How Does Robinhood Make Money? Dissecting Its Business Model

Executive Summary:

Robinhood is an online trading app that enables users to buy and sell financial assets, such as stocks, exchange-traded funds, options, and even cryptocurrencies. Users do not have to pay a brokerage commission when placing a trade.

Robinhood makes money via order flow payments, subscription fees, interest paid on stock loans, cash income from uninvested funds (by its partner banks), and interchange fees.

Founded in 2013 and headquartered in San Francisco, California, the company has grown to become one of the darlings of the FinTech industry. In July 2021, Robinhood went public on the Nasdaq stock exchange.

What Is Robinhood?

Robinhood is a FinTech company that allows its users to buy and sell stocks, ETFs, options, and cryptocurrency – without the need to pay a fee.

Most of the company’s users access the platform through its popular mobile phone application. Alternatively, users can check on their financial performance via the company’s website as well as tablet and smartwatch applications.

Users will receive a free stock when signing up to the service. There is a 1 in a 150 chance that this reward ends up being a stock like Facebook or Amazon, which trades in the thousands.

After providing one’s personal data and social security number, users can transfer funds into their Robinhood accounts and start trading right away.

One of the app’s biggest selling points is its simplicity and intuitiveness. Users can get an overview of their portfolio’s performance right after logging in. With just a few additional clicks, one can buy and sell on the trading platform.

Robinhood provides an in-app news feed along with a newsletter and podcast (called Robinhood Snacks) to update its users on any major market developments. Furthermore, users can create a watchlist where they can monitor any asset that they consider investing in.

Apart from investing, Robinhood furthermore offers a cash management product that allows users to earn interest on their account funds. The cash account comes with a debit card (issued by Sutton Bank) that can be used to pay and withdraw money at over 75,000 ATMs – free of charge, as you’d expect.

Both the investment and cash management products are insured by the SIPC (up to $500,000) and FDIC (up to $1.25 million), respectively.

A (Not So Short) History Of Robinhood

Robinhood, headquartered in San Francisco, California, was founded in 2013 by co-CEOs Vlad Tenev and Baiju Bhatt.

Both Tenev and Bhatt are first-generation immigrants whose parents came from Bulgaria and India, respectively. After excelling at high school, the two went on to do their Math and Physics undergrad at Stanford where they ended meeting up.

The duo hit it off right from the start and remained friends as well as roommates throughout their studies. Post-graduation, Bhat moved to New York City to work in finance while Tenev accepted a PhD position at UCLA. Their tenures in the academic and financial world would only last a few months though.

Bhatt invited Tenev to join him in NYC after experiencing first-hand how outdated and inefficient most financial institutions operated. They launched their first company a few weeks after in 2009.

The business, called Celeris, was a hedge fund that used algorithmic trading (and the founder’s expertise in math) to make investment decisions. Two years later, the idea for Celeris was abandoned and the founders moved on to start their next business.

In January 2011, they launched Chronos Research, a startup that sold low-latency trading software to other financial institutions, such as banks and hedge funds. Chronos, just like its predecessor, never really took off.

The idea for Robinhood arose from a few market developments that the founders observed. First, people were becoming more and more comfortable with using their phones to manage everything from finances to social contacts.

Second, trust in Wall Street (and the financial system at large) was, due to the Great Depression, at an all-time low. These feelings were exemplified by the Occupy Wall Street movement that started gaining traction in late 2011.

Third, access to stocks and other investment opportunities was reserved for the top 1 percent of society. Incumbents like E*Trade and Charles Schwab were charging customers anywhere between $7 to $10 for a trade – fees that made it nonsensical for the average joe to invest.

To get started, the duo obviously needed money. They therefore pitched the idea for Robinhood to over 75 investors who all said no. Furthermore, the founders couldn’t go ahead and start the app themselves due to the extensive capital requirements that are imposed for starting a brokerage company.

Eventually, as these things go, Tenev and Bhatt finally had their breakthrough moment. They were able to convince Tim Draper of Index Ventures and Marc Andreessen of Andreessen & Horowitz to pour $3 million into the startup’s seed round (announced in April 2013).

Wayback Machine

In early 2014, Robinhood’s website went live, asking people to join the app’s waiting list. The iOS app was launched a few months later in December 2014 (the FinTech’s Android app was released in August 2015).

By that time, Robinhood’s waiting list had grown to over 800,000, making it one of the most anticipated launches in entrepreneurship history. The ever-increasing interest allowed Tenev and Bhatt to raise another $13 million prior to the launch.

Armed with a $16 million war chest, Robinhood was finally unleashed to the public. The funding allowed Robinhood to snatch away top-tier engineers from companies like Facebook and Uber, which the founders deemed important to keep their app safe and secure.

Within a year of the launch, Robinhood was able to get close to a million users on its platform, process over $1 billion in transactions, raise another $50 million in funding – and even become the first FinTech company ever to win Apple’s prestigious Design Award.

In 2016, Robinhood launched 2 critical features that would help the company to further accelerate growth.

First, it introduced Robinhood Instant, which allowed users to borrow up to $1,000 for trading purposes while waiting for their deposit to clear. Furthermore, users would be able to instantly trade with any profits they make on their stock sales (which normally took a few days to transfer).

But there was a small catch: to get access to Instant, users had to join a waitlist. The more friends a user invited, the higher up the waitlist he was moved, which furthermore accelerated the startup’s growth.

The second homerun feature became Robinhood Gold, the company’s Netflix-like premium subscription service. For $10 a month, users with a minimum account balance of $2,000 could borrow up to 2x that amount and trade with it right away.

The 2 features propelled Robinhood’s business to new heights. That same year, in 2016, Robinhood became the fastest brokerage in history to hit $2 billion in transactions.

Fueled by their ambition, Robinhood opened another waitlist to expand to Australia, its first foreign market. Back then, Australians had to pay over $50 for placing one trade, eclipsing the $7 to $10 fee traditional American brokers charged by a considerable margin. Within a matter of days, its waiting list had more than 50,000 signups.

Just a few weeks later, Robinhood announced a partnership with Chinese search giant Baidu to offer commission-free trading on StockMaster, Baidu’s finance app. The launch lacked explicit regulatory approval, a theme that would follow Robinhood throughout its existence (more on that later).

The next major breakthrough for the company came in January 2018 when it allowed users to trade cryptocurrencies such as Bitcoin and Ethereum. At the time, Coinbase was charging users 1.5 percent to 4 percent for each crypto trade.

Furthermore, over 100,000 of the app’s users were frequently searching for crypto news on Robinhood’s app. A survey of its users, in which 95 percent they’d invest in cryptocurrencies, further supported the launch.

The rollout of its cryptocurrency product was a perfect example of the breakneck speed at which the company operates. It took Robinhood and its team of engineers only two months from the moment of ideation to launch the crypto product to its userbase. With the launch of crypto, Robinhood was able to almost double its user base.

The team applied that same rigor when it decided to launch a banking product (called Robinhood Checking & Savings) in December 2018. Robinhood would offer its customers a checking and savings account with a 3 percent interest rate (the U.S. average, at the time, was 0.10 percent and 0.08 percent, respectively) and a subsequent SIPC-insurance.

But the problem was that Robinhood’s Checking & Savings product was, in fact, not a banking product, but an extension of its brokerage account. Furthermore, no one at the SPIC had been contacted prior to the launch (and Stephen Harbeck, SPIC’s CEO, said after the launch that Robinhood would never have received ther approval).

Some of the startup’s product managers issued concerns about attaching the name to a banking product to which Bhatt allegedly responded, “fuck it, we’re doing it anyways”. He reemphasized his beliefs by saying that the name would resonate with users.

Robinhood and its leadership received a major public backlash just hours after announcing the feature. The criticism was amplified by the company’s employees who were urged to post about the launch on their social handles.

Within a matter of days, Robinhood deleted all the information that was posted and urged its employees to do the same. The Checking & Savings product was immediately rebranded to a cash management service.

The cash management product was released over 10 months later in October 2019. This time, Robinhood had invested the necessary time to ensure everything was set up correctly, offering FDIC insurance via its banking partners (including the likes of Goldman Sachs, Citibank, Wells Fargo, HSBC, and more).

By 2019, the popularity of Robinhood had finally rippled through the online investing industry. Some of the FinTech’s biggest competitors, including Charles Schwab and E*Trade, announced they’d drop their fees for good.

Robinhood’s rise to nationwide prominence was based on a few key aspects. First, Robinhood was ahead of its time when it came to allowing users to trade for free. Second, the app’s simplicity made it extremely easy for new users to trade right away.

Third, Robinhood’s branding absolutely hit the nail on the coffin. Labeling the firm as the go-to trading place for the average joe while associating itself with a hero that steals money from the rich and gives to the poor made it accessible for literally everyone.

Fourth, Robinhood made its trading data publicly accessible via an API. This allowed third-party sites like Robintrack to display data on some of the most frequented trades and investing strategies.

The firm even launched some in-app features that further accelerated the social sharing aspect. For instance, it added a profile feature that allowed and encouraged users to share their trades publicly.

Fifth, its users became big advocates for the app and even engaged in forums to boast about their trades. The most prominent example is Reddit’s wallstreetbets forum, which now has over 1.5 million members all by itself. TikTok videos under the hashtag #robinhoodstocks regularly receive over 8 million views.

All these initiatives were amplified at the start of 2020 when the world was forced to quarantine at home. With additional time and government checks at their disposal, Robinhood’s users began to make even riskier bets (not to say that the average Robinhood user suffers from risk aversion).

This newly developed thirst for risky bets allowed Robinhood, over the first quarter of 2020, to add another 3 million users to its platform (adding to the previous total of 10 million).

Unfortunately, the flood of new users came with its own set of problems. The app experienced 3 outages over the course of 2 weeks, leaving users locked out of their accounts and funds – and thus being unable to cash out on some of their trades. Many of them galvanized to file class-action lawsuits, which are still up in the air.

What became even more problematic was the fact that no one at the company was reachable for advice. In fact, Robinhood had disintegrated its customer service center back in 2017, seeing it as a cost center rather than an asset.

In fact, Robinhood even boasted to investors that the lack of physical branches and human capital was one of the firm’s strengths. A previously leaked pitch deck revealed that Robinhood had 23,700 customers per employee while one of its major competitors, Charles Schwab, only had 595.

In some cases, the masses of Robinhood traders even seemed to have influenced the pricing of stocks. Hertz, the car rental company that declared bankruptcy in May 2020, saw its stock price increase by 1,462 percent (from its low of $0.40 to $6.25) due to thousands of bets placed by Robinhood traders.

As a result, Robinhood decided to shut down access to its API. The belief was that the data presented on sites like Robintrack inspired many of the ill-thought-out trades made on its platform.

For some, tragically, these types of trades would end up being fatal. In June 2020, 20-year-old Alex Kearns committed suicide after his account showed a negative $730,165 cash balance.

What was even more tragic was the fact that Kearns didn’t actually owe that amount. Rather, it was only his temporary balance while waiting for the stocks underlying his assigned options were transferred into his Robinhood account.

Robinhood responded by assuring its users and the public that the company would heavily invest in making its platform safer and easier to understand. This meant releasing educational content on options trading, UX changes, as well as a $250,000 donation to the American Foundation for Suicide Prevention. The company furthermore promised to work closely together with U.S. regulators.

But even the flood of bad news (add to that a withdrawn U.K. launch and a hacking attack against a few thousand Robinhood accounts) wasn’t able to stop Robinhood on its train of growth. For instance, Robinhood reported that in June it saw daily average trades of 4.3 million – more than E*Trade and Charles Schwab combined!

Yet, the trading app remained the center of attention. In January 2021, Robinhood was the subject of widespread criticism when it blocked users form purchasing GameStop, AMC, and other stocks. Many believed that its leadership team was directed by the hedge funds to instate the trading hault.

CEO Tenev even came out on CNBC stating that they “absolutely did not do this at the direction of any market maker or hedge fund’ and said the goal was to “protect the firm and protect our customers”.

As a result, Robinhood was forced to raise another $3.4 billion in funding to settle its collateral demands as well as to comply with SEC regulations (which require the firm to have a certain amount of cash on balance to cover for any sort of default).

Nevertheless, the damage was already done. Robinhood’s users, hours after the trading halt, had filed a class action lawsuit against the company. Its rating on Google’s Play Store plummeted to 1 with many users stating they would leave the platform for good.

Despite its vast list of ongoing legal battles, Robinhood decided to confidentially file for an IPO in March 2021. But before the IPO went out, it was time for yet another fine.

In June 2021, the Financial Industry Regulatory Authority (FINRA) issued a $70 million fine – its largest ever. FINRA stated that Robinhood had misled customers (more specifically on how to trade on margin). Furthermore, multiple outages in March 2020 had prevented them from making trades, leading to substantial losses.

Regardless of the fine, Robinhood eventually managed to go public in July 2021, raising another $`1.9 billion in the process.

Today, more than 18 million customers are using Robinhood. These customers hold a combined $80 billion in assets, making it one of the world’s largest online brokerages.

How Does Robinhood Make Money?

Robinhood makes money via order flow payments, subscriptions, interest on stock loans, cash income from uninvested funds, and interchange fees. Let’s take a closer look at each of these revenue streams below.

Payment For Order Flow

Whenever you place an order on (almost) any online trading platform, the order is sent to a so-called market maker who pays the platform a small fee in exchange for deal flow.

Oftentimes, market makers provide better offers in order to compete with stock exchanges (like the New York Stock Exchange, or NYSE). Robinhood partners with various market makers to offer customers the best sales price, including Citadel or Two Sigma.

The market maker then aims to make a profit on the bid-ask spread (or turn), which is the difference between the quoted prices for an immediate sale (bid) and immediate purchase (ask). This essentially makes it an arbitrage business. Trades are algorithmically executed (without human involvement), which allows the market maker to execute thousands of trades at any given time.

In the past, the practice of selling to market makers has often been the subject of widespread criticism from consumer advocate groups and financial regulators alike. First, the process itself (due to the automatic execution) often lacks any form of transparency.

Second, the practice, due to the speed of execution (the practice only takes milliseconds), can cause significant market swings, which often benefit institutional investors as opposed to the small retail investors Robinhood serves.

Third, the practice can (!) impact retail investors by not receiving the best execution. For instance, a stock may be quoted at $10 (bid) by the market maker and sold later on for $20.1 (ask). The retail investor therefore loses out on some of the gains.

In December 2020, Robinhood agreed to settle a $65 million fine with the SEC over charges of deceiving its customers (without admitting any wrongdoing). The SEC claimed that the order flow payments were executed at price points that were inferior to other brokerage firms. Furthermore, it stated that Robinhood (between 2015 to 2018) failed to properly disclose how it generates revenue from the order flow payments.

On the flip side, the practice is what ultimately allows Robinhood trades to be commission-free. Just a few years ago, established brokerages like E*Trade and Charles Schwab were charging customers up to 10 percent in trade commission, which far outweighs the spread a trader would lose on the order flow.

Recently, online brokerages have been mandated by law to disclose the revenue they generate from order flow payments. Robinhood generated $90 million and $180 million in Q1 and Q2 of 2020, respectively.

Robinhood Gold

In 2016, Robinhood launched a premium subscription service called Robinhood Gold. Some of the premium features that Gold users get access to are:

  • Larger instant deposits
  • Unlimited access to in-depth stock research (powered by Morningstar) on over 1,700 companies
  • Level II market data, allowing traders to assess bids and asks for any given stock
  • Access to investing on margin (more on that in the next chapter)

The Gold subscription starts at $5 per month and can get as high as $50 per month. The pricing is dependent on the amount of money that traders borrow on margin.

As with any modern-day subscription, users can try out the service for free for the first 30 days. Furthermore, the service can be canceled at any time.

Margin Investing

Investing on margin allows Robinhood users to borrow money from the company to purchase stocks. Robinhood generates revenue from the interest that it charges on these loans. Users pay 5 percent yearly interest on any margin above $1,000.

Robinhood uses the trader’s account balance as a proxy to determine how much he or she can borrow. This allows the company to better assess the risk of payment default.

If the value of a trader’s portfolio drops below a certain threshold, he or she will receive a so-called margin call. In that case, the trader must either deposit new money into the account or sell off shares (and other holdings) to hit the minimum balance required.

In the past, Robinhood has been subject to some criticism for allowing users to trade on margin. Its predominantly young user base (the average Robinhood trader is 30 years of age), coupled with historic market volatility, can potentially expose (especially inexperienced) traders to risk that they cannot stomach.  

Interest On Cash

Robinhood, via its Securities division, generates revenue from uninvested cash. The firm lends the cash on balance to other banks for which it collects interest fees.

Parts of those profits are then channeled back to Robinhood users (after taking their own share), which, in turn, allows the FinTech to pay its users interest (APY) on balance.

Interchange Fees

As previously stated, Robinhood offers a Mastercard debit card in cooperation with Sutton Bank. Whenever a customer pays with the debit card, a so-called interchange fee is charged to the merchant.

The interchange fee normally ranges anywhere between 0.1 percent to 1 percent, depending on the country and type of payment (credit vs. debit vs. prepaid).

The revenue from the interchange fee is then split between the issuer of the card (in this case Mastercard), the licensing bank (Sutton Bank), and Robinhood.

Other FinTech companies, such as Chime or Revolut, utilize a similar revenue model by partnering up with other banks.

Robinhood Funding, Valuation & Revenue

According to Crunchbase, Robinhood has raised a total of $5.6 billion across 20 rounds of venture capital funding.

Notable company investors include Sequoia Capital, DST Global, Index Ventures, Andreessen Horowitz, Institutional Venture Partners (IVP), and many more.

When Robinhood went public in July 2021, its business was valued at about $32 billion. It raised another $1.9 billion during the IPO.

In its recent S-1 filling, Robinhood disclosed annual revenues of $959 million for the fiscal year 2020 (at a $7.45 million profit). The year prior, it had ‘only’ generated $278 million (at a loss of $107 million).

Hi folks, Viktor checking in! Years of experience in various tech-related roles have led me to start this blog, which I hope provides you with as much enjoyment to read as I have writing the content.