Robinhood: Disappointed Tomorrow for Finance for All

Published April 29, 2022, 1:57 p.m.Updated April 29, 2022, 1:59 p.m.

Robinhood ate his white bread. After surfing the brokerage boom during the pandemic, the neo-broker, recognized by young American stockbrokers, is experiencing a bad situation. The blessed days of ever-growing markets and stock market frenzy, such as GameStop, are over. Stock traders were deterred by the downturn on Wall Street earlier this year.

“Our customers have become more cautious with their wallets, transactions with all asset classes less frequently and to a lesser extent, although the decline in cryptocurrency has been particularly sharp,” said Vlad Tenev, head of Robinhood, on the occasion of the first quarter. Revenue from transactions decreased by almost 50% compared to last year. And the losses, more than expected, amounted to 392 million dollars.

The lights are red

All indicators for the brokerage program are red. The number of accounts has stagnated between 22 and 23 million in the last twelve months, after more than doubling from the previous year. More worrying is that monthly active users have fallen over the past three quarters, declining for the first time since last year to about 16 million from almost 18 million a year ago.

The brokerage program knows what to respond to. Its price fell after the IPO to $ 38 per share. After peaking at $ 70 on August 4, its shares fell to $ 10, down 85%. It still lost 10% in pre-market trade after its results. As a result, its estimate fell from nearly $ 30 billion during the IPO to less than $ 9 billion.

Trying to limit its losses and mourn the period of “hypergrowth”, Robinhood announced a big plan to reduce costs. It is expected that 9% of its employees will leave the company. It has also increased the launch of new features: extended working hours, debit cards and securities lending. The brokerage program also relies heavily on cryptocurrency to revive itself, with the development of specialized wallets and the inclusion of new tokens on its platform, including Compound, Polygon, Solana and Shiba Inu in April.

The economic model is suspended

The neo-broker faces many problems, the main one being his economic model. To make money by offering commission-free transactions, Robinhood resells its customer order stream to specialized agencies, such as market makers such as Citadel.

These order flow payments (PFOF) make up the bulk of a broker’s income. But the practice is controversial. The U.S. Financial Markets Officer, SEC, has initiated a reform of broker supervision that could lead to a total ban on PFOF, as is already the case in some European countries.

Stock traders lost significantly with “the same shares”

Robinhood regularly boasts of having “democratized access to Wall Street” thanks to its easily accessible app. The brokerage program has undoubtedly won over many young traders, but it is also under attack because of its tendency to encourage its users to increase the number of transactions and use derivatives, including options, which are the main source of income. A recent academic study (1) has given food for thought to critics of its “zero commission” model. According to these researchers, traders lost more than $ 1 billion by betting on options, usually cheap derivative financial instruments from November 2019 to June 2021. Taking into account the hidden transaction costs, the losses amounted to more than 5 billion. The popularity of very short-term options is questionable, with characteristics similar to gambling: low unit cost and most of the deadlocks for a few significant gains. With some exceptions, traders are losers. This was especially true of “meme stocks” such as GameStop or AMC, although institutional investors, for their part, profited from these stocks. Researchers estimate that during the peak of activity on these securities in January and February 2021, traders lost $ 682 million and $ 282 million, respectively. The big winners are three market makers, which cover more than 85% of retail options, namely Citadel, Susquehanna and Wolverine. “The new generation of retail investors is better at technology and better connected to investor forums, but these investors are still financial botanists,” the researchers said.

(1) “Retail options and the rise of the big three”, Svetlana Bryzgalova, Anna Pavlova, Taisiya Sikorskaya, London School of Business, April 12, 2022.