What is Robinhood, and how does it work

To sell an asset, the process is similar to buying. Users click “sell” on the asset’s detail page and choose whether they want to exchange the asset for dollars or another asset.

How much money is needed to start Robinhood?

The Robinhood business model is flexible to accommodate any type of investor, from large corporations to retail users who can open an account with as little as $1.

Robinhood’s breakthrough allowed retail investors to participate in the financial and trading markets because they could start using the platform with no minimum balance required and buy fractional shares instead of whole shares.

Although the number of customers has declined since 2021 at the peak of its popularity, some 22 million users are still actively using Robinhood.

How can an application allow so many users to invest quickly, be commission-free and be safe at the same time? Is Robinhood secure to use? As a financial services provider, Robinhood operates under strict regulations set forth by U.S. finance laws,  being registered with the Financial Industry Regulatory Authority (Finra) and the Securities & Exchange Commission (SEC).

Finra is an official body authorized by the federal government that regulates investment brokers and evaluates their compliance with set standards, promoting transparency and investment education. The SEC is a government agency that regulates the securities markets in the U.S. to protect investors from fraud and abuse. It requires brokers to operate transparently and comply with business restrictions, such as prohibiting insider trading and applying fair prices and fees.

Despite constant monitoring and registration with the relevant official bodies, Robinhood incurred a fine of $70 million in 2021 for providing false and misleading information that caused investors to engage in risky trades and suffer significant losses that could have been avoided.

Another challenge Robinhood investors face is the lack of suitable investment platform management tools, which leads to impractical activity instead of helping users avoid risky investment strategies. For instance, the app setup doesn’t allow users to manage their portfolio diversification easily, and it may be an issue for a platform that enables stocks, ETFs, options and cryptocurrency trading.

On the other hand, Robinhood offers sufficient Securities Investor Protection Corporation (SIPC) coverage, protecting its members’ customers up to $500,000 for securities (and $250,000 for claims for cash).

Robinhood’s business model sustains itself with multiple revenue streams, mainly through a practice known as payment for order flow.

Order flow

Order flow is a compensation structure widely used by Robinhood and other similar brokerages to process retail stocks, ETFs, options and crypto trades.

This is how it works: When customers place trades on the platform, their orders are routed to market makers or trading firms for execution and to make an order flow. These firms pay Robinhood fees for the opportunity to execute their trades and potentially profit from the bid-ask spread and other trading strategies.

While this practice allows Robinhood to offer zero-commission trades to its users, its order flow model has faced regulatory scrutiny and controversy due to concerns about potential conflicts of interest and the quality of trade execution.

Interest on cash balances

When customers hold uninvested cash in their Robinhood balance, Robinhood directs such funds to pools and earns interest on them. The platform shares a portion of this interest revenue with its users, typically through a “Robinhood Cash Management” program that users must opt in to to earn a small percentage of interest on their uninvested cash balances.

The cash can be accessed with a Robinhood debit card. The company moves customers’ uninvested money into FDIC-insured partner banks that then pay Robinhood a fee, including a small share of the interchange fees from the debit card transactions.

Premium accounts

While the basic trading services are commission-free, premium account subscriptions allow

investors to access various premium-tier tools. The subscription is called Robinhood Gold, and it provides additional features and benefits to users who pay a monthly fee. Such advantages include more significant instant deposit amounts, access to Level II market data provided by NASDAQ, professional research information from Morningstar and margin trading.

Robinhood API fees

Robinhood allows developers and companies to access application programming interfaces (APIs) that they can integrate with their platform. Robinhood earns revenue from these partnerships and integrations by charging API access fees.

Securities trading

Robinhood launched a lending program that entitles its customers to earn money on stocks. Users who opt for this solution allow the trading app to lend their shares to financial institutions that use such funds for different purposes, including covering deficits, facilitating trade settlements and executing short sales. Borrowers pay Robinhood interest on the loan they received, and a portion of that revenue is passed on to Robinhood users.

While it’s true that Robinhood has democratized investing, its business model still raises eyebrows because its approach is perceived as gambling. 

Here are some of the benefits and disadvantages for users to consider when embarking on the Robinhood trading experience.

Advantages

• Commission-free trades: Robinhood eliminates the cost barrier traditionally associated with trading and investing. Such a feature is particularly attractive for frequent traders or those with limited investment capital.
• IRAs with 1% match: Robinhood is the first company to have launched non-employer-funded individual retirement accounts (IRAs), which it did in December of 2022 with a 1% match on pension contributions.
• Intuitive interface: Robinhood provides a sleek and simple mobile app interface that is easy to navigate for non-tech-savvy investors and beginners too, although some may argue that it could also be a disadvantage since it has made complex strategies like options trading too easy for inexperienced investors who could easily make risky trades and lose money.
• Access to cryptocurrency trading: Robinhood was one of the first brokers to introduce free crypto trading, although it is still not possible to include cryptocurrency investments in Robinhood IRAs.
• Fractional shares: Robinhood allows users to buy fractional shares of stocks and ETFs, which means users can invest in their favorite stocks with smaller amounts of money. This feature enables broader market access and diversification, even for investors with limited funds.

Disadvantages

• Limited investment education: Its research and analysis tools are relatively limited compared to other brokerage platforms, making it unattractive to experienced traders who rely on in-depth market data to support their investment decisions.
• Lack of investment options: Mutual funds or bonds should be included in Robinhood services if it wants to remain competitive and offer the opportunity to build a diversified investment portfolio.
• Limited customer support: This weakness has caused Robinhood to receive a lot of criticism for reports of delayed responses and difficulties in reaching customer service representatives. Although efforts have been made to improve customer service, this remains an area where Robinhood still has room for improvement.
• Technical Issues: Untimely outages and trade restrictions during market volatility have been another cause for concern among Robinhood users and regulators who have applied fines to the company for misleading customers.

Since 2021, Robinhood has improved its cryptocurrency offering and launched the opportunity to invest in the industry’s latest innovations.

The new approach introduces Robinhood customers to the world of Web3 to keep up with the financial market trends of decentralized finance (DeFi). In April 2023, the trading app launched “Robinhood Connect,” a fiat-to-crypto on-ramp featuring support for decentralized applications (DApps) and self-custody wallets.

The service allows users to acquire “true ownership” of their assets by buying and transferring cryptocurrency directly to their self-custody wallets without the need to leave the DApp or be in their Robinhood Crypto accounts.

Some other features are also added, including a crypto home tab, price alerts and advanced charts to help users apply technical analysis, manage their portfolio better, track crypto prices and place stop and limit orders. Robinhood Connect allows customers to trade the same cryptocurrencies already supported by Robinhood Crypto, and they can be transferred easily between the two platforms, only requiring a network fee.

Some limits apply to the offering, including the ability to send up to $5,000 worth of crypto or make up to a total of 10 transfers a day. Users can purchase up to $1,000 per business day with a debit card; the same amount and time limit applies to instant funds in a bank account.

Source: https://cointelegraph.com/explained/what-is-robinhood-and-how-does-it-work