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by Finage at February 4, 2021 4 MIN READ

Stocks

Robinhood Might Have Broke Itself?

 

The lack of clarity of the free trade business model of the Robinhood initiative, which offers free brokerage services, has caused the quality of consumers to decrease. So, will this situation create bias against entrepreneurs who aim to provide similar services in the future?

 

Last week Robinhood investors were delighted to help develop this platform. But things suddenly turned upside down, and due to unexpected circumstances in the stock market, they no longer had any choice but to support Robinhood to protect their investments.

 

Recently, Robinhood faced a cash request from a Reddit subgroup called WallStreetBets. Because this group aimed to prevent well-known short sellers from decreasing the stock value of companies such as GameStop and AMC. The stock market language definition of this blocking is `` squeezing shorts. '' The high trading volume from the WallStreetBets group caused Robinhood to get stuck with cash, and the clearinghouse that helped the firm trades asked the company to put in more capital to meet its margin requirements. In response, Robinhood responded to the demands of WallStreetBets investors by restricting the trading of 13 stocks and lowering the prices of those stocks. Of course, this response angered WallStreetBets investors.

 

Robinhood, founded by Vlad Tenev and Baiju Bhatt and whose motto is "Democratize finances," focused on early investors to raise as much as $ 1 billion to sustain its continuity. News sources reported that the rescue funds came from previous venture investors, including Sequoia Capital and Ribbit Capital. In addition to these events, it was claimed that the platform notified its top investors about the trading activities of its individual users. With Stock API applications, the platform, which could transfer instant data and transaction orders to large companies faster than individual users, actually sold the data of retail users to large companies. While the lawsuits on these allegations continued, the prices of these stocks continued to rise at the closing last Friday, with GameStop and AMC shares rising to $ 325 and $ 13.26, respectively, for the week, up 400 percent and 278 percent.

 

Prior to its $ 1 billion infusion last week, Robinhood received $ 1.7 billion from major Silicon Valley stores and well-known investors such as Ashton Kutcher, Jared Leto, Snoop Dogg. Its value, which was $ 8.3 billion in May 2020, increased to $ 11.2 billion in August 2020. The firm had approximately $ 60 million in revenue in March, Bloomberg reported in April.

 

According to David Yermack, a finance professor, meeting customers' sales orders when the prices of GameStop stocks fall could expose Robinhood to bankruptcy. For this reason, they raised $ 1 billion from major investors as a precaution against bankruptcy. Although Yermack says that existing investors may support for a while in this case, he added that this support will not last forever.

 

How is Robinhood Free?

This negative experience with Robinhood has also created negative effects for the business model called "freemium". Robinhood, a free broker, does not charge its users around $ 6-10 per transaction. So how does it cover its expenses and make money? Robinhood makes money from the order flow. This means that it sells users' transactions to large firms such as Citadel Securities and Virtu Financial, known as "market makers." The ethics of this process is controversial, but it is not illegal.

 

In addition, there is a package called Robinhood Gold that offers premium features. Thanks to this package, it provides its customers with privileges such as pre and post-shift transactions for a monthly fee.

 

The freemium business model has been operating in the digital market for many years. According to this model, it is considered that after you offer a basic service for free, some of your customer base will pay to take advantage of your premium features. However, some companies do not rely on users to pay and choose other sources of income. Facebook is an example of this. Just like Facebook, Robinhood generates most of its revenue from customers willing to pay for access to data sets provided by its users. According to Jason Nazar, a tech entrepreneur and investor, a business that serves two masters by nature will eventually create a conflict zone. In this conflict environment, will you choose the end users who empower the company with data and information or your customers who pay your bills? Nazar thinks that many companies will make mistakes about their end users.

 

If Robinhood is guilty, it can be said that it is because of not being completely transparent about the income model. Ethan Kurzweil, a partner at Bessemer Venture Partners in San Francisco, said, "I don't even know to what extent it was understood how Robinhood made money until this last press tour on them." The most important event in clarifying the non-transparency was that last Thursday Robinhood restricted users' access to transactions, while hedge funds could continue to trade freely. According to the users who were brought transaction access, Robinhood has restricted it due to pressure from major financial companies. However, Robinhood denied this claim and claimed that the platform made a risk management decision.

 

Whatever the truth, Robinhood's image is badly damaged. However, it is thought that entrepreneurs planning to do business in the field of freemium will be subject to further questioning from now on. Because according to Kurzweil; "I think people will definitely be more skeptical when monetization is not clear and well understood." With this incident, companies with a freemium business model will be more careful about when such problems will arise and how they can find solutions.

 

Although the events are negative, it seems that Robinhood will not end. According to the Wall Street Journal, Robinhood's last round has excessive investor demand so the company can raise hundreds of millions more in the future.



With that knowladge you can build yout own trade platform or appplicaiton with Finage Market data feeds by API or Websocket in real-time.  You can also start with free market data feed API to build your platform.

 

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