🕶e8: Robinhood: Get ya money up, don’t get ya funny up

Jan 31, 2021

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🤡 Robinhood: Get ya money up, don’t get ya funny up

Robinhood: A fictional character who steals from the rich and gives to the poor. Fast forward to 2021 and we have an app that’s trying to live up to its namesake. But, is it? I remember being excited to sign up for the first fee-free brokerage six or seven years ago, waiting for my email to get into their beta. I had thought, “Finally! a way to bypass my $9 TD Ameritrade trade fee!” Of course, however, in life, there really is no free lunch.

Whether dealing with a plague of unreliability issues during peak trading times or struggling to keep up with its slew of customer support tickets, the company has definitely made it through some rocky times. If you haven’t been keeping up with what’s been going on in the market-wide short squeeze, I recommend you read this Gamestop Issue to get you up to speed!

We expected new retail investors to continue this current crazy trading behavior, seeing alternate assets such as Dogecoin experience insane all time highs. Robinhood had never experienced such volatility within their platform, and with this increase, the platform temporarily restricted the amount of shares users could buy of certain “hyped” stocks - a move drawing major backlash from smaller shut out investors. Will all this chaos spell the end for the non-commission trading giant?

Robinhood’s Past, PFOF, and why is it so important?

Robinhood started out as an ambitious platform to eliminate brokerage fees. Easier said than done… Finding revenue with a “free platform” is tough, and this is where PFOF really comes into play. For those unfamiliar, PFOF, otherwise known as Payment For Order Flow, is the practice of directing trade info to a specified high-frequency trading fund (Market Maker) which then goes out, buys the shares, and sells them to the brokerage/client at just a slightly higher cost. This profit is what ends up compensating the brokerage, usually without the client's knowledge. The amount of compensation depends on the efficiency and execution of the trades.

Lemme break it down: I buy 10 shares of Tesla on Robinhood. In the short time between me swiping up for confirmation and the time it takes to execute the transaction, the data of my transaction is sent to these large frequency traders. These traders have developed successful trading algorithms that can determine what users want to trade and at what price. In the interim, these funds purchase those securities that us retail investors want to buy, at a slightly cheaper price, and sell it to us at the price we want to pay. Yup. Mind. Blown.

Why Did They Halt Trading?

While 400% for these young bull savages wasn’t quite enough yet, waves of new retail investors turned to Robinhood’s easily set up platform to yolo into these high demanded stocks (GME, AMC, etc). However there was one big problem, how the heck was Robinhood supposed to keep up with the surge? The company reportedly had drawn millions of dollars from their credit lines to help cover margin requirements and provide liquidity for people who wanted to ca$h out. Furthermore, the Depository Trust and Clearing Corporation, which is Wall Street’s central clearing hub, had requested brokers to provide billions more to cover the increased transactions. To simply break it down, Brokers such as Robinhood provide capital to the D.T.C.C to cover investors while they wait for the trades to settle. Note: Stock trades settle T+2 meaning if you buy the stock Monday, the cash will settle on Wednesday.

The Consequences?

The company now only allows investors to sell and not buy shares in certain companies (50 securities are now restricted on the platform), as well as only allowing the purchase of a single share in Gamestop, and more
The restrictions were also placed on certain cryptocurrencies, turning off instant buying power
- So much for their mission statement to “democratize finance for all”... lmao

Ev’s Take

So, what’s next? A new business model? Canceling Robinhood and moving to a new brokerage? All sound boring. How about the introduction to decentralized finance? Before we dig in to what the heck I mean, I just want to note how freaking crazy this whole week was in the market. To sit and watch retail investors shock Wall Street and drive a billion dollar hedge fund to bankruptcy was just insane.

Now, let’s dig in. Lawsuits that were filed against Robinhood were centered around the argument that as a broker, Robinhood has the obligation to fulfil investors' order “promptly” and “effectively.” But Robinhood’s sneaky sneaky user agreement states that it may, at any time, in its sole discretion and without prior notice, prohibit or restrict abilities to trade securities. While, yes, the above states Robinhood’s actions were legal, the counterargument is that larger funds are benefiting on their short positions, as investors cannot continue to purchase at the current level of demand on the platform.

I am not sure whose side I am on here. If you know me, you know that I am not an advocate of Robinhood’s platform, as security is my #1 priority when it comes to trading. I’d rather use a larger broker like TD or Fidelity and pay the small transaction cost than deal with the BS that occurred this week.

Okay now to the juicy stuff - decentralized finance or better known as, DeFi. To begin, Bitcoin and other cryptocurrencies’ missions are to make money payments accessible to anyone with the power of just the internet. But, why not take this up a notch?

Imagine an open-sourced, decentralized, financial ecosystem that allows any and all users with a smartphone and an internet connection to have access to every financial service we use today. We’re talking access to loans, trading, insurance, savings, and much more, but without the intermediaries (central banks). To give a glimpse of how this would work, imagine living in a developing country with an unstable or corrupt banking system. You are working on your new business and need to raise capital. What are your options? 1) Take a loan out yourself from an unreliable, unstable central bank, resulting in low liquidity and high interest rates; 2) Crowdsource your next endeavor through individual investors, which is potentially highly unlikely in a developing country; or 3) Take advantage of the new decentralized financial network to meet your desired lender. The idea is to use existing networks like Ethereum to provide permissionless financial services through Smart Contracts or programmed service agreements to carry out a set of instructions between lender and borrower.

To conclude, in light of the recent events, I believe we will continue to see a push towards decentralization creating equal opportunity across the world for everyone to access necessary financial services.

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💼 Jobs/Internships

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Remote

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💯Thank You For Reading, See You Next Week!

What's up, my name is Evan Hiltunen! I am a recent finance grad from Indiana University and financial analyst @ Goldman Sachs. I have a strong passion for start-ups, finance, and technology, and I hope you find this newsletter informative!
I’d love your feedback - feel free to email me at thee8newsletter@gmail.com
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