Robinhood app: Stock Market without fees

Robinhood has become a popular way of investing in stocks and exchange-traded funds (ETFs) since its launch in 2013.

The app’s big selling point is its commission-free structure: you don’t have to pay a fee to execute trades with Robinhood.

The Menlo Park, California-based start-up announced Tuesday that it is adding 250 American depositary receipts of companies from Japan, China, Germany, the U.K. and Canada. They will be available to trade on the app starting Tuesday, and ADRs of companies from France will be added in the coming months. It is the biggest addition of securities since the platform launched three years ago.

The popular no-fee trading app Robinhood spent the past two years building an independent clearing system that will allow it to settle and clear transactions and provide custody for assets, the company announced Wednesday.

“It’s the only system that has been built from scratch on modern technology in the past decade,” co-CEO and co-founder Vlad Tenev told CNBC in a phone interview. “It’s a huge investment in the future of Robinhood.”

About seventy Robinhood employees based in Lake Mary, Florida, quietly built the “Clearing By Robinhood” technology from scratch, and worked on getting necessary regulatory approval. To do so, the company formed a new entity called Robinhood Securities in 2016 and received regulatory approvals from the Financial Industry Regulatory Authority, the Depository Trust & Clearing Corp. and the Options Clearing Corp.

Clearing is the trusted transfer of securities and funds between the buyer and seller, an essential function on Wall Street. Some other online brokers are self-clearing, meaning that they have their own clearing firm, while others rely on a third party to clear the transactions. E-Trade, TD Ameritrade, Charles Schwab and Vanguard are among those that already self-clear.

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.

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.

Robinhood is best known for its zero-fee trading platform that rolled out about three years ago. The company also offers ETFs, options and, as of February, cryptocurrency trading. Its users overwhelmingly fall into the “millennial” age category of 18- to 35-year-olds. In May, it surpassed its rival E-Trade Financial and now has a total of 5 million brokerage accounts.

Investors in its latest $363 million fundraising round included Sequoia, Google’s venture capital fund Capital G, DST Global and Iconiq, boosting its valuation to $5.6 billion.

While the start-up doesn’t charge trading fees, it does charge for premium services.

One is subscription-based Robinhood Gold, which Tenev compared to Amazon Prime. Robinhood also generates interest income from customer assets, the same way a bank does. And it lends cash and stocks and generates interest off that, a fraction of which Robinhood shares with the customer.

“Five to 10 years from now, you should be able to open up Robinhood and get anything you could get by walking into your local Bank of America, with a better customer experience and better pricing,” Tenev said.