Robinhood’s business model of making hundreds of millions from selling customer orders takes center stage during the GameStop hearings

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A major portion of Robinhood’s business model that relies on handling a high volume of trading is once again getting attention, and it comes at a critical junction for the fintech, which, according to Bloomberg, had been hoping to go public as soon as this quarter.

Robinhood made its name by offering users free stock and options trading. It led the charge in making money from what’s called payment for order flow (PFOF), instead of generating revenue from trading commissions, as brokerages had done in the past. Robinhood sells its customers’ buy and sell orders directly to market-making firms, such as Citadel Securities, Virtu, and Two Sigma, as opposed to going to a trading venue. 

While the practice is common among brokerages across the industry, and a key piece of their ability to offer commission-free trading, Robinhood has relied on it more heavily than others.

The attention the startup received in the wake of the Reddit-fueled GameStop trading frenzy is bringing the practice back into the spotlight. On Thursday, Robinhood cofounder and CEO Vlad Tenev will testify before Congress about the GameStop frenzy, with the topic of PFOF taking center stage.

In a series of tweets, the high-profile venture-capital investor Bill Gurley called on the Securities and Exchange Commission to ban PFOF, describing it as the key issue in the “plumbing” of the financial markets.

Many say $GME/RH situation is a “problem in the plumbing,” implicating the structural integrity/complexity of our financial systems. If the SEC/government wants to “fix the plumbing” the number one thing they should do is ban Payment for Order Flow. [more]

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— Bill Gurley (@bgurley) January 31, 2021

The outspoken tech investor Chamath Palihapitiya alluded to issues with PFOF in a tweet in which he said Robinhood was no different from Facebook, a company he previously worked at.

“They both trick you into thinking you are the customer. But, in fact, you are the product and your data is the asset,” he tweeted. “These assets are then sold to their true customers who pay them money and always at your expense.”

In the fourth quarter of 2020, Robinhood received more than $221 million in PFOF for equities and options flow, according to data collected by Piper Sandler from regulatory filings. The amount was larger than that of its competitors E-Trade ($107 million) and Charles Schwab ($63 million). It trailed only TD Ameritrade ($322 million), which sold more than twice as much volume to market makers. 

While larger brokerages have the benefit of scale and a more diversified business that includes other investing and wealth-management offerings that drive revenue, Robinhood was largely built as, and remains, a brokerage focused on free trading. 

If regulators were to go as far as to put restrictions — or an outright ban — on PFOF, Robinhood’s business model would be challenged, according to industry watchers.

“If you remove payment for order flow, there is a possibility that then the brokers can’t provide the zero commission — especially a guy like …read more

Source:: Businessinsider – Finance


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