Robinhood Markets Inc (HOOD) is a financial services company based in the United States that offers a popular investment platform called Robinhood. The company was founded by Baiju Bhatt and Vladimir Tenev in 2013, and its headquarters is located in Menlo Park, California.
Robinhood’s platform is known for its easy-to-use mobile app and web interface that allows individual investors to trade stocks, options, exchange-traded funds (ETFs), and cryptocurrencies without paying any commission fees. The app’s user-friendly design and zero-commission approach have attracted many first-time investors, especially among younger generations.
Robinhood makes money through several revenue streams, such as payment for order flow (PFOF), which is a practice in which the company receives rebates from market makers for directing trade orders to them. Robinhood also earns income from margin lending, interest on uninvested cash, and fees for its premium subscription service called Robinhood Gold, which offers features like instant deposits and access to professional research.
What Is Payment For Order Flow?
Payment for order flow (PFOF) is a practice in the securities trading industry where a brokerage firm, like Robinhood, receives compensation from a market maker or another liquidity provider in exchange for directing trade orders to them. This practice helps market makers profit from the bid-ask spread while providing liquidity to the market.
Here’s how PFOF works:
- A retail investor places an order to buy or sell a security through a brokerage firm.
- The brokerage firm routes the order to a market maker or liquidity provider instead of sending it directly to a stock exchange.
- The market maker executes the order and often tries to profit from the bid-ask spread or by netting it against other orders.
- In return for sending the order to the market maker, the brokerage firm receives a small fee or rebate. This fee is the “payment for order flow.”
PFOF is used by various brokerage firms, particularly those offering commission-free trading. Some well-known brokerages using PFOF include:
- Robinhood: As a pioneer of commission-free trading, Robinhood heavily relies on PFOF as a major revenue source.
- E*TRADE: This online brokerage firm, now a subsidiary of Morgan Stanley, also employs PFOF to subsidize commission-free trades for its customers.
- Charles Schwab: Following the industry trend of commission-free trading, Charles Schwab adopted PFOF as a revenue stream.
- TD Ameritrade: Acquired by Charles Schwab, TD Ameritrade is another prominent brokerage firm that uses PFOF.
While PFOF allows brokerage firms to offer commission-free trading, it has been criticized for potentially creating conflicts of interest. Critics argue that this practice may incentivize brokerages to prioritize payments received from market makers over securing the best possible execution price for their customers. However, the SEC regulates PFOF to ensure that brokerages adhere to their legal obligation of providing the best execution possible for their clients’ orders.
as of April 21, 2023
Robinhood is one of the fastest growing companies in the world. It’s barely a decade old and has amassed over 23 million funded accounts on its platform, with 11 million being active monthly. Robinhood also continues to be customer obsessed with new offerings in savings and retirement that are second to none. The issue is how long will it take for the company to grow account sizes from $2,700 to $50,000. That’s the investability question and I think the firm will get there as long as it doesn’t mess up like it did pre-IPO with Gamestop.