Exchange Review:

Robinhood

Overview

Robinhood is a commission-free trading app available to US residents. It was developed in 2013 and is based in Menlo Park California, and was founded by Baiju Bhatt and Vlad Tenev, who are both Stanford University graduates.

In October 2020, Robinhood had amassed over 13 million users, and its revenues had risen by approximately 300%. Since its inception, reports state that the app has executed over $30 billion US in trades. In September 2020 Robinhood was valued at $12 billion, which rose to $20 billion in December of 2020. In February of 2021, the company was valued at $40 billion.

Robinhood is taking money from vastly wealthy hedge funds and allowing middle-class investors to profit from fractional trading. The fintech project was created with the desire to democratize investment and day-trading. Robinhood’s platform created access to valuable stocks at a low volume. The target is primarily young millennial investors with a small amount of capital.

With Robinhood, users can purchase over 5000 stocks, which includes most ETFs (exchange traded funds) available in the US, top cryptocurrencies including, Bitcoin and Ethereum, as well as ADRs (American Depositary Receipts) for over 650 globally-listed companies. It is also registered with the Securities and Exchange Commission (SIPC) and is regulated by Financial Industry Regulatory Authority (FINRA).

Users can make trades using either their phone or desktop app. There are no commission fees for any transactions on the Robinhood app. Robinhood’s income comes from other revenue streams, which will be discussed later in this article.

Core Features

User-Friendly Mobile App: Central to its ethos, the app relies on an intuitive interface, much like your typical bank or shopping app. Users can easily and efficiently execute all trades with a smartphone.

Commission-Free Trading: All trades on the app are commission-free. This allows for increased profitability from low-volume investors.

No-Minimum Balance: There is no minimum for trades, which means that users can trade on fractional shares. Fractional shares sometimes referred to as penny stocks, meaning that traders can make trades for also low as $1. This enables investors to purchase small amounts of valuable stock options.

Robinhood Gold: Gold memberships give users access to research reports, analysis, margin trades, among other analytical tools and instant deposits for a monthly fee.

High-Yield Savings: Robinhood offers high yield savings accounts, which pay interest on uninvested cash held in that account. Robinhood’s cash management account currently pays 0.30% APY and automatically transfers uninvested cash into savings. Account holders also have a Robinhood debit card, and the accounts are covered by the Federal Deposit Insurance Corporation (FDIC).

Free stock: Robinhood gives one random free stock to each new member. There is a 1% chance that the stock it credits you will be valued between $50 and $200. Free stock is also accessible with their referral program.

Taxes: Robinhood syncs with TurboTax to help users with their taxes. All of the assets Robinhood deals in are taxable by the IRS.

Robinhood Products

Stocks and funds: Robinhood offers stocks, including “securities”, such as exchange-traded funds (ETFs) or REITs which are also traded on the stock market.

Options: Options are contracts that give the buyer the right, but not the obligation, to buy, an asset at a specific price on or before a specific date.

Gold: Account holders can purchase from $5k – $50k of the precious metal, depending on the account balance.

Cash management: Accounts can be used much like a traditional checking account. Users can use Robinhood for paychecks, bills, without a commitment.

Cryptocurrency:  Robinhood also offers access to multiple cryptocurrencies, including: Bitcoin (BTC), Bitcoin Cash (BCH), Bitcoin SV (BSV), Dogecoin (DOGE), Ethereum (ETH), Ethereum Classic (ETC), Litecoin (LTC) -and more.

Revenue Streams

Because the platform offers commission-free trading, Robinhood’s primary revenue stream comes from order flow payments, and monthly membership fees.

Monthly membership fees are optional. However, members have access to more of the resources on the platform. As such, even at $5/month for Robinhood Gold, if only one third of their users subscribe, that is around $240,000,000 a year from membership fees alone.

In an independent analysis, payments in 2018, for order flow generated an estimated $69 million in revenue for Robinhood. That is a 227% increase from 2017, which accounted for more than 40 percent of its overall revenue. Moreover, in Q2 2020, Robinhood generated approximately $180 million just from payments for order flow.

Order flow payments are compensation earned when a brokerage firm acts as an intermediary for directing orders to different parties to facilitate trades. It describes a way for “market-makers” to outsource the fulfillment of an order. This is similar to a relationship between retailers and suppliers, in which the supplier pays to have the product displayed, rather than just sell the product to the retailer straightforwardly.

In Robinhood’s case, as with other brokerages, these are micropayments. The average payment for order flow is less than $0.50. The practice is controversial, and is associated with Ponzi schemes, however, it is a perfectly legal practice. And, in this case, with billions of dollars in trades, the micropayments amass to a significant profit.

Lastly, Robinhood also has revenue streams from interest on uninvested cash, lending stocks purchased on margin, as well as membership fees and fees for purchases made with the Robinhood debit cards.

User Demographic

The app is available for both iPhone and Android and is designed for usability and ease for new traders. Although the features that Robinhood offers are not unique, the company has successfully targeted millennials who are new to investing. The median age of their customer is 31.

According to Business of Apps, the average account size is about $3,500. This is much lower compared to competitors such as E-Trade which is $100,000 and Schwab at $240,000.

This information suggests that Robinhood has in many ways succeeded in its quest to democratize trading. The app has provided young, new investors an easy and affordable way to begin investing.

Robinhood has faced a great deal of criticism from traditional investment brokers because it is seen, by some, as a platform that allows naïve traders to impulsively buy stocks. Despite this criticism, a recent study from a UCLA University Finance Professor, Ivo Welch, demonstrates that this is not necessarily an accurate representation of Robinhood’s users.

The case study examined the behavior of Robinhood’s traders in March 2020, amidst a bear market, as well as considering trading habits between 2017-2019. Ivo Welch argues that based on the evidence, users tend to make sensible trading decisions.

Even in a slower economy, investors continued to invest, rather than panic. Continued investment contributions show that these portfolios continued to show steady growth. Which suggests that new users are not prone to impulsive investment decisions.

Positives and Negatives

The app is only available to US residents, and requires that users meet the following requirements:

  • Users must be at least 18 years old
  • Have a U.S. Social Security number
  • Possess a U.S. address
  • Must be a U.S. citizen, a permanent resident or possess a valid U.S. Visa

The ideal user for Robinhood is new to trading but is interested in improving their understanding of active trading. Users also need to be able to exercise a certain level of self-control. The ease and cost of the platform means that users will have a chance to make low-risk, low-cost investments in a real trading environment. However, it also means that there is no oversight from professionals for guidance.

It is also primarily designed for those who are interested in active trading. Active trading is when investors make regular securities transactions, this is contrasted with passive traders, who buy and hold. Active investors aim to capitalize on short-term stock market trends. That means that users must want to pay close attention to trends to see the results of Robinhood’s investment model.

Positives

Robinhood’s platform is excellent for two main reasons: commission-free and fractional trades. This means that users do not need to invest large quantities to start, nor do they need to meet a minimum buy-in.

Robinhood also has no minimum trade or a minimum deposit to open an account. This means that it is theoretically possible for users to earn profits from penny stocks. Moreover, there are no fees involved with simple buys and sells, so the cost of the investment is totally up to each individual. This includes investing in cryptocurrencies. Most cryptocurrency trading platforms have between a $100-$500 minimum to open an account.

The app itself is very easy to use, which means that new traders can join and start trading within about 60 minutes, and deposits of less than $1000 can be used immediately.

Criticisms

Charlie Munger of Berkshire and Hathaway is a major critic of Robinhood’s approach to the “gamification” of investing is. Munger has reportedly referred to the app as a demonstration of “wretched excesses” in the financial system.

Munger states, “Well, it’s most egregious in the momentum trading by novice investors lured in by new types of brokerage operations like Robinhood. I think all of this activity is regrettable. I think civilization would do better without it.”

This criticism is in large part due to the lack of long-term investment opportunities which are available from projects such as Robinhood. Robinhood profits from massive amounts of micro day-trades. Day-trading is notoriously difficult to earn a steady profit from. So while the platform has large returns, users should not expect large returns on their investments.

Robinhood’s platform profits from the incredibly high-volume trades because it profits from order flow marketing. As such, the easy use of the app has been criticized as increasing risky investment decisions. Some investment experts, such as Munger, equate this kind of investing with gambling.

The problem of speculative trading combined with the app’s gamified investment model is exemplified by the GameStop incident of 2021. Investors drove GameStock’s value sky-high, based purely on speculative social trading mechanisms. While Robinhood was not the only trading platform that contributed to the stocks sold during the GameStop affair, CEO Vladimir Tenev was required to make a congressional testimony.

In the past, Robinhood has also faced charges of failing to disclose where its profits come from, failing to get the best price for its customers, as well as encouraging unsophisticated investors to take uneducated risks.

Outages During High-Volume Days

Technical issues have been reported to affect Robinhood’s trading platform on volatile, high-volume days. According to DownDetector, Robinhood experienced 21 outages in March 2020, including an outage on March 2 that lasted for nearly 17 hours. On the same day, S&P 500 rocketed up nearly 116 points (3.9%). Then, while a surge occurred in the post-coronavirus crash, users did not have access to their accounts.

Account Limitations

Robinhood does not offer a full range of accounts, nor does it offer a wide variety of investment opportunities, as the app’s primary goal is smaller day-trades.

They only offer taxable accounts, which means that 401(k) or IRA contributions cannot be made from a Robinhood account. The app also does not offer trading in bonds, precious metals, or mutual funds. It also does not offer joint accounts, retirement accounts, custodial accounts, or education savings plans.

Moreover, there is limited opportunity for passive investing with Robinhood, such as mutual fundsindex funds, ETFs, or real estate. The also app does not have an automated investment advance, nor does it offer any professional account management.

Lastly, their research and analysis tools are limited, and professional research is only available to Robinhood Gold members. And, certain fees inevitably come up, even with “commission-free” trading.