Robinhood struggles with the monster it created

If Robinhood sees one thing, it’s selling for free.

Before investors in Robinhood, the Menlo Park, California-based trading platform, started a stock market firestorm last week, they were only happy to continue the growth. Now they have no choice.

Robinhood has faced crippling cash claims raised by a Reddit subgroup of WallStreetBets, which has increased the share price of companies including GameStop and AMC, which have been targeted by well-known short sellers. The stated purpose: push in the shorts. The subsequent number of orders drove Robinhood with its cash position in difficult areas, when the clearing house that helps process and complete the business asked the company to set up more capital to meet the margin requirements. Robinhood responded by limiting trading to 13 shares on Thursday, angering WallStreetBets investors and dropping stock prices.

To stabilize itself, Robinhood, founded in 2013 by Vlad Tenev and Baiju Bhatt with a mission to ‘democratize finances’, turned to early investors to raise more than $ 1 billion within hours. The New York Times reported on Friday that the rescue funds came from previous investors, including Sequoia Capital and Ribbit Capital. Meanwhile, after the platform reopened to full trading on Friday, amid criticism and a lawsuit claiming to prioritize its high-end clients over retail investors, prices for these shares have started to climb again. By the end of Friday, GameStop and AMC shares were 400% and 278% higher for $ 325 and $ 13.26, respectively, for the week.

However, the larger stock market suffered a setback, while the S&P partly lost almost 2 per cent because the hedge funds that the companies shorted then had to sell other shares to cover their losses.

Prior to the $ 1 billion infusion last week, Robinhood raised $ 1.7 billion from the best Silicon Valley stores, including New Enterprise Associates, Kleiner Perkins Caufield & Byers, and Andreessen Horowitz, as well as from well-known investors such as Ashton Kutcher, Jared Leto, Snoop Dogg, and John Legend. With additional funding rounds, its valuation rose to $ 11.2 billion in August 2020, from $ 8.3 billion in May. The company had revenue of about $ 60 million in March, a doubling from a year earlier Bloomberg in April. Robinhood did not respond to a request for comment. Inc.’s request for an interview.

Nevertheless, investors have limits, says David Yermack, a finance professor at the Stern School of Business at New York University. He notes that when the price of GameStop drops – and it will almost certainly be – some customers will end up ahead of calls and will not be able to repay Robinhood because they bought too aggressively. “There is a risk that Robinhood could break even because they have concentrated too much exposure to this one high-flying stock,” he says. “That’s why they went out and raised a billion dollars from big investors.” He adds that existing investors will be supportive, but perhaps not forever.

The experience can also drive another nail in the coffin of the ‘freemium’ business model. As a commission-free broker, Robinhood drops from what used to be the industry standard a fee of $ 6 to $ 10 for each trade. Yermack notes that he indirectly earns money by possibly charging higher prices compared to other brokers. It also asks for order flow. Robinhood’s operations, which may include stocks, ETFs, cryptocurrencies and options, are sold to large companies such as Citadel Securities and Virtu Financial, known in the industry as ‘market makers’. The market makers execute Robinhood’s transactions, sometimes at lower prices, and offer a small setback to Robinhood. The process is controversial, but so far not illegal.

The company also earns money from its premium services. It launched Robinhood Gold in 2016 to offer features such as the ability to do pre- and post-hour trading in exchange for a monthly fee.

The freemium model has been a fixed place in the digital market for many years. After building a customer base by giving away a basic product or service, it is likely that a certain percentage of users will purchase premium or upgraded versions. Still other companies never count on consumers to pay. Like Facebook, Robinhood makes the bulk of its revenue from customers who are willing to pay to access its users. And therein lies the problem, says Jason Nazar, a technology entrepreneur and investor in Facebook and other companies. “I honestly think there’s room for conflict when you have a business that serves two masters. You have your end users who provide you with data and information, and then you have customers who pay your bills. Which side do you fall on?? he asks. “I think more businesses are likely to err on the side of their end users instead of their data partners.”

Indeed, if Robinhood is guilty of anything, it is that he is not completely transparent about his revenue model, says Ethan Kurzweil, a partner at Bessemer Venture Partners in San Francisco, where he focuses on developer platforms and digital consumer technology. “I do not know to what extent it was first understood about how Robinhood made money until the recent press round about them.” This opacity became apparent when users themselves on social media pointed out the irony that Robinhood restricted their access on Thursday, while the customers of the big fish were allegedly allowed to close their positions. The company denies this allegation.

Either way, Robinhood will have to clearly restore his image. And Kurzweil suggests that other start-ups entering the freemium space will be held to a higher standard of messaging and disclosure as a result of this disaster. To be clear, he says, freemium does not go away. “People like it for free … but maybe there are only a few companies where there is a disconnection as to what people believe is the cost they are paying, and maybe Robinhood is an extreme example,” he says. “I think people are definitely going to apply more skepticism if the monetization is not clearly understood.”

Entrepreneurs themselves are also likely to be more cautious in the future, Nazar says. “What you will see is that companies with such business models need to be much more considerate and diligent when such conflicts can arise, and how they want to deal with them,” he says. “I guess Robinhood are already kicking themselves for how they communicated.”