While investors are looking for a cheap way to invest on their own terms, an investment app like Robinhood makes it easier. It’s an online free-trading app that lets users trade stocks, exchange-traded funds, options and cryptocurrencies.
Moreover, it works on a commission-free investing business model having 13 million users. So, how does Robinhood actually make money?
Robinhood makes money through order flow payments, interest on stock loans, interest from cash income, interchange fees and Robinhood Gold. Eventually, this FinTech company generated total revenue of about $673 million in 2020. In fact, its valuation reached $11.2 billion from $200 million funding.
What Is Robinhood and How Does It Work?
Robinhood is a free online investment and trading app launched in April 2013. It allows investors to buy and sell stocks, ETFs, options, and cryptocurrency as well without paying a brokerage commission fee.
The app is available for Apple mobile, tablet and Android users (OS version 7 or above). Additionally, investors can check their financial performance on the company’s website and smartwatch applications.
In order to open a Robinhood account, you should be 18 years or older and a permanent US citizen or have a legal US residential address. You’ll receive the first stock free after signing up. However, there is very little chance that the reward stock will be off Facebook, Amazon, Apple etc.
After submitting the necessary documents and social security number, you can transfer funds into the Robinhood account and start trading in real-time. The platform allows lower-cost investing in thousands of stocks with as little as $1.
This best free stock trading app is simple and easy to use. You can easily create a portfolio and manage your assets with this single app. Furthermore, you can stay updated by setting customized notifications and news with the 3-minute newsletter and podcast called Robinhood snacks.
Even, you can make money with Robinhood while earning interest on your fund through its cash management product. With the Robinhood debit card (issued by Sutton bank), it’s convenient to pay and withdraw cash at over 75,000 free ATMs without extra fees.
Like its name, Robinhood basically provides opportunities to all to access trade markets inexpensively. Its main mission is to build a financial system for everyone.
How Does Robinhood Make Money?
Considering free registration and free trade, how does this investment app make money? Robinhood earns via order flow payment, subscription charges, cash income from uninvested funds, interest from stock loans, interchange fees and additional streams.
Here’s the detailed analysis.
1. Payment For Order Flow (Rebates and Trading Venue)
When you sell or buy stocks, options or ETFs on Robinhood, the orders are sent to market makers to execute. They pay a certain fee to the company for the deal flow.
Market makers generally offer better prices than other exchanges like the New York Stock Exchange. So, in order to compete with them, market makers offer rebates to the brokerages. Robinhood partners with different market makers to make money, for example, Wolverine, Two Stigma, Citadel etc.
Similar to the arbitrage business, the market makers make profits based on bid-ask spread or turn. It’s the difference between the quoted price of an immediate bid/sale and immediate purchase/ask.
However, this bidding process works on an algorithm called Smart Order Router by Robinhood. Their clearing broker, Robinhood Securities, has developed a routing system to stimulate the market makers. The algorithm prioritizes your order and sends it to a market maker, providing the best execution depending on the historical performance.
Payment for order flow is a major way Robinhood makes half of the yearly revenue, according to Bloomberg News in October 2018. Though many consumer advocate groups and financial regulators criticized the process and created controversies.
There are mainly three reasons behind it. First, there was a lack of transparency in their automatic execution of trading. In fact, the company was under investigation by the US SEC as it was unclear how they were selling orders to high-frequency traders.
Secondly, the speed of order execution within milliseconds caused huge market swings. Consequently, institutional investors might be benefitted, whereas small retail investors had to face loss.
Thirdly, the retail investors often didn’t receive the best offer and thereby lost some money.
However, Robinhood settled down the charges with SEC for a $65 million fine. At the same time, this so-called “controversial” practice by online brokerage allows the platform to trade commission-free. This is the reason many young investors prefer this low-to-no-fee app.
Similarly, Robinhood Crypto with zero commission is another way how Robinhood makes money. It lets users buy and sell cryptocurrencies like Bitcoin, Litecoin, Dogecoin etc., through the site. Robinhood Crypto receives volume rebates by trading venue.
2. Interest On Cash
Customers often have significant amounts of cash sitting in their accounts from the received dividends that were not reinvested or investing money transferred into the brokerage account. Robinhood can make money off of interest from that uninvested cash like any standard bank.
Generally, their cash management service sweeps the cash into the network of program banks and earns 0.30% APY on balance. Thus, Robinhood does make some money from the fees by the banks and interchanges fees when a customer uses the debit card, comes with the service.
Alternatively, Robinhood also generates income from uninvested cash that hasn’t been swept to the cash management network of program banks via its Securities division. This is done mostly by depositing the cash into the interest-bearing banks.
3. Robinhood Gold
Robinhood Gold is a premium subscription service offered by Robinhood. It allows users to trade more than what they’ve as the cash balance.
The following premium features you can get with the Robinhood Gold account:
- Bigger instant deposits ($5k-$50k).
- Level II market data to see multiple bids and asks for a given stock.
- Unlimited access to in-depth stock research reports by Morningstar on about 1700 stocks.
- Invest in the margin trading service for extra buying power, more flexibility and less time to get the invested fund. The minimum access to margin is $1,000 and if above, you’ll be charged a 2.5% annual interest rate.
You can get a Gold subscription starting at $5/month, including a $1,000 margin. Like other subscription apps, Robinhood also offers 30 days free trial.
Further, if there’s a change in Gold fee or margin interest rates, they notify you 30 days advance and you can cancel the subscription. It’s a good way to make money for Robinhood.
4. Interest On Margin Lending
Margin investing with a Gold subscription is another major revenue source that Robinhood is making money off. It allows a Robinhood investor to borrow money for buying stocks and eventually invest more.
The company, in return, pockets the interest charged on that loan amount. As already stated, once you sign up for the Gold account, you’ll have extra buying power, i.e., borrowing more money. For further margin loans, pay $5/month for another $1,000 along with interest.
In order to trade on margin securities, you need a $2,000 minimum deposit in the account. It is called margin minimum, set by the Financial Industry Regulatory Authority (FINRA). Meanwhile, if you’re a pattern day trader, you must have $25,000 in portfolio value (minus any cryptocurrency positions) before day trading.
Further, Robinhood checks the trader’s account to determine the amount he/she can borrow. So, the company can avoid the risks of payment default.
When the portfolio value falls under $2,000, you’re at risk of the margin call and potential liquidation. If you get a margin call, follow the two things to maintain the balance:
- Deposit additional funds (minus any cryptocurrency positions) to increase portfolio value above the margin limit.
- Sell off some shares or exercising options to cover a margin call.
Additionally, follow the tips to avoid margin calls:
- Daily check the Margin Investing setting screen or buying power screen to track your margin balance.
- Check for the inbox message and email sent by the platform when you’re close to the account’s minimum margin maintenance requirement.
Set up a maximum borrow limit to the account. However, in that case, the available margin doesn’t increase above that value.
5. Interchange Fees
Robinhood does make money off by offering debit cards (Mastercard International Incorporated) to the users issued by Sutton bank. This card is associated with the Robinhood brokerage account provided by Robinhood Financial LLC, members of FINRA and SIPC.
But, how does Robinhood make money from debit cards? When you use the debit card, the bank receives an interchange fee passed to Robinhood Financial (the introducing broker).
Based on the country and payment type, the fee can be 0.1%-1%. In addition, Robinhood doesn’t charge any foreign transaction fee on debit card usage.
The income from interchange fees further splits among the licensing bank (Sutton bank), the card issuer (Mastercard) and Robinhood itself. Other FinTech companies, including Revolut and Chime, follow the same revenue model through the partnership with banks.
6. Options Trading
Besides stocks and cryptocurrency on Robinhood, you can trade options also. Options investing doesn’t need the following:
- No commission fee.
- No base fee.
- No exercise and assignment fee.
- No per-contract commission.
- No premium Gold subscription.
Instead, your Instant account supports options trading at a low cost.
7. Others
There are some other small revenue streams from where Robinhood can actually make money. Though it’s a no-commission trading service, some hidden fees you still may find, like:
- Transfer fee, $75 (whether partial or full) in order to transfer your assets out of Robinhood.
- Domestic overnight check delivery fee, $20.
- Domestic overnight mail fee, $20.
- International overnight mail fee, $50.
- Regulatory trading fee, $5.10 per $1,000,000 of principals for sell only and rounded up to the nearest penny.
- Trading Activity Fee (TAF), $0.000119 per share for equity selling, $0.002 per contract for options selling and it’s rounded up to the nearest penny (not more than $5.95).
- Paper statements service fee, $5.
- Paper confirms service fee, $2.
- Live broker fee, $10 per transaction, although it’s not sure how to contact a broker.
Is Robinhood Safe?
There can always be potential risks with any online trading or investment app. Robinhood also is no different and that raises concerns like, is Robinhood safe to invest? Does Robinhood steal your money?
The Robinhood security team uses different security measures in order to protect a user’s account. Moreover, this brokerage firm is regulated by the Securities and Exchange Commission (SEC) along with Financial Industry Regulatory Authority (FINRA), a government-authorized organization.
Further, your securities and cash are protected by SIPC for up to $500,000, including $250,000 for cash claims. On the contrary, Robinhood Crypto is neither secured by SIPC nor a member of FINRA or SEC.
Here are some security measures by Robinhood to ensure safety:
- Your account password is always hashed by the Bcrypt hashing algorithm and never stored in plaintext.
- Encrypted sensitive personal details like social security numbers before stored.
- Get secure access to the mobile app using FaceID, TouchID or a custom PIN code.
- Get a two-factor authentication code via SMS or an external authenticator app.
- Mobile and web applications safely communicate over the servers using the Transport Layer Security protocol.
- After your banking credentials get varified, they never access them later.
Despite all safety, their announcement of launching savings and checking accounts created bank masquerade controversy once. It was not protected by FDIC and had an unusual interest rate (3%).
Later the company reconsidered the issue and now, they offer to link your bank account with the Robinhood account. But, it’s recommended to link a checking account instead of a savings account to avoid high transfer reversals.
Webull (65.17%), Tradestation (76.56%) and TD Ameritrade (100%) are currently the top competitors of Robinhood. According to Stockbroker, they are a better electronic trading platform than Robinhood.
An Overview On Robinhood Funding, Valuation and Revenue
As a giant FinTech company, Robinhood received a good amount of funding after it started. Popular investors like DST Global, Sequoia Capital, Institutional Venture Partners, Index Ventures and more, provided venture capital funding.
The company raised $5.6 billion from 20 rounds of funding, according to Crunchbase. Further, in August 2020, the business was valued at $11.7 billion following a $200 million funding. And in 2021, the company’s valuation is approx $20 billion till now.
Robinhood revenue statistics say that in 2020, Robinhood made around $673 million in which $221 million only from payment for order flow in Q4. It’s surely higher than 2019, where Robinhood earned $111 million in total.
Conclusion
As a financial service company, Robinhood is a pretty good platform to invest. Over 13 million users (mostly above age 31) have found the platform the cheapest and easiest way to trade stocks.
The company, though, doesn’t charge any commission but earns in other different ways. For example, a large portion of income is from payment from order flow and interest on customers’ cash account.
The company has also created few controversies like security breaching, GameStop short squeeze in 2021, infinite leverage etc. However, the founders and developers are working on their model and re-branding it for a better and safe experience.