Crypto-Friendly Robinhood under the Hood: Payments for Order Flow


Robinhood is little doubt fairly a revolutionary start-up. They’ve managed to fully rewrite the rulebook in relation to retail brokerage and buying and selling.

Utilizing a no charges mannequin, they’re giving customers the alternative to buy property akin to equities, Indices and cryptocurrency at the identical price as the institutional markets. Many view them as democratizing the investing house and leveling the enjoying discipline.

There have been many who have questioned how a brokerage that expenses no charges is ready to become profitable in a sustainable method.

This skepticism led them to uncover some attention-grabbing SEC disclosures of Robinhood which confirmed that the brokerage had a reasonably attention-grabbing enterprise mannequin. They have been promoting their shopper order move to Excessive Frequency Buying and selling (HFT) Companies.

After all, this raised extra questions than it answered and led many to conclude that Robinhood was something however a modern-day redistributor of wealth.

Is that this criticism justified?

I’ll take an in-depth look into the Robinhood enterprise mannequin, the HFT business and the way this might influence the finish person – you, the dealer.

Payments for Order Flow

It was first introduced under the highlight in Robinhood’s SEC rule 206 disclosure for the second quarter. These are studies that broker-dealers are required to publish which disclose their order routing practices.

On this case, the Robinhood report confirmed that they routed all of their orders to four completely different HFT corporations. These have been Citadel Securities, Two Sigma Securities, Wolverine Securities and Virtu Monetary.

Robinhood Disclosure
Supply: Robinhood rule 206 disclosure

In the identical report in addition they outlined the monetary relationships that that they had with these corporations. Robinhood is paid for every order that they route to those market makers. For instance, Citadel securities paid them “lower than $zero.00026 per greenback of executed commerce worth”.

So, in different phrases, as a substitute of Robinhood earning profits from the dealer, they’re being paid by the market maker to ship them your order. The market maker will then execute your order on their books at the market price.

That that is taking place shouldn’t be too shocking.

For one, the founders of Robinhood used to work with HFT corporations of their earlier startup, Chronos Analysis. This firm developed software program that was utilized by HFT corporations in an effort to place their orders.

Furthermore, it’s not simply Robinhood that sells entry to their order move. That is practiced by different brokers together with TD Ameritrade Holding Corp., E*Commerce Monetary Corp. and Charles Schwab Corp.

So, we now know that this follow is ongoing in the extremely regulated and clear fairness markets. Might the identical follow be taking place in the comparatively nascent cryptocurrency markets?

Robinhood in the Crypto Markets

At the starting of this yr, Robinhood made it their mission to leap head first into the crypto markets. has beforehand lined the efforts that Robinhood is making in these markets.

They’ve now launched in a lot of US states and supply Bitcoin, Ethereum, Litecoin, Bitcoin Money and Dogecoin. Customers have been fairly enthusiastic about the prospect of shopping for their favourite cash with no charges.

Nevertheless, when the disclosure grew to become public many in the crypto group have been involved with Robinhood’s enterprise mannequin.

That is additional compounded by the indisputable fact that the cryptocurrency markets are nonetheless unregulated. Which means that even when Robinhood had related agreements with corporations, they might not be obliged to reveal it.

It’s unlikely which have agreements with the corporations we talked about above. It is because each Citadel and Two Sigma haven’t entered crypto markets on account of their founder’s skepticism. Virtu stated that they want to enter the bodily bitcoin markets however solely once they turn out to be extra regulated.

robinhood cryptocurrency ethereum classic

Nevertheless, we do know of a lot of different HFT crypto corporations which were making markets over the previous yr. These embody the likes of Leap Buying and selling and Cumberland digital (a subsidiary of DRW).

So, it’s fully potential that there are market makers who could be prepared to pay Robinhood for the orders they route by their books.

What’s in it For the HFTs?

You might be forgiven for considering that HFTs purchase the order move in an effort to become profitable on the orders. This isn’t actually the case and they’re after one thing way more worthwhile.

HFTs are wanting for data and market knowledge which they will plug into their buying and selling algorithms. Extra particularly, they’re wanting for a greater understanding of what the present retail market move is like (particular person merchants).

That is vital as it would assist them to higher place their buying and selling books for institutional market move. They use the knowledge of their laptop fashions in an effort to map order move and section out the retail demand from the institutional demand.

That is maybe greatest illustrated in the under picture of HFT methods. Their passive market making is their least worthwhile technique. Nevertheless, by figuring out institutional order move and therefore with the ability to confirm path, they will use directional methods. These are way more worthwhile.

HFT Trading Strategies
HFT Buying and selling methods

After all, the establishments are effectively conscious that the HFT corporations try to reap the benefits of market and order knowledge. They are going to attempt to cowl their orders both by the use of iceberg orders or by the OTC markets utilizing “darkish swimming pools“.

That is simply scratching the floor in relation to the cat and mouse video games that giant traders and HFT corporations play. Additionally it is maybe one in every of the causes that the former despises the latter a lot.

What does this imply for the common retail dealer although?

Implications for Markets

Whereas the HFTs typically turn out to be the proverbial whipping boy for a lot of individuals in the market, they will present liquidity and drive down spreads.

The settlement that Robinhood has with the HFTs nonetheless gives a internet acquire for the finish person. You might be nonetheless in a position to buy your coin or share fee free.

Some might say that the indisputable fact that HFTs are paying Robinhood for their order move means it creates a perverse incentive for Robinhood to decide on solely the highest paying Market Makers. Nevertheless, Robinhood should by legislation search greatest execution for shopper trades. Greatest execution takes a lot of vital elements into play together with value.

So, who might be shedding out from this association?

Massive establishments or crypto whales are most likely going to seek out it bit tougher to position massive orders under the radar. Their order move might be sniffed out by the HFTs which is able to then use this data to the advantage of the market maker.

Nevertheless, in case you are getting fee free greatest execution buying and selling at the expense of a crypto whale, is that not the Robin Hood spirit?

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