Robinhood Gets Almost Half Its Revenue in Controversial Bargain With High-Speed Traders

Article strongly comes off as a hit piece, but fwiw:

“… The startup, valued at $5.6 billion, was bringing in more than 40 percent of its revenue earlier this year from selling its customers’ orders to high-frequency trading firms, or market makers, like Citadel Securities and Two Sigma Securities, according to three people with knowledge of the matter, who asked not to be identified because the details are private. Almost all retail brokerages employ the practice, called payment for order flow, but it’s an unlikely strategy for a company built on an anti-Wall Street message.

Here’s how it works: Retail brokers like Robinhood focus on recruiting customers and building the trading interface, but don’t actually execute their clients’ orders. They outsource that to firms—including Citadel, Two Sigma and Wolverine Securities—that pay for the right to handle those trades. While orders from large, sophisticated investors can burn the market maker who executes the trade, retail trades are considered relatively safe.

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These firms earn a tiny bit of money off each transaction, often 1 cent or less per share. Some see payment for order flow as a critical piece of market infrastructure—facilitating the fast and cheap buying and selling of stocks. But critics of high-frequency trading have long argued that the practice actually hurts the little guy, to the advantage of large firms.

Federal rules dictate that brokers must seek the best execution for clients’ trades, but finding the best price possible is not necessarily a requirement. Consumer advocates say the system creates an incentive for brokers to route orders to the market maker that pays the most.

During last year’s fourth quarter, regulatory disclosures indicated that Robinhood shipped virtually all of its orders for stock trades to four high-speed market makers. The bulk was bought by Citadel, which paid Robinhood an average of “less than $0.0024 per share” on the trades it was routed in that quarter. Those small numbers add up—Robinhood’s users have executed more than $150 billion in transactions.

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But regulators have scrutinized both brokers and market makers over rebates in recent years. TD Ameritrade, for example, faces a class-action lawsuit alleging its use of the payment-for-order-flow system is unfair. The company said it disagreed and would appeal.

Whatever the impact on consumers, some believe payments for order flow may not be a sustainable revenue source for Robinhood, thanks to regulatory pressures and consumer ire. “Robinhood’s revenue model could easily disappear,” said Tyler Gellasch, executive director of Healthy Markets, an investor advocacy group. “They’ve made it clear that they are comfortable living on this regulatory edge.”


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