For folks trying to understand this, some context which may be useful:
Checking accounts are loss leaders virtually everywhere, the exception being smaller community banks. Their primary revenue stream was, once upon a time, net interest income, but these days due to the extremely low interest environment and alternate sources of funding the revenue stream is more weighted towards fees (primarily NSFs, although that was hit a few years ago) and debit card interchange.
Robinhood also likely expects to not become the park-your-money account of choice for older dentists but rather to become the spend-your-money account for their millennial userbase. With high velocity of money and low balances the interest expense is minimal and, to the extent they use debit cards, the interchange revenue can be material. (In a stylized example where someone makes $2k a month and spends $200 on debit card purchases and $1.8k on rent/etc the interest cost for the year is ~$30 and the debit card interchange for the year is ~$60, even ignoring potential interest revenue.)
This is roughly in the same line as their core strategy, which is spending what would otherwise be a marketing budget on keeping commissions at zero, making money on the other ways brokerages make money. If you do not understand how a brokerage makes money, I encourage you to peruse the annual reports of e.g. eTrade or TD Ameritrade, which will happily explain their revenue sources and why commissions are a surprisingly small portion.
Metacomment: geeks who believe they have outmathed a financial firm should ask themselves "Are financial firms likely to be bad at math?" and "Are financial firms incapable of hiring their own geeks?"
> Metacomment: geeks who believe they have outmathed a financial firm should ask themselves "Are financial firms likely to be bad at math?" and "Are financial firms incapable of hiring their own geeks?"
reminds me of the first time i interviewed at google, and one of the interviewers asked "if you could set up your own project and get a team to work on it, what would you do?". i answered that i would get a bunch of maths phds together and have them work out graph-theoretic ways of detecting link farms (this was 2004, and i had actually been wondering for a while why google hadn't done exactly that).
the interviewer (who was a pretty senior person) asked "why do you think the spammers don't have their own phd mathematicians to defeat such measures?". i was only a few years out of grad school at the time, and it was honestly the first time i thought about the fact that people who were both smart and educated might nonetheless go into a shady and declasse activity like running spam sites. i consider it a valuable lesson to this day.
Geeks can and do outmath financial firms and even bookmakers and casinos.
The financial firm, bookmaker and casino just needs to outmath the 99.9% of customers who are not trying to beat them to win, and evict the 0.01% of customers whose outmathing is so good it is causing them problems.
Exactly. Counting cards at the blackjack table in Vegas isn't illegal, but they won't let you play after they figure out that you are. You can can beat the bookmakers, but once you do, you either get cut off or you only get offered odds with more juice.
How much are you willing to gamble on the prospect that you're in the top 0.1%? And before you answer, consider that you haven't been evicted so you're obviously not in the top 0.01%.
>> people who were both smart and educated might nonetheless go into a shady and declasse activity like running spam sites.
The crooks I've met have been the smartest and most insightful people I've met in tech. I know one guy who, after years with a CC scam operations when to work for an online merchant. His knowledge of payment systems and payment processor policies was encyclopedic. The big issue was whether he was trustworthy. Lucky he had never been convicted of anything.
For every criminal savant there's probably at least 10 script kiddies exploiting older people, prostitutes, and every other vulnerable group imaginable.
I’ve never imagined link farms to be so profitable an enterprise that they could afford a team of phds and come out ahead; but if they could, then its an arm race, and google would be at a much greater disadvantaged if they didn’t have their own.
Thus, your response should have been: link farms with their own phds is only more reason to instantiate your plan
>I’ve never imagined link farms to be so profitable an enterprise that they could afford a team of phds and come out ahead; but if they could, then its an arm race, and google would be at a much greater disadvantaged if they didn’t have their own.
Go on a blackhat SEO forum. Look at the number of sellers, the number of listings, the number of positive feedback and the cost of some packages (you can easily go on and spend 50$ or a 1000$+ for a single package). There's a LOT of money in blackhat SEO. That's just the people offering to do it for you.
Then look at the dozens of software packages for sell that are constantly being updated and have both one-time fees and ongoing subscription pricing.
Then go look at the people selling just various social media accounts which mass-creation of gets harder and harder.
Then there's people that sell VPS access. They'll buy the software tools and host them all on a VPS and rent to you weekly or monthly so you can shell out tens of dollars or hundreds of dollars a month instead of needing to cough up thousands just to get all of the software for the month.
And that's just what's readily available with paypal or a credit card on the clearnet.
I assume they're trying to break the inertia people have with major banks. There's no reason to change bank unless there's some substantial incentive like favorable interest rate to offset the hassle involved. I'm not sure there's an ulterior motive here other than customer acquisition.
Agreed, they are trying to buy customers, if it turns out that they can't convert these customers into traders they will lower the rate to a breakeven amount and not care if they lose those accounts.
Perhaps true, there's been an opening for a 'cool' millennial-oriented financial institution for a while now, so perhaps fewer customers will drop off than expected.
... I can't remember but there was one I used at some time that was like that. Had a weird spirograph logo and a cardboard motif on their site. There were a few others.
Which should tell you a lot. I've been through the "Millennial Bank" wringer.
Honestly, checking accounts are all the same. Especially because I use a credit card paid in full every month. It's a holding pool till next month's CC bill is due. Until the US treats debit cards with the same protections as credit, I won't let my debit card near a gas pump or wander off with a waiter or be used online.
I don't know that there's an opening really. That so-called opening keeps popping up since like 2005 and gets "filled" by a SV-backed MVNO-For-Banking and it's just........a checking account provided by some.other actual bank repackaged with a (nice) angular front end and on the AllPoint ATM network with crappy chat customer support.
Simple bank. They’re based out of portland. I use them. They’re pretty good and have great support. Also $1 out of country withdrawal fee which is nice.
Seems like a weak market to go after, given that people likely to respond to a "cool" financial services brand may be a poorer demographic that maybe doesn't have any prior experience with "legacy" financial services providers. So just because they create accounts @3% doesn't mean they'll also open trading accounts.
> So just because they create accounts @3% doesn't mean they'll also open trading accounts.
From the Robinhood website fine print “Robinhood Checking and Savings is an added feature to existing Robinhood accounts and is not a separate account or a bank account.”
So, yes, opening a Robinhood Checking & Savings account does mean that they will open a trading account, because they aren't actually different accounts. (And it's a waitlisted feature where you get moved up the waitlisted by referring others to RobinHood, so it's a clear way of getting the overall service in front of more users.)
Millennials may not have money now, but they'll accumulate more wealth as they get older. If you can convert them now, the friction to changing again is high enough that you'll probably still have them when they're worth something.
That's a good point. A friend of mine in medical school told me that banks are itching to give loans to broke med school students because they know building the relationship now is going to pay dividends when the now-broke student becomes a doctor looking to buy a new car or new house.
Yep that's a good play, but their page says that the 3% can change depending on the market. So if that percent changes a few months after you create an account, I would bet many people would leave cause of the bait and switch.
> Seems like a weak market to go after, given that people likely to respond to a "cool" financial services brand may be a poorer demographic that maybe doesn't have any prior experience with "legacy" financial services providers.
Yeah but people do grow up. And I don't know about you, but I've got some super long term relationships with some banks. They are in it for the long game.
Huh. I don't have much of a problem going in to a bank branch, given that there's one every half mile. A quick in-person meeting is fine compared to the shitstorm of unusable menus and nearly unintelligible communication that is calling your bank on a cell phone.
(I mean it would be great if there were a bank that did all its customer service over text chat, but that's too much to ask for, right?)
I'd prefer a usable website in addition to guarantees of prudence in investing the money. My $ for both. If Robinhood replaced SIPC with something as credible, I'd go for it. They could probably do it with US Treasuries and bonds from Google, Apple, Facebook, etc.
Judging by their recent activity, Simple won't respond well at all. They've been in a downward spiral for the past few years post-acquisition by BBVA. All the original founders have left amidst a revolving door of executives, and the company has struggled to launch new products and innovate beyond their initial budget features.
Right, but that incentive is only substantial if you’re going to park a lot of money there, which is exactly the sort of customer they don’t want according to the comment I replied to.
I'll move my ~$100K emergency fund into there just to get free money. And move it out somewhere else when the rates change. Over the years I've moved accounts between Dollar Savings, Emigrant, Orange, Ally, and probably 2 or 3 others...
I would have to read up on the transfer times. If it's reasonably standard (2-3 days) and doesn't have any daily limits, then yes. It's a US company, FINRA approved, SIPC insured, so the risk is minimal.
Not to make you feel bad, but at $150k/year salary (average in SV) one should be able to save $100k within 5 years, with little impact on quality of life.
They may be playing this on two sides: the more obvious one which is acquiring customers to feed their trading business, and simply trying to evolve into a financial institution, which should bolster their valuation in their inevitable IPO in 2019 or 2020. Their backers might be content to burn money for a year or so to get a larger multiplier at some point in the future.
here the catch, I believe:
1. it's ensured by SIPC, not FDIC, so it's not as safe.
2. They're going to lower that 3% rate down whatever all the other banks are at (2%) in a couple of years, unless the interest rates catch up to their higher rate, which they are expected to do in about 2 to 3 years: at that time, 3% will be roughly the norm for the highest interest savings accounts.
I remember the days when Citibank would give out 4% interest about a decade ago. now of course, it's about 0%. It's just classic bait and switch.
As far as I can tell, the coverage amount of 100,000 euros was respected in these cases, probably precisely to avoid doubts like that about the safety of deposits.
Your first link doesn't mention the insurance amount at all, the second only talks about deposits beyond the 100,000 euro limit and apparently British customers got an even better deal with the higher limit of £85,000.
Apparently the president of the SIPC stated that Robinhood didn't contact the SIPC before making their announcement. The SIPC president Stephen Harbeck is on record saying that "SIPC protects cash that is deposited with a brokerage firm for one limited purpose... the purpose of purchasing securities. Cash deposited for other reasons would not be protected. SIPC does not protect checking and savings accounts since the money has not been deposited for a protected purpose."
He later stated that the SEC would need to take the lead on clarifying the matter though.
I have a one-year emergency fund with Robinhood that is invested in index funds (secondary emergency fund as the primary emergency fund is in cash). I think I'll keep my primary emergency fund in the PNC high yield savings account for now until all that gets worked out.
Robinhood's checking page says "Robinhood Checking and Savings is an added feature to existing Robinhood accounts and is not a separate account or a bank account."
I have not dug thought this specific offering but here is how it works in general it works this way:
Account has 3 parts:
1. Marketable securities -- value is NOT insured.
2. Cash on hand -- value IS ensured.
3. Money market fund -- value is NOT insured.
(3) may or may not be offered and if (3) is offered it has to be elected by the account holder. Money cannot flow from (1) to (3) or from (3) to (1) bypassing (2) due to securities regulations -- one cannot pay for one security with another security, a settled cash must be used.
If the APY is on (2) they will get killed by the fatwallet/slickdeals crowd. If the APY is on (3) it is more complicated but debit/check transactions against (3) are very expensive to clear so I don't quite see what the play is.
>Why would they expect this account to be used as a high-velocity, low-balance account rather than a park-your-savings account, given the rate?
Think of it like being a health insurance salesman who puts your office at the top of a long flights of stairs. You can have a lower risk pool because the only clients who come to see you are the ones who can climb a bunch of stairs to get there.
In other words, they advertise to a user-base that doesn't have much in the way of savings so they're avoiding people who would keep high balances anyway.
Besides, most people who do have large balances tend to park them in money market funds anyway. They can usually hit between 2% to 3% annually and offer more flexibility in terms of being able to access the money without transferring balances around. Alternatively they'll be putting it in tax-deferred accounts.
If you have enough money coming in that you can accrue a lot of savings, a savings account isn't the most productive place to put it. It should be regarded as more of a rainy day fund or a place to park money that you're saving up for something specific, like a down payment.
I'm a millennial, and the target market for this sort of product.
1. I don't care about physical branches, I've been using online banking from the beginning.
2. I am at a stage in my life where I am slowly paying back all my debts and making just enough to set some cash aside every paycheck.
I don't have enough money to go looking at financial instruments such as money market funds or CD's, because they tend to lock my money up for a certain period of time.
I still need to be liquid. Some place where I can make 3% and have it just sit is fine for me, and allows me to access it in case of an emergency without paying fines or penalties for doing so, and with less hassle than some other financial instruments where it is locked up.
Once I have a buffer built up, and I feel comfortable with that buffer, maybe then I'll start looking at other places to potentially let my money make more money faster with a little higher risk and with less liquidity.
I’m sure a lot of people might start out that way. But if you get free money for parking your cash there, why not use that money to dabble in some trading? Seems like there is little downside for the company, and potential for upside for the consumer. Pretty good acquisition strategy, in my opinion.
>while the risks involved with trading that money are substantial.
Also, presumably lots of people would rather put their beautiful minds towards things other than being anxious about how their savings are going. There is a lot to be said for just being able to park your money somewhere and not have to worry about it while you go live your life.
Most people won't think like that though, especially the millennial target customer who has the time to gamble money, rather than necessarily needing to save for retirement. Currently Robinhood takes three days to transfer funds, so reducing that friction, when customers make impulse decisions when they see that the stock is going up, is paramount. Why wait a few days when the money is already there? This is the benefit of vertical integration.
Holding cash had higher returns than index funds over the last 6 months. That's not a high bar when the market is going down. VTI is below where it was 12 months ago.
Usually you want to build a tractor (recurring deposits to a reference rate) at the 7 or 10 year treasury, to ensure that you have a stable supply of available deposits, and a short term rate too to handle "hot money".
You make money on the spread.
I really don't see how they are funding their interest rate.
No one knows what Robinhood will do, but no bank can promise a perpetual 3% rate. The rate is probably a teaser. Even if it is perpetual, it may be "on the first $10,000, with a minuscule rate on larger sums...something that allows them to advertise 3% but offer much less on larger sums.
Kind of funny but I remember 3% rate being kind of normal for a checking account in the early 90s. Of course inflation and Fed was higher back then too.
What I don't understand is those people who willingly park their money in CDs at under 1% and the banks proudly advertising these rates.
This era of seemingly permanent low(or even negative) rates just somehow seem unnatural.
What happened to banker's 6-3-3 rule? "Lend at 6%, borrow at 3% and go golfing at 3:00PM"
> No one knows what Robinhood will do, but no bank can promise a perpetual 3% rate.
It's not too crazy, rates have gone up a ton without most bank accounts adjusting from being near 0%. The 10-year is currently just under 3% with the whole curve being really flat and lots of online banks offer over 2%. I currently get 2.05% with my Marcus account and Goldman Sachs isn't exactly known for giving things away (and with 3 month t-bills paying 2.41% they certainly aren't giving anything away!).
Their FAQ states no caps, though it can vary depending on what the fed does with rates.
With the current 2 year treasury being 2.76%, they must making money on fees. I am seriously considering moving my savings from a Capital One money market account that earns 2% to this that earns 3%. That extra percent is decently significant.
The catch is soon there will be a maximum balance or activity requirement, or something to that effect, all of which are not contradicted by their PR sheet. It's otherwise utterly unsustainable.
> geeks who believe they have outmathed a financial firm should ask themselves "Are financial firms likely to be bad at math?" and "Are financial firms incapable of hiring their own geeks?"
Moviepass was also bought by a financial firm... Come to think of it, they have many similarities. Both companies are basically handing out free money and it's unclear how they would make any profit. People speculate that both companies would make money by "selling data." Unless if Robinhood is doing something very illegal, there is no way that they could make enough money that way.
That said, I do think that Robinhood knows what they're doing. They're getting a lot of publicity right now. In the worst case scenario, Robinhood can cut costs by slashing interest rates and putting a cap on the number of free trades you can do. Their worth would plummet, but later investors would be the ones who pay that price. Overall, Robinhood would still be better off.
That's not "analytics"; that's order internalization, something almost every retail brokerage does†, both because they get paid to do it and because it improves outcomes for their customers.
† You could argue either way about whether IB gets paid to "internalize" orders or whether the order flow rebates they get are something else.
This article implies for example that on a $10,000 trade that Robinhood would be compensated $0.80 (0.00008 per $1 of trade). That seems pretty modest.
Moviepass also wrongly assumed they had greater leverage with theaters. Turns out moviepass is still small beans compared to normal moviegoers.
If they had been able to work out a profit share off concessions and cheaper tickets with AMC/Cinemark/Regal/etc they might be in a different setting right now.
Robinhood doesn't make money on commissions, but they do make money with payment for order flow [1]. So they wouldn't want to put a cap on the number of trades you can make.
With transaction fees alone, there's plenty of room to make money. A huge chunk of the population doesn't have money parked in savings/investment and literally spends nearly all of what they have coming in. Especially in younger/millennial targets.
Robinhood makes their revenue on rebate fees, it’s not illegal but considered shady by some people. Ordinary brokers generally don’t do that (although some might).
It's also a way they can secure their loans. It's the exact same reason Capital One has bank accounts along with their credit card business (and Amex doesn't). Getting credit on the open market is expensive, by getting you to sign up with your bank account, they can leverage it to get cheaper loans for buying stocks (i.e. margin accounts). Capital One targets lower income people, so it's riskier and more vulnerable to fluctuations in market conditions. Amex in contrast, targets higher income individuals so fluctuations impact then less. This they can get away not holding bank accounts and securing credit elsewhere.
This means if there's a downturn in the market, they won't go bankrupt due to all the outstanding margin accounts (or have to do margin calls).
Perhaps true in the past, but AmEx has recently (I think?) started offering bank accounts. Their high-yield savings account is 2%, which is pretty comparable to Ally, etc.
Commercial banks also have access to the Fed discount window, which other institutions do not. This is one reason all the big investment banks converted to bank holding companies during the financial crisis.
In answer to your metacomment. The financial crisis is a strong indication that, yes financial firms can be terrible at math. Luckily, they have friends who can bail them out with taxpayer money when they fail at math.
Was that them being terrible at math, or them knowing that they were selling overpriced goods (00's houses, 90's tech stocks, probably college degrees) to folks who didn't know the math?
Big Finance knew it was hustling rubes, and then was able to ride the Gub'mnt Gravy Train when it became unsustainable.
The financial crisis was not a result of bad mathematics. Investments are made because they promise to return dividends. But there is always a chance that they might return lower than expected dividends, or none at all. This can be because the market didn't grow as expected, wages rose above expectations, a tsunami wiped out your factory or an array of other factors completely beyond your control. The best mathematicians in the world cannot predict how many coca cola bottles will be sold in a year.
Not so! One can indeed defend the claim that poor mathematical modeling of the statistical properties of collateralized debt obligations (CDOs) was the underlying cause of the bottom falling out of that market.
In brief, models were constructed of the complex behaviors of packages of loans - CDOs. These models, trained under benign market conditions, did not account adequately for correlations that might make all their component loans default at once.
You can elaborate the story with a lot of context and granular detail, but the core of the crisis did have a strong element of "bad mathematics" -- bad mathematical modeling.
Your point directly contradicts the conclusions of the paper you linked.
The paper concludes that while there were deficiencies with the modelling method (as there are with any model), input manipulation was at greater fault than inherent failures of the model itself.
"These results support the arguments of Donnelly & Embrechts[4] and Mackenzie & Spears[12], that Li and the Gaussian copula were not to blame for the Crisis...Instead it appears that the gaming of the model beyond its original assumptions, the outsourcing of CDO risk management to credit rating agencies, and the failure to perform holistic risk assessment seem far more to blame."
"The simulation results in this paper show that it is more important to focus on parameter estimation than copula choice. This leads to the observation that when it comes to mathematical financial modelling: in order to avoid a disaster, the cooking is more important than the recipe."
The paper is pointing at one aspect of the modeling (estimating the covariances of the copula), versus another aspect (the copula concept itself). That’s a detail that was very important to the author of the paper, but not to my point.
My point is that mathematical models were indeed being used and followed in this case, and that the issue really was with overextension of the model, and not just generic volatility of any market, as claimed by the GP comment.
Completely agree that the crisis wasn't caused by generic volatility, but any mathematical limitations pale in comparison to the human failure of manipulating ratings due to a conflict of interest caused by private rating agencies. That is what the paper you linked concludes, versus your initial claim:
>poor mathematical modeling of the statistical properties of collateralized debt obligations (CDOs) was the underlying cause of the bottom falling out of that market.
The model is hardly to blame when falsified inputs yield poor results.
I'm choosing to include "protocols for setting parameters for the mathematical model" into the "mathematical modeling" line item - please note that is the phrase I used, twice.
I'm not "blaming the model" - probably everyone recognizes that all models have limits.
I call your attention again to the point of my original comment - the GGP comment was claiming that the best mathematicians in the world could not have foreseen the kind of conditions that caused the 2008 market failure. I'm arguing that it was possible, and that it was clear (mostly in retrospect) that the model assumptions were being violated most promiscuously.
In fact, the real reason I chimed in is that I think this crisis was a really awesome example of the power that quite abstract mathematical constructs have over our lives. I felt that point was missed in the generic comment about "who could have known" that kicked this thread off, and I sort of wanted to rescue that underlying mathematical issue.
You are framing it as an exercise in foreseen likelihoods and the pill falling on red rather than black in 2008, but there are many counterexamples that say that is not the whole story. Read the Black Swan, or watch Margin Call, for example.
Metacomment: geeks who believe they have outmathed a financial firm should ask themselves "Are financial firms likely to be bad at math?" and "Are financial firms incapable of hiring their own geeks?"
Ah yes, because as 2000, 2008, and 2019 have shown us, financial firms are infallible when it comes to maths and economics.
They did the math correctly, it was just different math than what they were supposed to be using.
The incorrect ratings were intentional and designed to look like they were correct so that no one would find out. It's easier to make sure no one finds out the number is wrong if you know what the correct number is and how to tweak factors here and there to influence it.
I would argue that they happened exactly because the brokers who made up those financial institutions understood the math perfectly well: They make huge commissions on CDO and other deals. They sell the bad debt to some other shmuck and walk away with cash in their pocket and someone else holding the risk.
That's why it keeps happening. They get rich and get away with it every time.
At least 2008 had nothing to do with being good or bad at math. In fact, it kind of happened because of some rather fancy math. This article has been posted on HN multiple times:
I would call misapplying mathematical tools being bad at math personally. If you said that because you are intergrating revenue back into investments and are showing nx growth you'll get quadratic growth in exchange for cutting growth in half I would call that being bad at math. An uncommon form of it but still bad due to it being a clear failure to model the underlying domain. They did the same thing really by not taking common cause failures into account at all, thinking one can build low risk out of high risks, and more that an ounce of critical thinking could have saved them from.
I think that's a pretty broad definition that wouldn't find much support. I think the words you used later, "critical thinking" or lack thereof, are much more apt.
Also, if you've read any of the stories about digitization in financial firms, they are totally incapable of hiring their own geeks because it would displace very, very rich people who would have to do the hiring.
No. But you don't have to be bad at maths to play exploitably.
Many years ago now I was a hand-to-mouth graduate student. New credit card companies wanted to attract customers so they offered an easy approval card with 0% finance for 18 months. Need to use some of your new credit on existing debts? Rather than figure out all the specifics they just included a cheque book with the product, just write a cheque to pay any debts and it goes on your 0% balance.
Everybody I knew took out a card, write the full credit amount on a cheque, paid it into a fixed term savings account.
Account term ends, you pay off the 0% card, keep the interest, cut the card in half and you're done. Free money.
The people who ran those new card companies knew this might happen, they just didn't guess it would happen often enough to ruin them. Not our problem. A few years later the deals on offer explicitly did not have a way to cash out. Lesson learned.
>their core strategy, which is spending what would otherwise be a marketing budget on keeping commissions at zero, making money on the other ways
"Making money others ways" aka stripping their clients of financial privacy by selling their clients' investment-decision data: "Robinhood Is Making Millions Selling Out Their Millennial Customers To High-Frequency Traders"[1] If your investment brokerage firm's strategy is to use you as a sucker, no marginal gain in interest rate is worth it.
Yes HFT buys trade flow from robin hood because they make more money executing against it but that's not actually to the detriment of the people on the robin hood app. The main way HFT firms make money is by making a market, they offer to buy and sell stocks cheaper than anyone else and get paid by people crossing the spread and sometimes exchange fees. The reason robinhood trade flow is valuable to HFT firms Isn't because they are trading against "dumb" millennials but because they know millennials aren't likely to move the market playing around on their smartphone. HFT firms can collect a small rent sitting in between millenials trading with one another without the risk of being on the wrong side of a trade that materially moves the price of a stock.
The stock market is a zero sum game. If HFTs are making money then someone else's is losing it. The other traders who's trades are closest are the most likely losers. HFTs will tell you what a great liquidity service they provide but they are doing nothing more than using the equivalent of insider information to skim the cream off the top.
This is a facile analysis. If you believe HFT internalizers are taking money from retail traders, try to outline the series of orders that results in money from the retail trader's pocket going into the HFT's pocket, and precisely how the retail trader could have made that same money on their own.
The reality is that market makers price non-retail flow more conservatively (ie: costing traders more) because they have to anticipate informed large block trades wiping them out. Since they don't have to do that for retail flow, their cost basis for those trades is lower, and they can (and do) split the proceeds of that reduced cost with brokerages.
It's overwhelmingly likely that any other brokerage you use does the same thing, and simply doesn't tell you or pass any of those savings on to you.
>The stock market is a zero sum game. If HFTs are making money then someone else's is losing it.
But who's that "someone else"? It's not the robinhood customer, because they're getting at least the best price on NMS[1]. So what's the issue? Would you rather pay $10/trade so your trade gets posted directly to the exchange and the profit goes to some random investment bank or daytrader rather than the HFT firm?
NMS regulations do not apply to "odd lots" (orders <100 shares). This likely constitutes 99.9999999999% of trades done on Robinhood (and most retail trading, to be fair).
The stock market is not a zero sum game. I don't know where people get this idea that because every transaction involves two sides, the sum is therefore zero. Every transaction in the "real economy" also has two sides, and we all know that grows. The stock market grows too. There are even indexes to track how well it is growing.
The “real economy” runs on a fiat (inflating) currency system that is effectively not zero sum. The stock market is a closed system that currencies feed into - at the end of the day it’s still a measure of a fixed amount of value and thus zero sum.
> The stock market is a closed system that currencies feed into
Currencies feed into the stock market, but it's not a closed system. If you think a company is undervalued in the stock market, and you buy shares, that raises the price of shares for that company. With a higher share price, that company can borrow money (by issuing shares) at better terms, and spend that money on growing more than they could have if they had not borrowed that money.
If the stock price is too low, the company may buy back shares of its own stock (thus enabling future borrowing). Alternatively, investors may buy up a majority of the stock of that company, thus acquiring control of that company, and either try to force the company to do a thing they expect to be profitable, or liquidate the assets of the company (which will then be distributed to shareholders in proportion to how many shares they hold).
So basically the stock market moves money to the companies based on how effectively they could spend borrowed money / how valuable they would be if liquidated.
Currency is a tool for measuring economic value, it's not the basis of economic value.
This is why fiat currencies are so useful: you can change the length of the "ruler" to accommodate changes in the thing you're measuring, so the value of the increment remains stable.
No, companies create excess value and grow. Tesla pre Model 3 is a very different company than Tesla post Model 3. A drug company is very different if they've patented a new wonder drug. New companies come into existence and offer shares via an IPO.
Investing in the stock market is literally investing in the collective appreciation of the value of the companies that make up it.
But there's stocks on the other side that represent real things that increase in value. E.g, compare Google 20 years ago with Google today and see if you think it's more valuable.
Stocks are not zero sum. In theory, their value is based on future income. Information about the future is what most affects stock prices, because it changes expectations around future income. Even with no transactions in a stock, offer price can continue to rise because of these expectations, and it represents real increase in wealth to people who own the stock, no transactions necessary. When offer price rises enough to tempt someone to sell then you have an estimate of the market value.
Here is my understanding. Let a<b<c be small numbers. Some investor thinks a stock is worth
x+c. They put in a limit buy order at x. Some HFT firm sees this and thinks well if they want it at x, I want it at x, and puts in their own order at x (+a fees to robin hood). Millenial comes and wants to sell their stock.
Normally the investor would get the stock since they placed their order first. But since the HFT firm is paying for the order they get it instead. If things go well the HFT firm can sell to the investor at x+b, if things go poorly they cut their losses and sell at x.
The investor that didn't get the order and has to buy it from the HFT firm at x+b is the loser.
The money that funds this dance comes from the millennial who sold a stock worth x+c at x, but that would have happened regardless.
I can't speak to the accuracy of your claim, but Matt Levine recently wrote about another factor, payment for order flow [0]:
>They want to buy stock for $99.99 and sell it at $100.01 and clip two cents on each trade. If their orders are random—if sometimes people buy and sometimes they sell, with no pattern—then that works out well for the market makers. But their big risk is what they call “adverse selection”: Sometimes, when a customer buys 100 shares at $100.01, it then buys another 100 shares at $100.02, and another 100 shares at $100.03, and keeps going until it has bought 10,000 shares and pushed the price up dramatically. The market maker who sold it the first 100 shares—and who is probably now short and needs to go out and buy those shares at a higher price—has been run over.
>[...] [I]f a market maker can guarantee that it will only interact with retail customers—if it can filter out big orders from institutional investors—then its risk of adverse selection goes way down. The way the market maker does this is by paying retail brokers to send it their order flow, and promising those brokers that it will execute their orders better* than the public markets would. [...] It can offer a tighter spread than the public markets—and have money left over to pay the retail brokers—because it doesn’t have to worry about adverse selection. If the retail broker is, say, one designed to let young people day-trade for free on their phones, then those orders are probably particularly valuable, because they are probably particularly random.*
That's not true. When Robinhood (or any other retail broker) sends orders to a 3rd party to be filled, there is no way for that 3rd party to see who is sending the order other than it's coming from Robinhood. Robinhood maintains their own book customer orders; the FIX protocol that the orders are coded in doesn't even support that kind of granular info.
There are valid criticisms of payment for order flow but privacy isn't one of them.
Aren't all orders eventually public anyway? I get that the liquidity that "market makers" claim to create is not really that beneficial to society, but as long as you're not trying to use robinhood to compete with the high speed traders, I don't see a problem with it.
Not doing so or at least in a condescended form is kind of operating a fraudulent exchange. It is kosher to bundle 50 buy orders of 1 stock into 1 order or visa versa - get a bunch of little orders that adds up to a cheaper option. If it doesn't work out refund and inform that it failed to go through. If they asked for 1 share at $25 and you legitimately give it to them it isn't fraud. It is another to say "buy" Tesla shares for people when you really shovel it into another investment and work out what they owe when you think they will just go bankrupt and Theranos is the way of thw future....
no. most orders are not executed on the public exchanges, but by internal matching via your broker and a market maker. (also most exchanges only support trades in multiples of 100 shares.)
Exchanges handle odd lot orders nowadays. Maybe some brokers or dark pools do not, but they are not exchanges (their quote is not protected, or they show no quote).
I believe all customer trades/executions on actual securities should eventually be publicly visible, though there may be a small delay for them to "print to the tape".
That's an extremely poor article. Anyone can throw a hot take on SeekingAlpha; that doesn't mean their take is worth anything.
1. I don't know why the title mentions "millenial" customers in particular, because every brokerage does this across all demographics,
2. This activity is not "selling out" customers. If you believe that customers are "suckers" because their order flow is sold to high frequency traders, you have a very fundamental misconception about high frequency trading and its role in market making,
3. There is no codified definition of, or law protecting, "financial privacy" in the sense of order flow. This data isn't connected to you as an individual, just as you can't see which individuals or companies are placing bids and asks in the order book just because you can see the amounts and prices. All trades in the market are publicly reported regardless of whether or not your order flow is sold.
It never ceases to amaze me how the term "high frequency trading" can compel people to pontificate about things they clearly don't understand. You'd think we'd have collectively moved on from the Flash Boys misconceptions by now. Yet here we are, with an article talking about high frequency traders as some kind of financial boogeyman in 2018.
Why does everyone keep referring to checking accounts as "loss leaders"? They are more like "income leaders" - the banks are funding themselves at basically 0% and then earning the spread on whatever they invest in....
The banks incur lots of operational expenses processing transactions, paying for an ATM network, handling customer support calls, dealing with fraud, etc.
That is nothing compared to interest expense on CD's or other interest bearing accounts. Checking accounts are one of the most attractive sources of funding for banks (notwithstanding maturity mismatch).
+100%, deposits are the cheapest and most reliable source of funding. no comparison to wholesale funding by a large stretch - anyone ever heard of Northern Rock?
But also, worth asking oneself "Are search engine companies likely to be bad at searching?" and "If geeks could make a search engine, is a $50 million revenue search engine company incapable of hiring their own geeks?"
Checking accounts are loss leaders for the big banks(10 billion in deposits or more) because of the Durbin amendment which caps interchange rates of debit cards to 0.05% compared to exempt debit cards which rate is around 1.5%.
Why/how is Robinhood now showing how far along I am compared to my friends on the waitlist? I dont believe I ever enabled any social sharing, and Robinhood's access to my contacts is shut off.
I do not feel comfortable sharing (and especially not broadcasting!) my financial decisions with people I am connected to on social media. This is pretty upsetting to me.
Still, 3% is not just a little loss, it's a big loss. This is into the low end of the reward checking range which comes with lots of strings attached. It doesn't matter if they think they're targeting millenials, once the word is out it will be exploited to the extreme, and it's either going to end in a few months or there will be severe capacity limits so that you can't just park money there. You can bet on that.
Their primary revenue stream was, once upon a time, net interest income, but these days due to the extremely low interest environment and alternate sources of funding the revenue stream is more weighted towards fees
There are still banks who are trying to do this. You can rephrase it as, "lending money to winners." Even better if you can lend money to an underdog winner, enabling them to borrow even more in the future. Community banks are now left with only the underdog borrowers, as the low hanging fruit is swept up easily by the megacorporation banks.
Metacomment: geeks who believe they have outmathed a financial firm should ask themselves "Are financial firms likely to be bad at math?" and "Are financial firms incapable of hiring their own geeks?"
This is the POV of my wife, who manages underwriting: Community banks are having problems hiring the "A-Students" and "B-Students." This means that employees either make more mistakes, or need more rigorous support through custom software, which community banks can ill afford, and where the big megacorporation banks can handily outcompete them.
I'm not sure it's even this complicated. They want people to use Robinhood to trade. People need to have cash in their account to do so. Rather than having to wait a day to transfer money they can incentivize you to store your money within Robinhood so that there's no friction to you making more trades.
Things might be very different in the US, but interchange is nowhere near 2.5% for a debit card in Australia. Maybe that's what is levied to the merchant (or more) but by the time it gets back to the issuer, after merchant service fees and on-charged scheme fees it's more like 0.5% for a debit card.
I could be mistaken but business models built on interchange (I think) have been the downfall of a number of 'neo-banks' from the last 5-10 years. More recently I've seen people adopting a commercial-classified card (or other) for these types of plays for the sole reason of it attracting a higher rate of interchange vs a typical consumer debit card.
I imagine that the demographic they are supposedly going after for debit cards is the same demographic that takes advantage of great credit card deals. I don't see debit cards becoming fashionable as the go-to charge card for reasonably well-off millennials that are eligible for great credit cards. Those that aren't eligible for these credit cards likely have inconsequential amounts of savings anyway...
They may expect it - but I could see plenty of savvy investors using at as a short term cash deposit, hell I would (if I was in the USA) its 2x what I get in the UK
Great summary @patio. I was just telling some friends about it..simple bank, offers 2% on checking with certain balances met, and I experienced similar to example above.
Your question seems to be implying that you believe financial firms are more stupid than greedy. In contrast to Hanlon's razor, I think it's usually fair to assume greed over stupidity.
You are just wrong. Being unable to overcome bureaucracy or organizational tech debt is not a matter of stupidity, and various actors up and down the hierarchy can have misaligned incentives that ensure it remains contentious and political.
Furthermore, many boutique investment business exist for purposes of client services and plausible deniability on part of the client’s board.
I’ll give you a concrete example from when I worked in an asset management company. One client was a large pension fund for a state’s retired firefighters.
We showed them time and again a variety of enhancements to the basic portfolio construction product they bought from us, particularly in line with their overall goal of balancing investment in certain sectors across different asset managers to reduce risk.
They were not interested, not even on the basis of paying reduced fees for a simpler process. We also talked to them at length about why using a concentrated benchmark for that product (SP500) was a bad idea. Again, not interested.
After some months where our performance was pretty flat in that portfolio against SP500, pretty much as we told them we predicted it would be, they fired us.
In the client exit interview with two members of their board, they basically told us that each year they have to fire a certain number of the asset managers they do business with, in order to appear proactive and justify getting bonuses for taking action.
They obviously didn’t say this directly, but it was clear enough. They ended the call by saying they would be super excited to review re-investing with us later the next year, presumably at which time they have to do musical chairs with which asset managers they hired & fired to look proactive again.
Internally, some of my older mentors on the portfolio management team badically said this was the business. Nobody cares what math you use for investing at all. Everybody just uses super stupid linear regression based on outdated factor models from 40 years ago, all using the same data from the same big data vendors.
As long as you have hilariously over-credentialed PhDs selling linear regressions based on momentum or price-to-earnings, the clients are happy because you are cover-their-ass hire & fire insurance to them, nothing more.
It would not be hard at all for skilled amateurs to outperform these shops.
I never implied that. Stupidity has nothing to do with the inertia that comes with big organizations and institutions.
Of course they're greedy, but sometimes it's easier and more "natural" to make more money by rising fees, as opposed to deeply changing a modus operandi.
Why is a question like this being downvoted? It seemed honest and in good faith – what is it that leads to organizational ossification and stagnation. It might be different factors in different industries.
my experience with this is that its not whether they are able to - but the cost benefit of abandoning legacy service lines that are still hugely profitable but maybe not be growing (or actually shrinking)
Hopefully, they've already added some fine print, or will shortly. I've seen other banks be successful with this high interest strategy but every one of them requires 12-20 debit transactions per month in order to receive the high rate.
If Robinhood allows users to simply park their money, they could be in for a world of hurt.
My thoughts exactly. This looks like a good deal for people who would alternatively invest in money market funds. I bet they have an account cap or tiered rates.
Checking accounts are loss leaders virtually everywhere, the exception being smaller community banks. Their primary revenue stream was, once upon a time, net interest income, but these days due to the extremely low interest environment and alternate sources of funding the revenue stream is more weighted towards fees (primarily NSFs, although that was hit a few years ago) and debit card interchange.
Robinhood also likely expects to not become the park-your-money account of choice for older dentists but rather to become the spend-your-money account for their millennial userbase. With high velocity of money and low balances the interest expense is minimal and, to the extent they use debit cards, the interchange revenue can be material. (In a stylized example where someone makes $2k a month and spends $200 on debit card purchases and $1.8k on rent/etc the interest cost for the year is ~$30 and the debit card interchange for the year is ~$60, even ignoring potential interest revenue.)
This is roughly in the same line as their core strategy, which is spending what would otherwise be a marketing budget on keeping commissions at zero, making money on the other ways brokerages make money. If you do not understand how a brokerage makes money, I encourage you to peruse the annual reports of e.g. eTrade or TD Ameritrade, which will happily explain their revenue sources and why commissions are a surprisingly small portion.
Metacomment: geeks who believe they have outmathed a financial firm should ask themselves "Are financial firms likely to be bad at math?" and "Are financial firms incapable of hiring their own geeks?"