impressive options in the market today, I would recommend Robinhood to any beginner looking to start trading.

Question: Can I Trust Robinhood?

Answer: Robinhood is very safe, and your funds cannot be stolen while on this platform. Money on Robinhood is protected up to $500,000 for securities and $250,000 for cash claims by the SIPC.

In addition, the Securities and Exchange Commission (SEC) heavily regulates the brokerage niche, and players like Robinhood are closely monitored for any sign of foul play.

Question: How Does Robinhood Make Money Without Commissions?

Answer: Robinhood generates money from multiple sources, primarily through rebates from market makers. When you place a trade on the platform, they are sent to a market maker to execute it. These makers often offer better prices than exchanges and, in turn, offer rebates to brokerages for choosing them.

Think of a market maker as an entity that completes the trade for you. These makers compete and offer reasonable rates for varying trades, and in exchange, pay a little commission to the brokerage for bringing them business. This concept allows commission-free brokerage platforms like Robinhood to enable you to trade without paying.

Other ways Robinhood makes money is through its premium services, Robinhood Gold, and lending out money to traders through margin trade.

Question: Is Robinhood Suitable for Beginners?

Answer: Robinhood is an excellent option for beginners, and this has been one of its key selling points from its inception. It was formed when trading was left to the seasoned professionals and, its concise and straightforward interface allowed just about anyone to trade.

It charges no commission on trading, lets users see their account status in a snapshot, and even place a trade within no time. While there are other equally impressive options in the market today, I would recommend Robinhood to any beginner looking to start trading.

Question: Can I Trust Robinhood?

Answer: Robinhood is very safe, and your funds cannot be stolen while on this platform. Money on Robinhood is protected up to $500,000 for securities and $250,000 for cash claims by the SIPC.

In addition, the Securities and Exchange Commission (SEC) heavily regulates the brokerage niche, and players like Robinhood are closely monitored for any sign of foul play.

Question: How Does Robinhood Make Money Without Commissions?

Answer: Robinhood generates money from multiple sources, primarily through rebates from market makers. When you place a trade on the platform, they are sent to a market maker to execute it. These makers often offer better prices than exchanges and, in turn, offer rebates to brokerages for choosing them.

Think of a market maker as an entity that completes the trade for you. These makers compete and offer reasonable rates for varying trades, and in exchange, pay a little commission to the brokerage for bringing them business. This concept allows commission-free brokerage platforms like Robinhood to enable you to trade without paying.

Other ways Robinhood makes money is through its premium services, Robinhood Gold, and lending out money to traders through margin trade.

Bottomline

Robinhood should get a lot of credit for disrupting the brokerage niche and opening the way for commission-free trading. Today, we see many other companies offering these services, as it is hard to appeal to traders if you charge a commission on trades.

However, its business model was spot-on as running such a robust and secure platform requires many resources. Market rebates are a significant source of income for the company, in addition to margin trading and premium service.

While Robinhood has faced many issues that forced it to disclose the amount it makes from market rebates, customers are generally happy with the platform.

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