How Robinhood Makes Money

Payment for order flow generates most of Robinhood's revenue

NEWS ALERT November 11, 2021, 12:42 p.m. EST: The online brokerage Robinhood announced on Nov. 8 that a data breach resulted in various information about 7 million customers being exposed. For 5 million customers, email addresses were accessed, and an additional 2 million had their full names revealed, according to the company.

Robinhood Markets Inc. is a financial technology (fintech) company that operates an online discount brokerage offering commission-free trading. It provides a web- and mobile-based financial services platform that allows users to invest in and trade stocks, exchange-traded funds (ETFs), options, and American depositary receipts (ADRs). It also allows users to invest in certain cryptocurrencies based on their geographic location. The company makes money through payment for order flow, premium membership fees, stock loans, interest on uninvested cash, interchange fees related to its debit card, and other smaller revenue streams.

After announcing a confidential IPO filing on March 23, 2021, Robinhood submitted an S-1 registration to the U.S. Securities and Exchange Commission on July 1, 2021. On July 19, 2021, it amended its S-1 to announce that it would be selling 52.4 million shares with its founders and CFO selling another 2.6 million for a total of 55 million. Robinhood went public at $38 a share, giving it a valuation of $32 billion. The shares are listed under the ticker HOOD on the Nasdaq. Robinhood expects the IPO to raise about $2 billion, possibly as much as $2.3 billion if the greenshoe option is exercised.

Robinhood faces significant competition from other discount brokerages, new and established fintech companies, banks, cryptocurrency exchanges, asset management firms, and technology platforms. Some of its major competitors include Charles Schwab Corp. (SCHW), Morgan Stanley's (MS) E*TRADE Financial Holdings LLC, Coinbase Global Inc. (COIN), Square Inc. (SQ), and River Financial Corp. (RVRF).

Key Takeaways

  • Robinhood is an online discount brokerage that offers a commission-free investing and trading platform.
  • The company gets the vast majority of revenue from payment for order flow.
  • Robinhood plans to expand internationally, focusing on Europe and Asia.
  • The company recently filed an S-1 form with the SEC in anticipation of its IPO.
  • The SEC in June said that it was conducting a broad examination of market structure, including payment for order flow. Robinhood said in its S-1 that an SEC ban of this practice would pose a "risk" to its business model.

Robinhood's Financials

In its recently submitted S-1 form, Robinhood provided financial results for Q1 of its 2021 fiscal year (FY), the three-month period ended March 31, 2021. The company's net loss widened to $1.4 billion from $52.5 million in the year-ago quarter. However, revenue for the quarter more than quadrupled to $522.2 million. The net loss was driven primarily by a $1.5 billion one-time, noncash charge related to a mark-to-market (MTM) change in the fair value of convertible notes and warrant liability.

Robinhood's net cumulative funded accounts, a key metric that gauges the number of accounts into which users made an initial deposit or money transfer during a specified period, rose 150.0% year-over-year (YOY) to 18 million in Q1 FY 2021.

The company also provided results for FY 2020, which ended Dec. 31, 2020. Robinhood posted a net income of $7.4 million, a significant turnaround from the $106.6 million net loss reported in the prior year. Annual revenue rose 245.5% from the previous year to $958.8 million.

Robinhood's Business Segments

Robinhood operates and reports its financial results as one business segment. However, it does provide a breakdown of revenue into the following categories: transaction-based revenues; net interest revenues; and other revenues. We take a closer look at these revenue categories below.

Transaction-based revenues

Robinhood generates transaction-based revenues by routing its users' orders for options, equities, and cryptocurrencies to market makers, which is a process known as payment for order flow (PFOF). Brokerage firms that use PFOF receive a small payment as compensation for directing orders to a particular market maker. The payment is usually only fractions of a penny per share but can be a significant source of revenue for companies dealing with a large number of orders. PFOF is a major reason Robinhood is able to offer zero-commission trading. Robinhood's transaction-based revenue rose 339.6% to $420.4 million in Q1 FY 2021, accounting for more than 80% of companywide revenue.

Net interest revenues

Robinhood generates net interest revenue (interest revenue minus interest expenses) on securities lending transactions. Interest is also earned on margin loans to users, and interest expenses are incurred in connection to the company's revolving credit facilities. Net interest revenues rose 160.2% to $62.5 million in Q1 FY 2021, comprising approximately 12% of Robinhood's total revenue.

Other revenues

Robinhood's other sources of revenue primarily consist of memberships fees for Robinhood Gold. Robinhood Gold is a paid subscription service that offers users premium features, including enhanced instant access to deposits, professional research, Nasdaq Level II market data, and access to margin investing for approved users. Other revenues also include proxy rebates and miscellaneous user fees. Revenue from these sources rose 396.5% to $39.2 million in Q1 FY 2021, accounting for nearly 8% of companywide revenue.

Robinhood's Recent Developments

In early June 2021, the SEC announced that it was conducting a broad examination of market structure after the meme-stock trading frenzy that drove the share prices of companies like GameStop Corp. (GME) and AMC Entertainment Holdings Inc. (AMC) up to astronomical levels earlier this year. The SEC will be paying specific attention to the PFOF process whereby trade orders from individual investors are routed by brokerage firms to off-exchange, high-speed traders known as wholesalers, such as Citadel Securities LLC and Virtu Financial Inc. (VIRT). These off-exchange traders must offer prices that are at least as good as the national best offer, which is what is offered by the official exchanges. But with an increasing number of trades happening outside of the official exchanges, the SEC is concerned about a lack of transparency over the prices that off-exchange traders offer to their customers.

SEC Chairman Gary Gensler, who recently took over as head of the SEC in April, has been highly critical of PFOF. He and other critics of PFOF believe the practice creates a conflict of interest for brokerages because it incentivizes them to send customer orders to the highest bidder as opposed to the market maker that offers the best prices or fastest execution. The SEC's plan to review PFOF has led to speculation that the practice could be banned. Robinhood noted in its recently filed S-1 form that the banning of PFOF is a risk to its business model and would have a substantial impact on its operations.

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