Neither the author, Tim Fries, nor this website, The Tokenist, provide financial advice. Please consult our website policy prior to making financial decisions.
In a brief time span, Robinhood took the world as the dominant trading app for stocks, options, ETFs, and cryptocurrencies. The stock app has become the go-to for millennials, and now boasts over 13 million users and an $8.3 billion valuation.
Millennials love the app due to its DIY nature and commission-free stock trading. So, with the ongoing surge in use from millennials, how does Robinhood make money?
Is Robinhood Profiting From the Millennial Surge?
Obviously, if Robinhood is not making any money directly from its massive user-base, it is making money from the act of trading itself.
Not to look a gift horse in the mouth, it would behoove you to have some level of clarity as you enjoy your commission-free stock trading. In key aspects, Robinhood’s background profit-generating processes relate to:
- how modern trading is executed in the first place
- the proper framing of Robinhood’s past (mis)conducts
Robinhood’s Past Missteps
To be generous, it is difficult, if not impossible, for any business to operate without some initial birthing pains. Despite Robinhood’s predictable popularity around the globe, and favorable reviews, it incurred two major stains on its 7-year record:
- Legal stain – FINRA, Financial Industrial Regulatory Authority, fined Robinhood $1.25 million in 2019 for failing to ensure that clients receive best prices for trades.
- Technical stain – Over the last year, as Robinhood experienced rapid growth, its infrastructure couldn’t handle the influx of new users and the expansion of trading volumes. This lead to Robinhood’s numerous outages, which then lead to many customers losing money in the middle of their trades.
When dealing with the legal stain, Robinhood has improved drastically to increase its transparency. They have released a statement clarifying what steps they need to take to make a profit, and how this process then aligns with the goal of providing the best online stock-trading service:
We perform regular, rigorous reviews of the market makers’ execution quality by looking at factors like execution price, speed, and price improvement. For even finer control, we offer limit orders, stop limits, and trailing stops, which allow you to name your own price.
Additionally, in lieu of a recent tragic suicide resulting from confusion when using the Robinhood app, they’ve taken necessary steps to improve the customer experience. The popular trading app has increased the eligibility level for some trading options, expanded its educational content, and is in the process of tweaking its user interface.
The Role of Market Makers in Free Stock Apps
Where does Robinhood’s $8.3 billion valuation come from if its 13 million customers can use the service without paying for it? As you can see from the above Robinhood statement, market makers are the key ingredient in profit margins for all brokerages.
Market makers are not human individuals per se but rather algorithmic systems designed to…make a market. They accomplish this by buying at the best current bid and sell at the best current offer.
The balance between the two is how stock prices are generated. However, in a market environment with high volatility, market makers refrain from setting transactions.
As you can logically conclude from market makers’ core task, they make trading easy because they allow traders to execute trades within reasonable time frames. For example, if you were to place a market order to sell 100 shares of Power Plug, market makers will buy it even without sellers already lined up to take the offer.
The reverse also applies, as sell orders on hold will facilitate other sell orders coming down the line.
How Does Robinhood Make Money?
Now that you understand how market makers facilitate brokerages, it is easy to understand how one such brokerage – Robinhood – makes money. Robinhood rakes in the profits from market makers’ rebates alongside volume rebates from trading exchanges, usually related to cryptocurrencies. Keep in mind though, on their own, these are minuscule sums, but they accrue with volume.
Another significant income stream for Robinhood comes through their Robinhood Gold plan, a premium feature upgrade at $5 per month, offering a suite of professional investing tools for non-casual traders. Robinhood Gold is also a platform for an additional stream of income – margin trading. Namely, margin loans and margin interests.
Lastly, Robinhood takes interest income from uninvested cash, by depositing the money in the highest-interest generating bank accounts. Speaking of banks, Robinhood Financial and Robinhood Securities divisions receive interchange fees and bank program fees respectively.
Robinhood’s Bright Future as a Stock Broker
In conclusion, Robinhood has a solid business strategy they can keep up as long as their system is capable of taking the load. Thanks to these factors, Robinhood’s competition in the form of automated investing will have to work long and hard to take the lead.
- Being first, and all the experience and expertise this brings.
- Relatively low maintenance and personnel cost inherent in virtual ventures.
- Exceedingly appealing fee-less trading proposition designed to be easily used by an average customer.
As a result, Robinhood keeps increasing its client base, which in turn increases their profit margins from all the high volume trades. The app has deservedly staked the title as the top stock broker for beginners. To top it off, its premium plan provides an additional layer of steady monthly income.
In the end, it may come down to engagement preference. Do you prefer investing to be done automatically on your behalf, or do you like the adrenaline rush when you click on that set order button? Let us know in the comments below.