Robinhood – The Nuts and Bolts

  • General Information about Robinhood and Apex
  • How They Make Money
  • Planned Offerings and Services

 

Robinhood was founded by two rather smart men, Baiju Bhatt and Vladimir Tenev, who have a background in computer science, physics, and math. They started off building trade platforms among many other cool things for large banks and hedge funds. While they were helping these banks to make a bunch of money, they realized how cheap trading actually is. It cost banks fractions of a penny to execute the trades that they were charging consumers $5 or $10 for. From working in the industry, Bhatt and Tenev also estimated that about a million and a half people trade more than 10 times a month. This meant that there was a lot of money being spent on trading, mostly due to a huge markup and a lot of services that many investors weren’t using. This is the problem that Robinhood solves.

Bhatt and Tenev’s company, formally known as Robinhood Financial LLC, naturally caters to the younger generations since it’s only available on your phone or tablet (you can use Robinhood on the desktop through a workaround). When they were starting out in 2014, about three-quarters of their accounts were held by people who were 36 or younger. Fast forward to today; Robinhood has grown up quite a bit. They are registered with the SEC, are a member of FINRA, and are sanctioned by the Securities Investor Protection Corporation (SIPC). With about $66 million in funding behind them (about 738 base-model Porsche 911’s for comparison), venture capitalists have placed their bets on the idea. Big institutions from Google Ventures and Andreessen Horowitz to pop icons like Snoop Dogg and Nas are jumping on board with their money.

So what is Robinhood technically? They are classified as a “stock trading service company” by Bloomberg, which is an incredibly broad name for what they actually do. Robinhood is the face of your buying and selling. They are a brokerage, but the minute that you place an order to buy or sell, it goes beyond the brokerage. You may notice on your account statements that, on the first page in the bottom right-hand corner, a company named Apex Clearing House makes an appearance. Clearing houses do all of the actual buying, holding and settling. If you work in insurance, they’re pretty similar to a TPA. They facilitate a transaction by sitting on both sides of the table during a trade, and they are essential to our financial markets. They make it efficient and stable to trade stocks, as well as many other asset classes.

The big question that has been on a lot of peoples’ minds is “How does Robinhood make money?”. There’s an age-old adage “If you aren’t paying for the product, you are the product”, and that holds true for trading on Robinhood as well. Since this is a private company, there’s been some speculation about how they get their revenue. Primarily, they are sitting on a huge pile of cash from investors. Acorns, another Fin-Tech competitor, has a little less than half as much as Robinhood in investment capital (about $23 million, meaning half as many Porsches). The next piece of the pie of Robinhood’s cash flow comes from the interest they earn on the uninvested cash that sits in their investors’ accounts. All that cash doesn’t just sit there, most brokerages will loan that money back out to other account holders to buy and sell with. Robinhood doesn’t offer margin, but they put it somewhere that earns them a rate.

There are other revenue streams that Robinhood takes advantage of too. Exchanges like the NSYE or the NASDAQ will actually pay brokerages to trade on their exchange. This is called “paying for liquidity or volume” and exchanges do this so that people can jump in and out of the market quickly and efficiently. The problem for you is that this really helps high-frequency traders who may or may not be paying for Robinhood’s trade data. This is bad for you because those high-frequency traders can use the information to build an algorithm that will beat you to the trade and sell it back to you at a higher price.

When Robinhood first started out, they said they’d make money by selling their order flow; basically who gets to execute on the transactions. This is cool if you’re a small clearing house or brokerage and you want to sell your surplus trades to another company to make some extra cash. Traders still get their trades executed on, so it’s usually a win for all parties. SEC Rule 606 requires a clearing house to declare who they sell their order flow to, and Apex’s can be viewed here. The trick is that Robinhood is not the only brokerage that works with Apex, and so this doesn’t really tell us much about Robinhood. Betterment, eOption, Firstrade, Scottrade and many other brokerages all use Apex. Another cool way that Robinhood gets cash is by selling their API to other developers. An API is a tool that allows a software developer to build on top of what someone else has already created. Developers do this to get more people on their service (here’s looking at your Openfolio), and that doesn’t come free.

Robinhood plans to offer a lot of things like trading Over-the-Counter, ForEx and other exchanges, as well as other financial products and asset classes. They’ll probably use these additions to charge based on if the user takes advantage of them. They currently allow margin trading via their Instant offering but they don’t charge you for it. I’ll get into that a little later.  They plan to offer full margin accounts costing about 3 ½ to 5% in the future (E*Trade costs around 8.4% right now). Another cool thing they have hinted at doing is to offer tax-qualified accounts like IRAs, as well as custodial accounts and joint accounts, which would get younger investors started earlier on.

If you have any questions please feel free to write a message on the contact page above and I’ll write up a response to it! Again, this is all research based, please refer to the disclaimer on the bottom of the welcome page.

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