How Does Robinhood Make Money?

October 17, 2018 — 4:37 PM EDT

Robinhood, which bills itself as a disruptive force in the online brokerage industry, launched to the public in 2014 as a mobile app for Apple smartphones and tablets. Robinhood's innovation was to allow customers to buy and sell stocks and exchange-traded funds (ETFs) without paying a commission. Users could not short sell or trade mutual funds, options, or fixed income instruments. Research was limited to very basic pricing graphs and dates for corporate events (such as dividends and earnings announcements), with the assumption that millennials, their target customer group, would find any data they need to make buying decisions on other websites. An Android app went live in 2015.

When Robinhood first opened its virtual doors to the public, there was a lot of noise about free trades and how $0 commissions “democratized” trading. Most online brokers charge a fee that ranges from $1 to about $7 per transaction, and they offer an abundance of research, news, charting, and educational resources alongside the trading engine. Robinhood made a big play for millennials, implying that brokerage commissions are ripping investors off, and all that research offered by other brokers is overrated. Several million people were intrigued enough to open accounts and place trades.

How Robinhood Makes Money: Interest, Premium Accounts, Margin Interest

Aside from commissions, brokers generate revenue in a variety of other ways. Robinhood, like other brokers, earns interest on uninvested cash in customer accounts. They also pass through any regulatory fees that are incurred when a trade is placed. These are typically fractions of a penny, but the firm rounds those fees up to the nearest penny. Robinhood charges $10 per transaction made on the phone with the aid of a live broker, and they also assist in some foreign stock transactions for $35-50.

Robinhood claims that they receive very little income from payment for order flow, according to a statement issued by Vlad Tenev, the firm's co-CEO and co-founder, on October 12, 2018. According to Tenev, Robinhood earns ~$0.00026 in rebates per dollar traded, or 2.6 cents per $100 traded. Most brokers report payment for order flow on a per-share basis, but Robinhood does not follow that traditional method of communication, making it very difficult to compare how much they reap from market makers versus other brokers.

In September 2018, Logan Kane, a contributor to Seeking Alpha, stated that Robinhood's payment for order flow generated ten times the revenue as other brokers receive from market makers for the same volume. Bloomberg has analyzed Robinhood's reports to the Securities and Exchange Commission (SEC), and calculates that Robinhood generates almost half of its income from payment for order flow.

Robinhood's lack of transparency on this issue is troubling. Beyond that, payment for order flow is slowly being regulated out of existence, so a brokerage that depends on generating income by selling order flow to market makers will find itself in trouble within 5 years.

As it nears its fourth birthday, the firm has added a website, along with options trading, limited cryptocurrency trading and after-hours trades at no fee. Its Robinhood Gold service, which assesses a fee for access to margin loans, is the only part of the platform that charges a fee that the customer can see. Using Robinhood Gold, the customer pays a flat monthly fee that allows them to tap into additional cash that is borrowed from the brokerage – also known as buying on margin. 

Buying on Margin

At most online brokers, the standard margin agreement requires borrowers to pay interest only on the money borrowed. The account minimum for Robinhood Gold, the broker’s “premium margin account,” is $2,000, which is a regulatory requirement that all brokers must follow. Then you pay a fee every month for access to a set amount of margin loans, whether you use the money or not, starting at $6/month for an additional $1,000. The more money you have in your account, the more you can borrow; your margin is approximately 50% of your balance. (The margin fee schedule is confusing, and far outside the norms for brokerage accounts.) That’s the equivalent of approximately 7.2% interest, which is low when compared to TD Ameritrade or E*Trade, but high when compared to Interactive Brokers.   

If your account is large enough to qualify for more than $50,000 of margin, the rate is 5%. 

Gold customers also get an added service that allows you to use funds that are in the process of being transferred into your account, rather than waiting 2-3 business days, up to the maximum tier to which you’ve subscribed. 

Can Free Trades Last?

While free trades are a good idea for getting millennials on board, eventually those who decide to grow their investing assets will grow out of the limited features available on Robinhood. 

Robinhood’s order execution engine does not seek out price improvement opportunities, which is something investors who trade large lots of 500 shares or more look for in a broker. An order that is price improved either finds a lot to buy at a slightly lower price than the customer’s limit order, or a higher price when selling. At Fidelity, which charges $4.95 per trade, price improvement often saves the investor more money than they pay in commissions on those large blocks. If you’re trading just a single share at a time, free trades make sense since there’s little to be made on price improvement. Once you’ve reached the point of being able to trade 300 or more shares at a time, though, price improvement becomes more of a priority.

Online brokers continue to make overtures to millennials, abiding by the prevailing wisdom that they need mobile apps, social tools, few numerical displays – and a visible cost of $0.  Other apps have sprung up that allow very small investments, including Divy and Clink, but they don’t have the venture backing that Robinhood has attained, along with the attendant publicity of huge funding announcements. 

At some point, those venture capitalists are going to want some return on their investment, and zero commission trading removes a major source of revenue.  But free trades are the key feature Robinhood offers. They will have to generate revenue somehow.

Many other brokers have flown the free trade flag over the last 25 years, but those services have gone the way of the buggy whip.

Trading Cryptocurrency on Robinhood

Opening an account is a process similar to any online broker: identify yourself, answer a few questions to assess your suitability as an investor, and link a bank account for funding. Once your account is open, you’ll be sent a link to a short video that offers a quick overview of the mobile app. 

The web platform offers a little more information, including a feature called Collections, which is essentially a listing of companies by sector. On both web and mobile, all quotes are real-time with no restrictions, but there’s little research available otherwise.  Portfolio analysis is limited to showing your current account balance. 

Customers in 19 states can trade the 6 cryptocurrencies available, including Bitcoin, Ethereum and Dogecoin. There is real-time data available for 10 additional cryptocurrencies, such as Ripple, Stellar and Dash. There’s a long waiting list that is reportedly over 1,000,000 people long at present, so it could be a while before you get an invitation. You can sign up for the crypto feature in the app or on Robinhood’s website. Current customers will be notified once cryptocurrency trading is available for their account. To learn more about how Robinhood works, and to see if it is the right fit for you, check out our comprehensive Robinhood review.