Editor’s note: This article is part of InvestorPlace.com’s Investing for the Next Decade.
Innovations in financial products and financial technology (fintech) have been shaping how millions of Americans invest. Most analysts concur that the Robinhood app has disrupted the brokerage industry since 2014. The company recently raised $460 million in private funding and its valuation has passed $11 billion.
Even more established brokers such as Charles Schwab (NYSE:SCHW), which now owns TD Ameritrade, and Morgan Stanley (NYSE:MS), which recently acquired E-Trade, followed suit and started offering free trades.
Of emerging trading tech seeking to compete with the Robinhood app, Qian Yang, doctoral student of finance at Michigan State University said:
… it is critical to locate technologies that have transformative powers. To me, VR and AI related technologies are still very promising, and their potential are yet to be fully explored. It’s not only the producers of these technologies, but also how and to what extent conventional firms adopt these technologies to improve their productivity.
Put another way, the new decade may see a battle of fintech wars among brokers as they compete for more customers. Therefore, we will take a look at what may be next for the Robinhood app in 2021 and beyond.
In order to think about how, if at all, the Robinhood app will evolve over the next decade, it’s important to review where it currently stands — and what it stands for.
Taking From the Rich and Giving It to the Poor?
Several versions of the historic Robin Hood legend exist, but he is generally accepted as an outlaw who had lived in Sherwood Forest in England with his ‘Merry Men.’ His fame grew as he stole from the rich and generously gave to the poor.
Hollywood has also made a number of movies based on the character. Movie critics believe, “The film Rogues of Sherwood Forest (1950) in particular portrays the outlaw as a defender of democracy and an opponent to excessive government taxation and control.”
In a similar fashion, the mission of the Robinhood app has been to “democratize finance for all.” The company has made account opening procedures quite easy, particularly for younger and less-experienced market participants who may not necessarily have a lot of investing capital. It also offers commission-free trades.
Robinhood is now a FINRA-approved and SEC-registered broker-dealer that provides access to a range of financial products. However, critics of the app do not necessarily believe it “takes from the Street” and gives “to retail investors.”
Research conducted by Ivo Welch of Anderson School at UCLA and published by the National Bureau of Economic Research (NBER) points out, “Instead, RH earns its revenues through margin fees and cash balance interest, payment-for-order flow, and sales of its investor data to more sophisticated high frequency traders.”
Order flow, or the right to fill orders, is what the company gets most of its revenue from. A recent Forbes article explained as much: “The problem is that Robinhood has sold the world a story of helping the little guy that is the opposite of its actual business model: selling the little guy to rich market operators with very sharp elbows.”
How the RobinHood App Could Evolve
The company is clear about how it makes money. It highlights, “When you buy or sell stocks, ETFs, and options through your brokerage account, your orders are sent to market makers for execution. To compete with exchanges, market makers offer rebates to brokerages.”
Put another way, there is no free service as the company is selling investors’ order flow to wholesale market makers. In fact, the company is currently under investigation by the SEC for not properly disclosing how it has been selling investors’ orders to high-frequency traders. Accepting payment for order flow (PFOF) is not illegal, but Robinhood’s income heavily depends on the process. Therefore, the company may be forced to update its revenue model in the near future.
One might argue that it is not much different from social media companies like Facebook (NASDAQ:FB) selling user data. But then Facebook has never claimed to “take from the rich and give to the poor.”
Recent months have seen customer complaints soar along with the number of trades placed via the Robinhood app. A great number of market professionals believe the app now stands for risky directional bets that resemble gambling, not investing. Lack of live customer agents to take phone calls has also been an issue.
Mr. Yang of Michigan State University thinks that as it evolves, the app could cater more toward educating its wide user base of beginner investors:
Robinhood has been an equalizing power that grants greater access to a greater mass of investors. Their easy-to-use interface simplified the process. This is a double-edged sword as unexperienced investors can be nudged to think that investing is ‘easy.’ Therefore it is paramount for Robinhood to ponder on how to strengthen investor education along the way.
The Bottom Line
2020 has seen a surge in the popularity of the Robinhood app. In England, the tale of Robin Hood evolved over time as England evolved. It is likely that the trendy Robinhood app will also evolve in the years to come.
A Harvard Business Review article by Ndubuisi Ekekwe cites, “Nothing breeds copycats like a successful business venture. When a new business idea is incubated and executed successfully, cloners naturally emerge and imitate.”
In the recent past, established brokers copied from Robinhood and started offering free trades. Soon, it may be Robinhood’s turn to copy from those firms whose operations have been successful for decades. As a result, Robinhood may offer more transparency, customer service and investor education. Otherwise, the app may develop an increased reputation for gambling and not investing.
A sign of things to come, Robinhood’s management recently announced it would stop sharing data on stocks popular among its customers. That step is an important “coming of age decision.” The broker is considering going public in the near future and would need to have strong credentials before filing for an IPO. The platform has also decided to invest in customer service and investor education.
Meanwhile, Robinhood could possibly find itself a takeover target, especially before the price tag gets any higher.
On the date of publication, Tezcan Gecgil did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Tezcan Gecgil has worked in investment management for over two decades in the U.S. and U.K. In addition to formal higher education in the field, she has also completed all 3 levels of the Chartered Market Technician (CMT) examination. Her passion is for options trading based on technical analysis of fundamentally strong companies. She especially enjoys setting up weekly covered calls for income generation.