In recent years, commission-free trading platforms like Robinhood have disrupted the traditional brokerage industry. While these platforms offer zero-commission trades, they still manage to generate significant revenue. This article explores the key ways Robinhood and similar brokerages make money.
1. Payment for Order Flow (PFOF)
The primary source of revenue for Robinhood is payment for order flow (PFOF). Here's how it works:
- When a user places a trade, Robinhood routes the order to market makers.
- These market makers pay Robinhood a small fee for the right to execute the trade.
- The market makers profit from the bid-ask spread, while Robinhood profits from the routing fee.
While controversial, PFOF allows Robinhood to offer commission-free trades while still generating revenue.
For a deeper understanding of the complexities and controversies surrounding payment for order flow and high-frequency trading, readers may be interested in Michael Lewis's book "Flash Boys: A Wall Street Revolt" (2014). This work provides a detailed exploration of how the stock market's evolution has led to practices like PFOF and their impact on retail investors.
2. Interest on Uninvested Cash
Like traditional banks, Robinhood earns interest on the uninvested cash in user accounts. This includes:
- Cash waiting to be invested
- Proceeds from sales before withdrawal
- Dividends before reinvestment
The company can invest this money in low-risk, interest-bearing securities, creating a steady stream of income.
3. Robinhood Gold Subscriptions
Robinhood offers a premium service called Robinhood Gold. For a monthly fee, users get:
- Access to margin trading
- Larger instant deposits
- Professional research reports
- Level II market data
This subscription model provides a predictable revenue stream for the company.
4. Margin Lending
For users who opt for margin trading (borrowing money to invest), Robinhood charges interest on the borrowed funds. This can be a significant source of income, especially in bull markets when more investors are likely to use margin.
5. Cash Management
Robinhood offers a cash management account that functions similarly to a checking account. The company earns money from:
- Interchange fees when users make purchases with their Robinhood debit card
- Interest on the cash in these accounts
6. Stock Loans
Robinhood can lend out the shares held in user accounts to short sellers, earning a fee in the process. This practice, known as securities lending, is common among brokerages and can be quite lucrative.
7. Foreign Exchange Fees
For users trading in foreign stocks, Robinhood charges a small fee for currency conversion. While not a major source of revenue, it contributes to the overall business model.
Conclusion
While Robinhood and similar platforms offer commission-free trading, they have developed multiple revenue streams to remain profitable. By leveraging technology and adopting innovative practices like PFOF, these brokerages have been able to disrupt the traditional brokerage industry while building sustainable business models. However, it's important for users to understand these revenue sources and consider how they might impact the service they receive.
