Investors have been looking for easier ways to invest. Any inexperienced first-time investor would want to make trading simple with easy access to the stock markets. With the accessibility of online or app-trading, investment apps seem to be the future of stock trading.
Many companies have been launching stock-trading apps and Robinhood is one such investing app. Named after the English legend who took from the rich and gave to the poor, Robinhood has caught the attention of many millennial investors who are looking for an easy way to invest on their mobile or handheld devices.
What is Robinhood?
In the wake of the 2008 financial crisis, people were losing money in the market, millions lost their jobs and homes, trust in the Wall Street was at its lowest and people were protesting on the streets. Robinhood was launched in the shadow of this crisis.
Launched in the early months of 2013, Robinhood is a commission-free online investment and trading app that supports the trading of more than 5000 stocks, equities, ETFs, ADRs, options contracts and cryptocurrencies such as Bitcoin and Ethereum through its website and mobile app. The commission-free model keeps the costs low for investors.
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Who is Robinhood?
Robinhood Markets Inc. was founded by two Stanford University graduates, Vladimir Tenev and Baiju Bhatt and is based in Menlo Park, California, with the aim of ‘democratising America’s financial system and making it more accessible to young and less affluent investors’.
The commission-free brokerage app is available both on iOS and Android. Robinhood has more than six million users with an average age of their user base in the thirties.
Revenue Generation - Funding
The funding raised by this powerful investing tool is just as remarkable as its customer base. This is true of both the amount Robinhood has raised and the wide variety of investors that they have been able to appeal to.
Funded by the likes of Ribbit Capital, ICONIQ Capital, Andreessen Horowitz, Sequoia, Index Ventures, and NEA, Robinhood had raised $3.4 billion in the first quarter of 2021. Robinhood has raised $5.6 billion in total across a series of funding rounds.
In the real world, when an individual stock broker or brokerage firm executes the transactions of a client, his purchases, sales or any other services, the firm makes money through the services they provide to clients. These include commissions, trading fees, monthly maintenance fees, inactivity fees, account rebalancing charges, and other charges. The brokerage fee is directly debited from the clients’ account.
How Robinhood Makes Money
But as a company with a valuation of more than $7.5 billion that does not take any commissions for trades, how does Robinhood make money?
The unique style of Robinhood’s product obviously raises questions on how the company makes money. A conventional investment firm obviously charges commission and that, typically, is one of the main revenue streams.
But Robinhood’s USP itself is as an investment platform that does not charge for opening an account with them and nor is there the usual brokerage or commission on a trade.
So what exactly is their business model? What is the trump card that they play to make their cash register ringing?
1. Interest on the float
Banks do this all time and Robinhood too has found that the idle cash lying in a client’s account is a good pool to make some interest income. They make the float of the uninvested amount work to their advantage creating an income stream.
Robinhood has over 6 million clients that have money lying around in their accounts. They all add up with the significant interest earned on this vast sum across the portfolio.
2. Income from premium subscriptions
As with most offerings, Robinhood too has a premium subscription package that comes with some useful features. Called Robinhood Gold, clients signing up for this get to try it out for free for 30 days, post which there is a $6 monthly charge.
A Gold client gets to bypass the standard verification period of two to three days and can immediately make large deposits. Also, they get to trade during off trading hours as well and can place orders before and after market hours.
Besides, Gold clients get to access useful market reports like Morningstar Research reports, Nasdaq Level II Market data and other helpful publications.
3. Income from Margin trading
Robinhood Gold extends a feature for margin trading whereby a client can have a minimum portfolio value of $2000. An additional $1000 loan can be had for another $6 a month. This has proved to be a successful offering as a 50% margin on the account balance is both handy for traders and a unique feature in the market.
For higher tiers, like the $200 per month Gold tier, there is a 5% charge a client needs to pay as a margin fee. For amounts greater than $50,000, an interest of 5% gets charged. Given the client base that Robinhood has, income in the form of interest from margin lending is a tidy source of revenue.
There are also other heads under which fees are levied. For instance, there is a $75 fee that any existing client looking to transfer their trading account to another broker would need to pay.
4. High-frequency trading and Payment for order flow
This one income stream for online brokerages, in general, has been somewhat controversial and Robinhood too has had to address concerns on this. Orders received from clients are sent to market makers with the assurance of “better execution quality and better prices”.
Instead of directing orders to a public exchange, online brokerage firms deflect orders to third party market makers who eventually process the deal. This enables Robinhood to make an income on the side which they claim covers the cost of their operations and help the brand remain commission free for their clients.
With over 40% of the annual income (in 2018 as reported by Bloomberg) coming from this stream, income from high frequency trading and payment for order flow has been substantial for Robinhood.
Robinhood earns around $0.00026 in rebates per dollar traded. For instance, if a client buys a stock for $100, Robinhood earns 2.6 cents from the market maker.
Is Robinhood Safe?
Robinhood is regulated by the Securities and Exchange Commission (SEC) and is registered with the Financial Industry Regulatory Authority (FINRA). Moreover, the app is protected by the Securities Investor Protection Corporation (SIPC), which protects up to $500,000 (or $250,000 for cash claims).
Robinhood has faced criticism for business practices and there are a few lawsuits filed against the platform after it went down for two days leaving customers locked out of accounts.
However, the company's incredible growth and popularity with younger investors means that it could be a major player in trading.
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