How Robinhood Addicts Consumers - YouTube

in folklore robin hood is an outlaw that  steals from the rich and gives to the poor  

the eponymously named robin hood the company was  founded to democratize access to financial markets  

through commission-free stock trading but the  company suffered a series of scandals including  

one of robin hood's users committing suicide and a  record fine from regulators after misrepresenting  

its users cash balances today the company is  a lightning rod for our socio-economic divide  

ask two different people and the company's either  a hypocritical fraud serving the hedge fund elite  

or a savior to the next generation of aspiring  investors in the wake of robin hood's ipo and  

tumultuous up and down history we're going to  dig into exactly whether the company is indeed a  

hero like its namesake or something else entirely  and what it says about the future of the company

there's no denying robin hood is a disruptive  company not just in the generic sense of the  

word but in the textbook sense harvard professor  clayton christensen famously defined two forms of  

disruption a disruptive innovation generally has  to cause you to go after new markets people who  

aren't your customers and the product that you  want to sell them is something that is just so  

much more affordable and simple your current  customers can't buy it this is exactly what  

robinhood has done before robinhood brokerages  charge trading commissions in the five to ten  

dollar range if you made say a hundred dollar  trades this would immediately make that trade  

highly unprofitable if you started out in the red  five to ten percent robin hood offered a simpler  

product that was free it was clearly worse in  that it didn't have anywhere near the level of  

customer support or even the most up-to-date  information in the app but for consumers who  

wanted to trade relatively small amounts it was a  lot cheaper and simpler and in that way robinhood  

both disrupted the low end of the market and  brought in new younger investors into the market  

in fact as robin hood states more than 50 percent  of robinhood users are first-time investors  

it's hard to overstate how impactful that is for  the american consumer as albert einstein once said  

the most powerful force in the world is  compounding and the greatest compounding  

asset over the long run is stocks in fact if you  invested ten thousand 000 in the stock market in  

1980 it would be worth almost a million today  in 2021 but almost half of american households  

don't even own stock it's arguably been one of the  biggest drivers of increasing economic disparity  

in the us when trading platforms charge high  commissions it makes small trades for the masses  

too expensive and robinhood is tackling this  problem at an incredible rate and scale by the  

time of its ipo 18 million users have created a  funded account in a single quarter this year robin  

hood grew funded accounts by 5.5 million or 44 to  put this in context at the beginning of 2020 robin  

hood only had 5.1 million users revenue grew 309  year-over-year to 522 million within that equity  

revenue grew 322 and cryptocurrency revenue grew  a staggering 1967 so robin hood has also become  

a very popular on-ramp into crypto investing as  a fun sidebar dogecoin alone comprised a full 34  

of cryptocurrency revenue and nearly six  percent of robin hood's entire q1 2021 revenue  

competitors eventually recognized they're  going to be disrupted and so are compelled  

to follow suit and cut commissions td ameritrade  schwab and e-trade all moved to zero commissions  

effectively giving back more than a billion  dollars per year to consumers in the process  

so far so good but like the mythical robin hood  the company's had a checkered past with the law  

to understand what's at the root of this we  have to understand how robin hood makes money

if robin hood's free for users then how is it  a viable business well if you're not paying for  

it you're the product just like google makes it  search engine free but then sells user intent to  

advertisers robinhood makes its trading free  but sells the information to market makers  

this is called payment for order flow when a user  places an order on robinhood the company passes  

the information about that order to market makers  such as citadel who can choose to execute the ones  

they want they in turn pay robinhood a small fee  for these orders typically fractions of cents per  

share but those pennies add up really quickly this  revenue constituted 81 of robinhood's revenue and  

robinhood made more than half a billion dollars  in 2020 from just five firms now this sounds  

super sketchy and a conflict of interest after all  hedge funds can just front run trades right well  

there's actually strict laws against this and  it turns out payment for overflow is a natural  

way for most subscale brokers to get paid for  sending orders to these massive institutions  

that can process the orders more efficiently and  cheaper in fact this is a fairly common revenue  

stream in the brokerage world it's interesting to  note robinhood gets paid more than other brokers  

per share is it because there are market orders  from unsophisticated retail investors that can  

be priced liberally and profitably for the market  makers or maybe it's just because robinhood has  

the high share of payment for overflow coming  from options which pay out more per 100 shares  

than equity trades do this is all speculation but  it's definitely not good about this whole thing  

is that robin hood for years misled consumers  about this revenue stream this was the faq page on  

their website explaining how robinhood makes money  and as you can see it had zero mention of payment  

for overflow until they changed it in 2018 and  as the sec found training documents for customer  

service representatives in early 2018 explicitly  instructed them to avoid talking about payment  

for overflow and stated that it was incorrect to  identify payment for order flow in response to  

the question of how robinhood makes money okay  but so what if robinhood sells your order flow  

at the end of the day all the other brokers do it  too so you're probably still paying similar prices  

for trades right not entirely despite robinhood  advertising their rates beat out other brokers  

in sec inquiry in march of 2019 found that  no matter how we cut the data the percentage  

orders receiving price improvements lags behind  that of other retail brokerages by a wide margin  

what's more the same inquiry found that if orders  were large it would have been better to just use  

another brokerage with fees forwarders have more  than 100 shares the analysis concluded that robin  

hood customers would be better off trading at  another broker dealer because the price per share  

improvement would likely exceed the five dollar  per order commission cost savings from trading on  

robinhood that said robin hood has been designed  for new investors executing smaller trades so  

maybe it's still an aggregate a net net win for  its target users the most challenging part of  

robinhood though is that it may be designed  to monetize unhealthy investing practices

we've already covered that robinhood makes most  of its money selling order flow to maximize  

that revenue you want them to trade as much as  possible in some sense all the brokerages have  

this incentive but robinhood has taken this to the  next level the company's applied years of silicon  

valley's learnings in gamification and addictive  product design to push people to trade as much as  

possible robinhood could feel the users more like  a video game or casino than an investment account  

and that can sometimes compel inexperienced  investors to take big risks especially when making  

trades that involve borrowing money and there's a  large body of research that's found such behavior  

does not generate optimal investment returns as  an example robin hood uses variable rewards and  

confetti to add a casino type vibe to the app and  make robinhood more engaging as another example  

robin hood's product is full of recommendations  that create elements of fomo here's the top movers  

leaderboard and then of course if you buy stock  it will tell you other stocks similar to it not  

a crime in of itself but certainly encouraging  of more trading behavior well what if you don't  

actually have the money to trade robinhood  actually gives those users margin to trade on  

when you sign up for a robinhood brokerage  account it may take two to four days for  

your money to actually show up in your account so  what does robinhood do they give people up to a  

thousand dollars in instant deposits even before  the original deposit clears remember that 81  

of robinhood's revenue comes from payment for  overflow well it turns out that of the remainder  

most of it comes from interest from investors  trading on margin while robinhood wants users  

to trade a lot and on margin they also want them  to trade the highest margin products options have  

a higher payment for order flow relative to  shares so ideally you want people to trade as  

many options as possible options though are risky  and dangerous on robinhood you can be approved to  

trade options within a minute and it takes up  a ton of real estate in the app robinhood still  

doesn't support buying stocks in lots which  would help users on capital gains to be more  

tax efficient but they do offer same-day options  and not every user is fully educated about how  

to trade options that's compounded by the fact  that robin hood has focused on the presentation  

and engagement of the information rather than the  accuracy and not only that but robin hood's been  

criticized for not presenting accurate information  to traders sadly a 20 year old committed suicide  

after seeing an incorrect negative 730 000  balance and finra find robin hood a record  

70 million for its system-wide outages and  misleading communication and trading practices  

so now coming to the famous gamestop saga robin  hood was the broker of choice for a lot of people  

who were buying gamestop stock during the height  of the run-up they decided to stop allowing people  

to buy gamestop which caused the stock to crash  and in some cases even executed sell orders on  

behalf of traders right at the very low point  so why did this happen turns out robin hood had  

liquidity issues in large part driven by the  fact that robin hood's users of course trade  

on margin which is basically robinhood's balance  sheet and the fact that a lot of users leverage  

their positions with options making it even more  volatile in this case robinhood's own tactics  

of encouraging riskier behavior including  recommending buying fast rising stocks like  

gamestop through its top movers worked against it  and there were no advance warning to users that  

robin hood was about to shut down add all this  up and you get an idea of why even respected  

investors like warren buffett and charlie  munger have called robin hood a major problem

robin hood made ipo history when  they reserved an unprecedented 35  

of its initial public offering for the trading  apps consumers in a bid to appeal to the little  

guy it was initially ironic that the ipo debut  was the worst on record for an ipo of its size  

but since then the stock has soared crashed  and settled in at a reasonable return to its  

ipo price as of the time of this video so where  does this all leave robinhood from this point on  

robinhood still has the potential to teach a  new generation of investors the fundamentals  

of financial management but they've introduced  people to risky options trading trading on loan  

trading stocks and frequent day trading behavior  driven by business model that monetizes these  

practices since the company has such an incentive  to drive more speculative trading from its users  

curbing abuse and overreaches will likely have to  come from regulation as a result the company's ipo  

and any associated increased regulatory oversight  might actually be the best thing that could happen  

for consumers at large the legend of the original  robin hood paints a more complex character than  

the popular hero persona one in which stealing  and robbing may hurt rich and poor alike as  

the legend extends to our world of financial  access and inclusion the sheriff of nottingham  

may be a ray of hope that robin hood's arrow  flies straight in giving back to the poor  

if you're a fan of giving back drop a like or  comment on the video and i'll see you next week