Happy Eastern break everybody,

today I want to talk about Robinhood, the extremely successful fintech unicorn that is cherished by millennial stock investors. The idea is simple, unlike traditional online brokers like Charles Schwab and TD Amitrade, which charge $4.95 and $6.95 for each stock trade, Robinhood takes no commission fees (only some small SEC and FINRA charges, which are unavoidable).

If you haven’t heard of them, I can recommend this session with Vladimir Tenev and Jason Calacanis.

The startup had a meteoric rise from inception in 2013 to now. It famously built a massive waiting list of more than one million users before even launching. Some guy recently joked on twitter that Robinhood inspired the new trend that the waitinglist is the new MVP. The pre-launch FOMO certainly helped, but when it finally launched, the product was so frictionless and intuitive to millennials compared to the incumbents, that the company has since grown to a last valuation at around $5.6bn.

As a person who is somewhat familiar with the functioning of financial markets, I always wondered how they execute the trade volume on the “back end”. The thing is, if you are a broker-dealer and you get a sell or buy order, you need to match it with the other side of the market. Meaning, when someone wants to sell, you need to find someone who wants to buy. I always wanted to find out more about how they handle this, but never found the time to research. Given that they are a startup with a limited balance sheet, it was clear to me that they must route the orders to third-party market maker.

So today, I came across this CNBC piece and things suddenly started to make a lot more sense. Apparently the way it works, Robinhood is sending the order flow to high-frequency traders like Citadel or Virtu, who then execute these trades in the dark pool. They get paid for this by these firms by what is known as “payment for order flow”. And payment for the order volume isn’t peanuts, apparently in 2018 it was around $69m, up from $21m in 2017.

Things now make a lot more sense to me now. Here I was wondering for years how they could grow so impressively just on the back of their “Robinhood Gold” premium subscription fees, which has been the official narrative. To be fair, since the company is still private and we don’t have the full income statement, we thus don’t know about the breakdown of subscription fees vs. order flow revenue. But looking at these figures, I would assume that payment order flow revenue makes up a substantial chunk of the top line. In a Bloomberg article from last October, “three people with knowledge of the matter” argued that order flow revenue made up 40 percent of Robinhood’s revenue.

Another day, another riddle solved.

Ttyl,

Erasmus

Note: If you don’t like reading, I do voice recordings of these posts while walking on Sand Hill Road (not really SHR, but some busy street).