How do commission-free trading platforms like Robinhood make money?
In: Economics
1) Interest. When you have cash sitting your Robinhood account, that either earns interest at the bank or is loaned out to others (for a fee Robinhood charges).
2) Premium Accounts: Robinhood Gold, the company’s premium account, allows investors up to $1,000 of margin – allowing them to trade with more than they have in their cash balance on the app. This account costs money.
3) Marginal Interest and Margin Lending: They charge customers to trade on margin – basically, buy investment vehicles with loaned money.
4) High-Frequency Trading and Order Flow: Instead of orders being processed on a public exchange, companies like Robinhood can make money off of processing (or directing) trades through behind-the-scenes parties that provide the other end to the trade.
5) Robinhood does make some money from rebates. According to co-founder and co-CEO Vlad Tenev in a statement issued in 2018, “Robinhood earns ~$0.00026 in rebates per dollar traded.
Robinhood, and all the other smaller brokers make nearly all of their money on a tactic called “pay for order flow”. Like literally nearly all of it, anything else is extremely minor and this applies to all of the free services that aren’t the big boys. Anything else anyone is saying on how Robinhood makes money is incorrect– its pay for order flow, anything else they do is exceptionally minor compared to this aspect of their business.
What happens when you place an order in Robinhood is that they “sell” the right to execute that order to a company, which can through some complex business tactics, make a small arbitrage gain of a few cents per share or so. However, they trade absolutely insane amounts of shares each day, so it adds up. They pay Robinhood for this. You should make absolutely no question, that while this is completely legal, even brokers and people in the industry find this tactic (and the people who pay for the order flow) to be pretty damn shady and not good for the market… but its technically legal.
Larger trading platforms, like a Vanguard or Schwab are massive trading companies that make money all sorts of way. Pay for order flow exists, and they do it (but they also take advantage of it on trades themselves), but they also make money by selling investment products, like ETFs and mutual funds, charging fees for it, along with using any money in accounts not invested to gain interest on. But these companies are massive and just make money tons and tons of way, including doing their own trading, which is a gigantic portion of their income.
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