INTRO: Just one year ago, Robinhood was the up-and-coming
mobile brokerage that millennials and retail traders couldn’t get enough of.
Robinhood’s total user count was surging in the millions as users got addicted to Robinhood’s
phenomenal UI and their gamification of investing.
Ever since the GameStop fiasco and the collapse of DogeCoin though, Robinhood has struggled
to maintain the excitement or even maintain a positive public opinion.
In fact, so many people left terrible reviews on the app store and the play store following
the Gamestop situation that Robinhood’s rating fell to 1 star at one point, and Google
had to bail out Robinhood by removing reviews that quote-on-quote violated Google’s policies.
To make things worse, Robinhood has been consistently losing hundreds of millions of dollars every
single quarter forcing them to constantly raise money.
These worries were finally supposed to subside with their IPO last year, but the IPO has
only made things worse as it’s made it crystal clear that the market doesn’t like Robinhood
at all right now.
Since their peak in August right after their IPO, Robinhood stock has fallen 85% which
correlates to a market cap loss of $56 billion within just a matter of 6 months.
This is actually super ironic given that their current market cap is nearly equivalent to
their cash reserves meaning that the market is giving Robinhood’s business itself very
little credit.
So, what happened to Robinhood, and can they recover from this nightmare.
VIRTUOUS AMBITIONS: Taking a look back, the story of Robinhood
dates back to 2011 at the height of Occupy Wall Street.
If you’re familiar with this movement, it was basically a protest against Wall Street
bailouts following the 2008 financial recession.
At the time, two college friends named Vlad Tenev and Baiju Bhat had classic jobs on Wall
Street.
These guys were immigrants from Bulgaria and India respectively and had met at Stanford.
Initially, neither of them had any problems or concerns with their careers.
They were quickly moving up the corporate ladder and were likely earning fat salaries,
but all this changed during Occupy Wall Street when one of their mutual friends accused them
of profiteering from an unequal system.
The duo didn’t instantly quit their jobs or anything, but this statement stuck with
them, and they started looking for ways in which they could bridge the gap between retail
investors and Wall Street.
One of the most obvious disparities they stumbled upon were the lofty fees and large minimum
deposits required by most brokerages.
Now, the fees weren’t actually that bad in nominal terms given that it was just 60
cents or a dollar per share or per option that you purchased.
But, from the backend, it only cost pennies to execute each of these trades, so brokerages
were enjoying massive profit margins.
Combine this with the rise of free-to-use games and apps like Clash of Clans and Facebook,
and it was clear to Vlad and Bhaiju that they could create a free-to-use brokerage.
To match the underlying mission of the company, they selected the name Robinhood which is
of course a reference to the Disney character that steals from the rich and gives to the
poor.
Aside from free trades and no minimum balances, the duo placed a massive emphasis on the app’s
UI.
If the app was going to appeal to regular people, it better be easy to navigate.
Baiju says that his goal with the app design was to make it quote “dead simple”.
Every time he came up with a new feature or design, he’d run over to Stanford from Silicon
Valley to have random college students test out the feature.
Not only did this allow Baiju to develop an intuitive app, but an app that was fun to
use.
You got confetti whenever you bought new stocks, and Baiju paired this with clever vibrations
and haptic feedback that kept the user engaged.
Robinhood would later face charges for gamifying investments, but this was great for appealing
to and retaining new users.
And with that, the duo was ready to launch Robinhood.
EXPLOSIVE GROWTH: While Robinhood’s UI was phenomenal, the
key to actually succeeding in the app market is marketing whether that be organic or paid.
Baiju and Vlad couldn’t pay for much marketing due to their limited capital, so they decided
to spark interest through another medium: exclusivity.
People who wanted to use Robinhood were placed on a waiting list, and they could move up
the waiting list by referring friends and family to Robinhood.
Not only did this make the original launch easier to handle from the backend thanks to
a limited user count, but it gave people who made it through the cut exclusivity which
is extremely powerful.
Naturally, as humans, we crave exclusivity because it gives us a sense of belonging and
importance as well as a certain level of social clout.
Every luxury company out there leverages this instinct to the max, but likely the best example
of this within the tech world is Gmail.
Back in 2004, when Gmail was launched, Google was the small player going against players
like Microsoft and Yahoo.
Plus, they had limited infrastructure, so they made Gmail invite-only, and this is how
it was till 2007.
Clearly, this worked out extremely well for Gmail, and the same could be said about Robinhood.
Following their initial launch in 2013, they were able to build up a waiting list of 50,000
people and by the time they launched on the Apple app store, this number had ballooned
to 1 million users.
This massive user interest allowed Robinhood to raise tens of millions from venture capitalists
and start investing in new features and marketing.
In 2018, for example, they started rolling out the infamous Robinhood Crypto.
And in late 2019, they launched fractional shares.
The new funding also allowed them to start their famous free stock referral program that
basically every finance YouTuber has milked to the max.
In the meantime, Robinhood was also upgrading their backend infrastructure as well.
In late 2018, for instance, they started to self-clear their orders.
All these new features made Robinhood more and more established within the stock brokerage
industry, and that’s when the pandemic hit and the stock market crashed.
Generally, this would be a terrible time for brokerages, but a lot of retail traders were
actually looking to buy the crash.
Combine this with Papa Powell’s money printer, and it didn’t take long for stocks to recover,
and this time tens of millions of retail traders were on board.
It looked like things couldn’t get any better for Robinhood, but in the background, there
were actually several red flags.
BROKEN REVENUE MODEL: Likely the biggest red flag surrounding Robinhood
was their revenue model.
While they weren’t directly charging users for trades, they were charging users from
the backend through something called payment for order flow.
Similar to Google and Facebook collecting information on our browsing habits and selling
the data to advertisers, Robinhood was collecting all of our trades and selling them to wall
street firms called market makers.
Now, Robinhood didn’t actually invent this revenue model.
Other low costs brokerages like E-Trade have been leveraging payment for order flow for
years, but this doesn’t mean it’s a good strategy.
Payment for order flow is not only heavily frowned upon, but actually illegal in several
countries including the UK, Canada, and Australia.
But, wait a minute, what’s the problem with payment for order flow in the first place?
It gives us basically unlimited free trades.
Well, the truth is, it’s not actually free, you’re just charged indirectly.
You see, market makers aren’t idiots to pay for our emotional day trades and hype
investments.
They’re paying for the order flow in order to flip our orders and make a profit.
For example, let’s say you’re willing to buy 1 share of Apple for $100.
If this order executes, that means that the market maker was able to find someone that
was willing to sell 1 share of Apple for $99.50 or even $99.
This gives the market maker 50 cents to $1 worth of profit which they’ll split with
Robinhood.
The difference between how much you’re willing to pay and how much the seller is willing
to sell for is called the bid-ask spread, and market makers have been leveraging such
disparities for decades.
Usually, this isn’t a problem because market makers only made a penny or two from each
share.
But given that market makers working with Robinhood have to split their profits with
Robinhood, their bid-ask spreads are generally way larger.
In fact, a Wall Street Journal study found that Robinhood’s spreads were as much as
60 times larger than Charles Schwab.
So, with Robinhood, sure you don’t have to pay 50 cents for every share you purchase
upfront.
But, you’re constantly overpaying for every share you purchase which indirectly charges
you around the same amount if not more.
And to make things worse, with traditional brokerages, since you’re paying the fee,
you’re the customer and you’re the top priority for the brokerage.
But, with Robinhood, since the market makers are the ones that are technically paying the
fees even though you’re being charged for it, market makers are the customer and they’re
the top priority.
MORE RED FLAGS: Robinhood’s broken revenue model would eventually
come back to haunt them, but in the late 2010s, they had much bigger issues to address.
In July of 2019, for example, Robinhood admitted that they were storing their user’s passwords
in a readable form across their servers which had made it easy for hackers to steal passwords
and subsequently steal money from these accounts.
Similarly, just a few months ago, Robinhood confirmed that a voice phishing scheme allowed
hackers to steal the email addresses of 5 million customers and the full names of 2
million customers.
Aside from these security breaches, a couple of WallStreetBets users had found a glitch
within Robinhood that allowed them to borrow infinite amounts of money.
The glitch entailed purchasing shares on margin and then selling covered calls on these shares.
Users could then use the proceeds from selling covered calls to purchase more stock and sell
more covered calls on these newly purchased shares and the cycle continues.
Many WallStreetBets users used this glitch to engage in extremely risky trading which
resulted in many accounts sustaining 6 figure losses.
And when all the fun was over, Robinhood was the one that had to pay the bill.
But none of these issues holds a candle to the PR nightmare that followed the suicide
of Alexander Kearns.
Alexander was a University of Nebraska student that had been margin trading on Robinhood.
This wasn’t going too well though and at one point, Robinhood said that his account
balance was -$730,000.
After seeing this, Alexander took his life, and on his suicide note, he accused Robinhood
of allowing him to take on too much risk.
The worst part was that the -$730,000 account balance wasn’t even legitimate.
It was a temporary settlement glitch that would’ve resolved by itself.
As you would guess, this led to several lawsuits regarding gamification and risk disclosures
many of which are still ongoing.
But all these lawsuits were just a sneak peek into what would follow after the GameStop
fiasco.
ONE LAST HOORAH: By now, I’m sure all of y’all are familiar
with what happened to GameStop.
WallStreetBets identified a massive short interest in GameStop and proceeded to buy
heavily into the stock.
It’s not clear if this actually resulted in a short squeeze or not, but the hype and
momentum itself took GameStop to the moon, and Robinhood was at the center of this movement.
When things started getting exciting though, Robinhood restricted users from purchasing
GameStop and other short squeeze stocks.
Their official reasoning for this was that these stocks were getting too volatile and
that they were trying to protect their users from massive losses.
But, given their history with risk, this was rather hard to believe and suspicions went
elsewhere.
One of Robinhood’s biggest market-maker customers is a company called Citadel which
also happened to have a major short position in GameStop.
Now, this isn’t confirmed, but it seems like Robinhood was pressured by Citadel to
halt trading on GameStop.
And fearful of losing one of their biggest customers, Robinhood complied.
See, this is the problem with your customers and your users being different people.
This trading halt was followed up by dozens of class-action lawsuits, but this was the
least of Robinhood’s problems.
Whether the speculation around Robinhood’s actions is true or not, the incident destroyed
their reputation as the broker of the people and their user growth and suffered every since.
Despite this poor outlook, Robinhood would actually experience one last hoorah accidentally.
In March, April, and May of 2021, Dogecoin would rocket from a few cents up to 73 cents,
and given that you could buy Dogecoin on Robinhood, this gave Robinhood one more spectacular quarter.
But after Elon Musk’s appearance on Saturday Night Live, Dogecoin fell off a cliff and
so did Robinhood.
And Robinhood’s initially hyped IPO ended up being a massive bust.
IMPOSSIBLE COMPS: In terms of Robinhood’s short-term future,
it’s really not looking that great.
Sentiment surrounding Robinhood is still as bad as ever and it’s going to be nearly
impossible to beat their revenue numbers from last year which largely benefitted from GameStop
and Dogecoin.
Fortunately, Robinhood has billions in the bank and can weather a few painful quarters
or even a few painful years.
Maybe Robinhood’s phenomenal UI will end up shining through to retail investors, but
we’ll just have to wait and see.
At the end of the day, while Robinhood did several things right, it seems like their
entire mission was a bit misguided.
You see, I don’t think people hate Wall Street because of high fees or prices, I think
people hate wall street due to their lack of transparency and accountability.
So, the key wasn’t to open a free brokerage, but rather to open a transparent and accountable
brokerage.
This is one of the main reasons that Vanguard is so highly respected.
Vanguard doesn’t have shareholders or customers that are different from their users.
So, Vanguard’s interests are always aligned with their users.
Porting this business model to mobile devices paired with a tremendous UI is what I think
Robinhood should’ve done, but instead, they’ve become the epitome of Wall Street, the exact
thing that they were trying to fight.
Would you prefer to use a brokerage with upfront fees or a brokerage with backend fees?
Comment that down below.
Also, drop a like if you’re glad that Robinhood got a taste of their own medicine.
And of course, consider checking out our international channels to watch our videos in other languages
and consider subscribing to see more questions logically answered.