How Robinhood Makes Money
It’s a theme as old as money itself. The struggle between the rich and the poor.
And it became especially apparent after the financial crisis. People were losing
money hand over fist in the market, millions lost their jobs and their homes.
Trust in Wall Street was at its lowest point in memory. People were protesting
in the streets. One company launched a stock trading app in the shadow of the
crisis, Robinhood. Named after the English fairy tale character who took
from the rich and gave to the poor.
Good sword. Good archers. Good fighters. Are you with me? (Cheers)
But those guys didn’t start a 5.6 billion dollar company. These guys did.
It’s an eye-popping valuation for a financial company with opaque metrics
and plenty of competition. The young company had its share of missteps as
well. Too good to be true? Well for Robin Hood that might be the case. We know that
this practice is highly criticized, not only from regulators but also from
consumer advocates. Yhey say that they were inspired by the financial crisis
and all that. Well, guess what? They’re getting a huge chunk of their revenue
from high-frequency trading. Prompting questions over whether or not
they can handle primetime. But let’s go back to the beginning.
Today’s Robinhood, the app, was founded by two people who were fed up with the way
you had to trade or at least they knew others were fed up. We’re focused on
building an awesome user experience. Onboarding something like a 150,000
customers in such a short period of time is is pretty much
unprecedented in the brokerage industry. The cost to trade had come down so far
in the last 20 years. Since online trading began, why not make it free?
Now if you want to invest in the stock market without paying fees, there’s an
app for that. Since Robin Hood came into the App Store, we’ve saved customers over
five million dollars in commissions. All in the theme of sticking it to the banks.
The mission of Robin Hood is to democratize America’s financial system.
But there was something else that made this product work. We were already
addicted to our phones. Robin Hood made trading easy on the device we were
looking at all day. The combination incredible growth. The company launched
in 2013, just over a year late, they had hundreds of thousands of people on a
waiting list. The beginning of 2018, they had three million customers. By the
end of that year they had doubled that amount to six million users. The darling
of FinTech. Many believe the company is revolutionary. Where they are really
groundbreaking is how fast they’re moving and how much they’re pushing the
envelope. You know, they can’t be dismissed because there is something in
being able to double time and time again where clearly you’re resonating with
consumers and then this speed at which are offering new types of capabilities, I
don’t think anything companies could move that fast.
But there are questions about how much money is really in the accounts. Robinhood
gets a lot of attention because the account growth has been really
impressive and everything like that. But there’s very little money there. With
Schwab, Ameritrade, we have larger accounts accounts that are in hundreds
of thousands. Not single-digit thousands on average, which is the last time we
looked at Robinhood. A JMP analysis estimates
the average assets and Robin Hood accounts to be one to five thousand
dollars. That’s compared to a $100,000 for Fidelity, a $110,000 for TD Ameritrade and about $240,000 for Charles Schwab.
Robin Hood would not disclose account values when asked by CNBC. We
don’t know exactly where the account sizes are. I suspect that based on the
types of accounts, they’re typically lower acid accounts and so
they’re going to be less profitable today. But I think probably one of the
key things to think about is that a small account today could be a large
account in the future. Especially, if you’re getting to the customer when
they’re young or early in their financial life. Not only could they take
on brokers like TD Ameritrade and Charles Schwab, they might just challenge
the big banks too. Especially, if you add more capabilities and more service and
then service the cash in the account. Hopefully, you have an opportunity to
compete for a higher percentage of the wallet. Which some of the big incumbents
are doing quite well today. There are also other startups trying to take
advantage of this trend. A slew of investing oriented apps have come on the
market in the last few years, including Betterman,Acorns, Stash and more. But it
is not as easy to take the Silicon Valley approach of moving fast and
breaking things in FinTech. There are plenty of competitors with really deep
pockets and of course tons and tons of regulation. Some have called out a
hypocritical side to the FinTech unicorn that makes it not so different from
old-school Wall Street. In October, Bloomberg reported that the company gets
almost half of its revenue through a practice called “payment for order flow,”
meaning a company’s pain Robin Hood to be the other side of your trade on the
platform or at least get the first right of refusal. it’s a controversial practice
but commonplace among online brokers. It means your orders aren’t happening on a
public exchange but behind closed doors in a dark pool. Some say it helps market
efficiencies because companies invest in making faster trades. Others say, it’s
just a way for high-speed computerized traders to skim off every trade keeping
markets opaque. The SEC has proposed a pilot program to
look into the practice. There’s a concern maybe it’s taking advantage. The
arguments are to improve liquidity. That it takes what would be a small trade and
aggregates it and allows it to get a better execution quality. The reason to
run a pilot is to make sure that those claims are all actually valid. Robinhood
would not disclose how much it makes from this practice to CNBC but the
company did offer an explanation of the system on its website saying: “We send
your orders to market makers that allow you to receive better execution quality
and better prices. The revenue we receive helps us cover the cost of operating our
business and allows us to offer you commission-free trading. The question is
can accompany the built a name, literally on fairness, convinced its customers it’s
on their side. One way to do it, is to offer better interest rates and that’s
exactly what Robinoohd tried to do. In December, the company announced three
percent checking and savings accounts. Compare that to the national average of
.09 percent offered by most savings accounts. For the median American
house that’s got about 8,000 dollars in the bank, this adds up to a
staggering 240 dollars a year. Except, the company isn’t a bank.
The move ended up being a fiasco. There are a lot of concerns about masquerading
as a bank. Banks are tightly regulated in this country and so if you have
something that doesn’t have the sort of safeguards put in place around those
operations and you try and present yourself as a bank they’re not going to
allow that. So I reached out to Robinhood. They wouldn’t provide any details
about the potential relaunch of the cash management account. They pointed me to a
blog post and said to “stay tuned.” On top of all of that, the market may be turning.
While accounts were almost surely growing with a broader stock market for years,
Millennials, already scarred by entering the job
market during the financial crisis, have now gotten just a taste of their first
bear market. Robinhood gained millions of users just after announcing you could
trade Cryptocurrencies on the platform in early 2018. But for the people who
invested in Bitcoin the day the company started allowing crypt
trades, things probably aren’t looking so great. They lost almost two-thirds of
their money by the end of the year. At the same time, a younger generation of
traders may be willing to stomach more risk and volatile markets could be an
opportunity for Robinhood. When times are volatile, consumers typically look
for help or they look for more types of professional capabilities. So volatility
in the moment can be chilling and can be startling to the customer. But it tends
to actually accelerate growth. So what’s next for Robinhood? The company claims
its users have transacted over a 150 billion dollars on the
platform and saved over a billion in commission fees as of May 2018. It’s
beefing up its executive staff, hiring an Amazon veteran as its first CFO, as it
tiptoes towards an IPO. It’s not like Robin Hood hasn’t faced challenges before.
We’ll see if today’s financial product can live up to the legend.