Since Robinhood offers commission-free trading on all its platforms, a question a lot of people ask themselves is how does Robinhood make money?
Robinhood makes most of its money from rebates and its additional functionality called Robinhood Gold. However, the brokerage firm also makes some of its money through its cash management network feature, by lending out margin securities to their counterparties, and from uninvested cash.
As seen above, Robinhood generates the majority of its revenue in several ways, according to the company. In the rest of this post, we’ll be sharing with you, in detail, how the online brokerage makes its money. Apart from that, we’ll also be answering some of the burning questions that people have been asking regarding investments with Robinhood, including whether or not the online brokerage is profitable, does it take your money, and does it sell your data?
How Does Robinhood Make Money?
Here are the five key ways in which Robinhood markets generate revenue.
1. Payment for Order Flow (PFOF)
As earlier mentioned, Robinhood makes money in five key ways. One of them, which is the company’s primary revenue center, is payment for order flow (PFOF). In case you don’t know, “payment for order flow” refers to the compensation that a brokerage firm receives from third-party market makers, interested in influencing how the broker routes client orders for fulfillment.
Here’s a better illustration of how PFOF helps Robinhood make money; When you enter your trade on the platform, these trades are sent to certain market makers, usually the high-frequency traders, for execution.
According to Robinhood, some of its market makers include Citadel Securities, Two Sigma, Wolverine, and Virtu. That said, after execution, these market makers make their profit on spreads, and then rebate a certain percentage of it back to the brokerage firm, compensating them for the flow of orders.
Payment for order flows comes with a few advantages. First, it enables people to enjoy commission-free trading. What that means is that, without payment for order flows, Robinhood won’t have been able to survive with its zero-commission trading model. Another benefit of PFOF, according to Eugenio Carlo of High-Frequency Trading, is that it enables retailer investors to get prices at the national best bid offer (NBBO).
2. Robinhood Gold
As we all know, Robinhood is an online discount brokerage that offers zero-commission stock trading, across its platforms, to more than 10 million users. However, the brokerage firm also has additional features, which it only makes available to its premium customers. This additional functionality, which is the company’s second primary revenue center after PFOF, is called Robinhood Gold.
In case you don’t know, Robinhood Gold is a “suite of powerful investing tools”, which enables you to gain access to premium features. These features include professional research, NASDAQ Level II market data, and better instant deposit up to your Portfolio Value.
Another benefit of Robinhood Gold is that it encourages margin lending – a feature that enables users to buy stocks, using funds borrowed from the brokerage firm. That’s not all! By opting for the Robinhood Gold package, customers will also be able to gain access to premarket and after-hours trading. That said, the gold package currently goes for $5 per month, and this contributes to the amount of revenue that Robinhood generates.
3. Income from Uninvested Cash
Apart from “payment for order flow” and “Robinhood Gold package”, Robinhood also generates some of its revenues from interest income from uninvested cash. That said, here’s a burning question; how is that even possible?
Many investors have some extra money lying in their Robinhood account. The purpose of that could be because they just got the cash from a previous stock sale or buy, and are not willing to cash out yet into their local banks.
That’s not all! They might also leave the money in their account on purpose, so they can utilize it for quick trades – especially when markets go up. That said, Robinhood takes advantage of these uninvested cash amounts, by sweeping them into interest-bearing bank accounts or using them to purchase very safe bonds. Apart from that, the brokerage firm also utilizes the money, by lending it out to facilitate margin trades.
4. Margin Securities Lending
Another means, which enables Robinhood to generate revenue, is margin securities lending. Speaking of it, it involves users borrowing money from the Robinhood platform to make quick trades. That said, the question is; how does Robinhood make money via this approach? Well, it’s pretty simple. As earlier mentioned, the online brokerage firm offers its customers loans, with the help of client’s uninvested cash amounts. On any loan that’s over $1000, Robinhood charges a 2.5% interest rate.
5. Cash Management
Launched on December 11, 2019, cash management is a feature for Robinhood’s investing app. The purpose of this offering is that it enables Robinhood clients to utilize their brokerage accounts in a way that is similar to a checking account.
That said, Robinhood launched its cash management account alongside a debit card, which is issued by Sutton Bank. So, anytime a Robinhood client uses the card, a certain percentage of the transaction – in the form of an interchange fee – goes to the brokerage firm, Robinhood.
While there’s no specific value of the interchange fee, it can sometimes be between 1.1% and 1.8% annual percentage yield of the whole transaction value, according to NerdWallet.
Is Robinhood Profitable?
Having talked about the primary ways in which Robinhood generates its revenue, another burning question that needs to be addressed is whether or not the brokerage firm is profitable. To answer this question, we’ll start by saying that Robinhood is a private firm. As such, it can be pretty hard to get the company’s exact financial values.
That said, Robinhood was established in April 2013 by Vladimir Tenev and Baiju Bhatt, offering its trading services with zero commission. So far, even with this commission-free model, the brokerage firm has seen an improvement in its organization, by surpassing 10 million customer accounts as of 2019.
One interesting thing about commission-free trading is that a couple of firms, before Robinhood, tried to offer it but ended up folding into another service that charged commission. Examples of such brokerage firms include Freetrade.com and Zecco.
Although Robinhood makes money primarily from Payment For Order Flow, the percentage of money generated per share is usually negligible (about 1 to 4 cents per share). What makes the online brokerage firm gain a lot is the number of its users and the amounts of dollars in trade (usually billions) that it directs to the market makers.
While it’s hard to say whether the firm is profitable, the figure generated through PFOF and other sources of revenue, its growth over the years, and its number of active accounts, are enough to let you know the company is getting it right.
Does Robinhood Take Your Money?
With a zero-commission trading model that Robinhood offers its customers, it’s safe to say that Robinhood doesn’t take your money. However, in case you’re the type that wants to enjoy all the goodies (mentioned above) that come with the Robinhood Gold package, the online brokerage firm will charge you $5 every month. Of course, this is affordable, when you compare it to what you’ll be getting from the paid package.
Furthermore, in case you’re also the type that wants to go for the marginal loan feature, Robinhood takes a 2.5% annual interest rate on every loan that’s over $1,000. Well, this is fair enough when you compare it with what you’ll be gaining in the long run.
Does Robinhood Sell Your Data?
As mentioned earlier, the primary means of generating revenue by Robinhood is through payment for order flow. As we all know, this involves selling or routing clients’ data (orders) to high-frequency market makers and trading venues. Although this kind of selling happens in the brokers & exchanges industry, it is still uncertain whether or not the practice is ethical.
While some groups believe it’s ethical, others think it’s highly unethical. That said, PFOF is a controversial practice – and that’s due to its lack of transparency.
Robinhood isn’t the only brokerage firm in the industry that employs PFOF. The likes of Charles Schwab and E-Trade also make money from this approach. The only difference, however, is that Robinhood capitalizes heavily on PFOF, and this has caused it a couple of legal issues.
For instance, in December 2019, the Financial Industry Regulatory Authority (FINRA) fined Robinhood about $1.25M for “Best Execution Violations”. However, this is understood, since the company runs a zero-commission trading model. Left to us, we’ll say Robinhood isn’t breaking any laws by selling the order flow data – it’s just the way the company runs its business.