What's up guys and welcome back to wall street millennial on this channel, we cover everything related to stocks and investing robin hood has taken the investment world by storm over the past couple years. Throughout the pandemic, their number of users has exploded, as individuals became more invested in trading stocks and options. Their monthly active users grew to 18.9 million. As of the third quarter of 2021, and these users have an aggregate 95 billion dollars invested in stocks options and crypto.

They ipod in july of this year and currently have a 30 billion dollar valuation. So far, they've made 1.4 billion dollars of revenue in 2021, which is an increase of 126 percent over the prior year. Robin hood is the pioneer of commission-free trading and they say their corporate mission is to democratize finance and allow everyday people to build wealth in the markets. They even named themselves after the iconic robin hood legend, who stole from the rich and gave to the poor.

But how is robinhood the company able to generate billions of dollars of revenue when they don't charge commissions to their customers? The money has to come from somewhere, while hood started out as a simple stock brokerage. They've expanded significantly and some parts of their business now resemble a casino. At the end of the day, they are a profit maximizing institution that is always looking for new ways to grow and monetize their user base. The most recent example of this is their entry into cryptocurrencies.

They advertise their crypto trading as being commission free. They say that if you spend 100 to buy crypto on robinhood you'll get a full 100 worth of crypto with no fees. If you use other brokerages like coinbase or gemini, you'll only get about 97 worth of crypto after deducting the fees that they charge when they first launched crypto trading. In 2018, ceo vlad tenef said they were planning to operate this business on a break-even basis and don't plan to profit from it for the foreseeable future.

It would essentially be a loss leader to better serve their existing customers and attract new users, but when something sounds too good to be true, it usually is in the past two quarters alone. Robin hood has made more than 280 million dollars of revenue from crypto trading. On their platform, obviously this money has to come from somewhere in this video we'll go over how robinhood is able to make so much money from crypto and whether or not they're? Actually a good thing for individual investors. Robinhood was founded in 2013 by vladimir tenet in baiji uba.

Their idea was to create a commission-free brokerage which would significantly reduce costs for individual investors in the past, stock trading was a slow and labor intensive process. If you wanted to buy shares of a company, you'd have to call up your broker on the phone. They would send your order to a stock exchange where a human would try to find a counterparty for your trade. This would take a long time and cost a lot of money, because the brokerages need to hire thousands of traders to execute the trades in person.

These costs were passed on to the consumer, who would often have to pay hundreds of dollars to execute a single trade since the turn of the millennium financial technology has advanced significantly. Instead of having to find a counterparty on the floor of an exchange, buy and sell, orders are now matched electronically in a matter of seconds with everything being electronic, it only costs a brokerage, a few pennies to execute an order on an exchange, despite the fact that Their marginal cost is almost zero. The incumbent brokerages like e-trade and charles schwab, continue to charge five to ten dollars per trade. These high fees are prohibitive for small investors who are just getting started.

If you only have one hundred dollars to make a trade, a ten dollar fee would cost you ten percent to buy a stock and another ten percent to sell. This means that the stock price would have to go up by about twenty percent. For you to just break, even robinhood's goal was to disrupt the industry by giving zero commission trades. By doing this, the advances in electronic trading technology were finally being passed on to the end consumer.

Their free trades, as well as their simple user interface, made them a far superior option than the incumbent brokerages who continued to price gouge their customers with high fees by 2019. Robin hood was taking share from the likes of e-trade charles schwab and td ameritrade. All the major u.s stock brokerages were forced to follow robin hood's lead and cut their own commissions to zero. This was a major win for the individual investor.

They had single-handedly disrupted the entire brokerage industry and made zero commission the norm. They were living up to their name of robin hood as they effectively save individual investors billions of dollars per year at the expense of the brokerage establishment, while executing a trade on an exchange only costs a few pennies. These costs do add up. Also robinhood has significant fixed costs, such as their physical office space and software development.

They need to generate revenue somehow to cover their costs and make a profit. But how can you generate revenue when you charge nothing to your customers? They make a little bit of net interest income from robinhood gold. They charge an interest rate for margin which is a little bit higher than their own borrowing cost. They pocket the difference as profit, but this is only a small fraction of their total revenue.

They make the vast majority of their profit through so-called payment for order flow market makers such as citadel pay robinhood for the right to execute their customers. Orders pretty much all stocks have a bid. Ask spread if you submit a sell order. Citadel will buy the stock from you for a couple pennies above the best bid price.

They will then try to flip the stock by selling it for a couple cents. Higher citadel will only execute an order if they think they can make a profit on it. Otherwise, they'll send it directly to an exchange if you trade, large liquid stocks, such as apple or google. The spreads are so tight that differences in execution quality will amount to little more than a rounding error and, to the extent that you get poor execution, you would still be much better off than if you had to pay ten dollars per trade, which was the case.

I e-trade until a few years ago, but options are a different story: they're far less liquid and usually have a giant bid-ask spread, because the spreads are so wide citadel can make a killing by trading option orders from robin hood customers, citadel and other market makers make Billions of dollars per year, a significant portion of this - comes from robinhood. In the first nine months of 2021, robin hood made 1.1 billion dollars in payment for order flow. The market makers need to make a profit too, so the gross amount of money that they make from executing robinhood customers orders was well in excess of 1.1 billion. So where is all this money coming from on an annual basis? They make a little over 100 of revenue per active user.

This seems like quite a lot of money. You can think of robinhood's business model as something similar to a freemium video game. Most of the users spend a very insignificant amount of money on the game, but maybe 10 percent become addicted and spend hundreds or even thousands of dollars. These two pie charts show robinhood's revenue and assets under custody for the first quarter of 2021..

As you can see in the bottom of the chart, eighty-seven percent of assets and robinhood accounts are held in stocks. The six percent held in crypto and the three percent held in options are tiny in comparison, in fact, only about thirteen percent of robin hood traders own any options at all. But if you look at the revenue graph on top, it's a completely different story. Almost half of their transaction based revenue comes from options and 21 comes from crypto.

Obviously, these two asset classes punch well above their weight. The majority of robinhood users are just buying large liquid stocks like facebook or google. These traders contribute almost nothing to robinhood's payment for order flow, but there are a few traders who actively day trade options and crypto. This is where the market makers and robinhood make their real money.

We've gone over. How robinhood makes money from stock and options trading, but what about crypto in their marketing materials? They claim that their crypto trading is commission, free, so you're much better off trading on robinhood than other crypto brokerages, which charge high fees. But we also know that robinhood somehow makes hundreds of millions of dollars on crypto transactions, so there's got to be a catch. If you open up robinhood and go to trade bitcoin, you can open up what they call live chart of the bitcoin price.

But if you're, one of the few people who take the time to look at their crypto disclosure you'll see that their prices and historical charts do not reflect real-time pricing. When you see a price on the robinhood bitcoin chart that isn't the price you'll actually be able to buy or sell it for you'll, probably end up getting a slightly worse price in their crypto user agreement. They say that robinhood may receive activity-based rebates from market actors. In relation to cryptocurrency transactions, basically, they make money from crypto in the same way that they do for stocks and options they partner with market makers who specialize in trading crypto.

These market makers take advantage of bid, ask spreads just like citadel does with stocks and options. These types of high frequency trades are zero sum games. If robin hood and the market makers are making money, that money is coming from investors on the robin hood platform, who get a few pennies or dollars shaved off every time they make a trade. Robin hood doesn't charge fees directly, but they do charge an invisible fee in the form of payment for order flow.

This is a genius marketing strategy because now they get to say, we charge zero fees. While coinbase and gemini charge you three percent, but robinhood's invisible fees are untransparent, we don't know exactly how much slippage you should expect to lose. Every time you make a trade also because many robinhood users think there are no commissions. They end up trading far more frequently than they would on coinbase or gemini, which charge an explicit fee.

This is great for robinhood because they make money on every transaction, but it can be a very bad thing for robinhood customers. If you lose one percent every time you buy or sell based on order execution, your account will decay very quickly if you trade every day or even every week, robinhood will start to democratize finance, lower fees and help people save money and achieve financial freedom and for The most part they've succeeded in this mission. Most people on robinhood are buying high quality companies like microsoft and apple and investing for the long term. Many robin hood users probably never would have entered the stock market at all, as they were intimidated by the high fees and non-user-friendly interfaces of the incumbent brokerages.

But at the end of the day, they're a profit maximizing institution and their primary goal is to make money for their own shareholders. If we're being completely honest with ourselves. Dogecoin is more akin to a casino than a way for people to prudently invest for their retirement. There's nothing necessarily wrong with this.

If people want to gamble their own money, it's their own choice to make and robinhood just allows them to do it, but you won't see a sign at the bellagio saying that their corporate mission is a democratized finance. This video isn't meant to criticize robin hood they've, arguably done much more good than bad, and for the vast majority of users they provide a good experience at a very low cost, but they should be more transparent, around payment for order flow with their customers, especially with Regards to crypto trading, if you use robinhood to buy or hold stocks or crypto for the long term, there's not really any need to worry the execution. Quality issues only become significant if you trade, frequently, especially with crypto and options, if you actively day trade on robinhood, a significant portion of your account balance will probably end up as a donation to citadel or other market makers, all right guys that wraps it up. For this video, do you think robin hood, zero commission, crypto marketing is misleading.

Are you a robin hood customer? Let us know in the comments section below as always. Thank you so much for watching and we'll see you in the next one wall, street millennial, signing out.