How Does Robinhood Make Money was written by Amaku Chukwuma and originally appeared on Wealth of Geeks. Amaka Chukwuma is a freelance content writer with a BA in linguistics. As a result of her insatiable curiosity, she writes in various B2C and B2B niches. Her favorite subject matter, however, is in the financial, health, and technological niches. It has been republished with permission. Please note that contributing opinions are that of the author. They are not always in strict alignment with my own opinions.
In March this year, Robinhood Markets, Inc. launched a cash card that allows its customers to earn up to 8% cash back on purchases. This included the option to earn bonuses ranging from 10% to 100%.
The company has drawn a sizable user base over the years due to appealing offers like this. The platform's groundbreaking trading-without-commission feature is what attracts the majority of young users.
Because of this pioneering effort, the discount brokerage's larger competitors were driven to adopt a similar strategy, which relies on similar financial technology and commission-free trading. Consequently, other investing applications, like Webull, Charles Schwab, and Acorns, now provide clients with commission-free trading.
Robinhood offers financial services and a vast array of investing goods and services, including stocks, American depositary receipts, Exchange Traded Funds (ETFs), Initial Public Offerings (IPOs), cryptocurrency, and options.
How Trading on Robinhood Works
Robinhood generates most of its revenue from accumulating minimal profits from individual trades. It accomplishes this by offering customers enticing features such as “free stocks” and commission-free trading. It keeps those customers around by utilizing behavioral triggers that encourage trading, where they earn slim profits from those trades.
These behavioral triggers reward specific actions to keep users interested. For example, Robinhood advertises that all new users will get a free stock – one share in a company chosen randomly. They also leverage push notifications to keep users coming back. When a user's position changes, Robinhood sends a push notification to remind them to check the app.
This personalized user experience is core to their strategy of keeping people on their trading app for as long as possible. This app makes investing and trading easier because it presents users with the most pertinent data in the simplest of formats.
To trade on Robinhood, you first need to sign up for an account. The Securities and Exchange Commission (SEC) mandates that all US-based brokerages collect and verify sensitive personal information from their traders, including Social Security numbers and net worths. Robinhood users must connect a bank account to invest using the platform to transfer money to and from their trading accounts.
How Does Robinhood Make Money: 6 Ways
1. Payments for Order Flow (Pfof)
Robinhood routes its users' orders through a market maker who makes the trades and compensates Robinhood for the business at a rate of a fraction of a cent per share. The HOOD Q4 2021 earnings report indicates that transaction-based revenue was Robinhood's biggest source of income for that quarter.
Rather than using a central exchange to execute trades, Robinhood uses market makers, who pay them rebates. Even though these rebates only amount to a tiny fraction of a penny per transaction, they add up to a sizable sum when applied to millions of accounts.
2. Premium Robinhood Gold
Robinhood's premium service, known as Robinhood Gold, offers subscribers access to research reports, market data, larger instant deposits, and margin trading. This generates a separate revenue from subscription fees paid by Robinhood's premium user base. The monthly cost for this service is $5 per user.
About 7% of the company's income comes from this premium subscription service. As of March 31, 2022, Robinhood's net cumulative funded accounts reached 22.8 million – an increase of more than four million more users from March 31, 2021.
3. Margin Trading
Margin Trading is Robinhood's second-biggest revenue generator. In 2021, margin lending accounted for 12% of Robinhood's net revenue. Robinhood's customers can use margin lending to finance stock purchases with borrowed funds. Users borrow money from Robinhood Securities to invest on margin. Robinhood Gold includes basic margin trading.
The advantage of a margin loan is that it helps investors have more leeway to make quick investments. But the downside is if the value of their investment goes down and they get a “margin call,” they may be in even more debt. When an investor's margin account holdings drop below the maintenance margin, the investor is subject to a margin call. When this occurs, the account holder must either make a maintenance margin deposit or sell securities until the account balance satisfies the brokerage's maintenance margin requirements.
Interest rates tend to be higher for those who make heavier use of their available credit lines, which means more money for Robinhood.
4. Cash Management Fees
Cash deposited into the various banks that make up Robinhood's Cash Management network renders the company fees. It also benefits from using the Robinhood debit card by collecting interchange fees. Issuers of debit and credit cards frequently charge these sorts of fees to cover costs like transaction processing and fraud loss.
5. Income From Cash
In large part, Robinhood Securities may generate revenue by depositing customer cash into interest-bearing bank accounts if customers have money that is not invested and is not swept into their Cash Management network of banks. A higher interest rate is earned on the user's cash deposit.
6. Service Charges
Users who wish to move funds from the Robinhood platform into the services of another broker pay a transfer fee of $75. Robinhood has several additional costs, including $5 for paper statements, $5 for paper confirms, and $20 for overnight check deliveries.
The Safety of Robinhood
Robinhood is a secure platform since, first and foremost, the SEC regulates it. This means the site meets the same regulatory criteria as other popular brokers. It's also part of the Financial Industry Regulatory Authority (FINRA), which enforces regulations that govern the conduct of registered broker-dealers and brokers in the United States on behalf of the SEC.
The SEC has rules about fair dealings that Robinhood has to follow. One of these rules is that Robinhood must show proof of honest dealings and tell the truth about its business, the securities they sell, and the investment risk. If they don't, they could be fined or sued in court. This way, the SEC protects investors by vigorously enforcing federal securities laws to hold companies accountable and defer future misconduct.
Cash Management accounts at Robinhood are also FDIC-insured. And through its cash sweep program, users can have their savings swept into deposits at a group of affiliated financial institutions. That grants $1.25 million in total FDIC insurance (or $250,000 per bank).
A further reason to feel comfortable using the platform is that Robinhood Financial LLC and Robinhood Securities are registered with the Securities Investor Protection Corporation (SIPC) that provide up to $500,000 in SIPC insurance for securities (including $250,000 for cash claims). Robinhood has also purchased additional insurance through Lloyds of London to supplement its current SIPC protection limits.
So if the company suffers bankruptcy for whatever reason, investors have two options to recover their losses. Either they can get a refund in cash or get snapped by another brokerage firm (whereby the account gets transferred to the adopter firm without losing any funds). This way, your funds, and investments are insured.
Protecting Consumer Data
Some of the precautions Robinhood takes with user data include:
- Encryption: Private information, such as a person's Social Security number, name, and bank account information, is protected by encryption. To continue accessing your information after Robinhood has verified your identity for Know-Your-Customer (KYC) purposes, it will use trusted third-party integrations like Plaid.
- Two-Factor Authentication: All Robinhood accounts can be made more secure by demanding two-factor authentication.
- Password Security: To prevent unauthorized access to your account, Robinhood uses a standard process to hash passwords before storing them.
When it comes to passwords, you're in charge of guarding both the usage of and access to your password so that you are not liable if someone hacks your account. It's important to remember that in late 2021, a hacker stole millions of email addresses and names from Robinhood. The hacker also acquired access to some sensitive data of a few users.
Robinhood is not the only platform targeted by such data theft attacks. Since January 2018, financial companies have had almost a thousand data breaches, affecting more than 153.3 million records. Cybercriminals often try to break into these companies.
Finally, it is still up to you to do the legwork necessary to make an informed decision about your investments and the amount you are comfortable risking.
There is no doubt that Robinhood has had its fair share of controversies over the past few years. The SEC once penalized the company $65 million for failing to give proper information about its profit-making practices and sued it for failing to deliver the best stock trading pricing to its customers. In January 2021, Robinhood temporarily locked investors out of trading GameStop and other hot stocks on its platform.
In this instance, users tried to make a quick buck by purchasing GameStop shares as their price soared on Robinhood but were abruptly unable to use the “Buy” button to do so. The company cited a liquidity crunch, Wall Street rules, and clearinghouse limits as reasons for the trade restriction.
Knowing the history of an investment platform before making any financial commitments is crucial.