Robinhood, the American discount brokerage startup, is immensely popular among millennial investors and traders. The company's app offers its 4 million customers commission-free trading of stocks, ETFs, and options. It even enables no-fee trading of cryptocurrencies Bitcoin (BTC), Ethereum (ETH), Bitcoin Cash (BCH), Ethereum Classic (ETC), Litecoin (LTC), and Dogecoin (DOGE) in 19 US states. It also offers flat-fee margin financing accounts called Robinhood Gold. It is no wonder that the company was recently valued at $5.6 billion in its last funding round.
But the startup, long heralded for its support of retail traders, might be selling its customers' order flow for financial gain.
A recent Seeking Alpha article sheds light on how Robinhood sells order flow to high-frequency trading firms. SEC filings show that Robinhood not only sells order flow to firms like Citadel, Two Sigma, Virtu Financial, and Wolverine Securities, it earns over ten times as much revenue selling order flow than do traditional brokerages like E*TRADE and TD Ameritrade. Citadel and Wolverine have paid fines for violating securities laws and insider trading in the past. Although it is clear that Robinhood makes millions from selling order flow to algorithmic trading firms, it is unclear what exactly that costs the app's users.
Another Seeking Alpha article argues that the fact that Robinhood gets kickbacks does not make it a villain. The startup simply routes all of its customers' orders to market makers, many of which are high-frequency trading firms, instead of internalizing orders like larger brokerages do. Internalizing means the brokerage matches orders within its customers' order flow and takes the spread as profit. As nefarious as it sounds, payments from market makers for order flow is a common practice among brokerages. High-frequency traders often make a small profit from buying orders before they directly reach the exchanges, even after paying brokerages a fixed price per share. Moreover, the selling of order flow does not change ordered prices or hurt investors.
The bigger question is what happens with Robinhood's crypto orders. Since Robinhood does not give users physical access to coins with private keys, users cannot be sure what goes on behind the scenes after they submit orders. And because it is unclear if SEC regulations also cover crypto, Robinhood has yet to disclose crypto order flow information, including to which exchanges it routes orders. Whatever the truth is, it seems that there might be a cost to Robinhood's free trading services.
The author owns a small amount of BTC and LTC and is a Robinhood user.