Another fine example of Late Stage Capitalism:
PFOF etc.
The basic idea is that if a Robinhood customer is buying stock, it is usually good to sell it to them. In general, if you sell stocks, you will worry that the people buying from you know something you don’t. They might know that, like, the company is about to announce a merger or whatever, but realistically the main thing they might know is that they themselves plan to buy more stock: If you sell them 100 shares of a stock at $10, and then they buy 10,000 more shares, the price will go up and you will wish you had not sold to them at $10. If BlackRock Inc. is buying stock and you are selling it to them, that is a real risk that you face; it is called “adverse selection.” But if a Robinhood customer buys 100 shares of stock from you, the chances that she’s buying 10,000 more over the next two minutes are pretty slim. That is mostly not how Robinhood Markets Inc. customers behave. So selling stock to Robinhood customers who want to buy — or buying it from Robinhood customers who want to sell — is a better and safer business than trading stock with BlackRock. 1 We talk about this a lot around here.
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Much of US equity market structure is driven by this basic fact, that it is better to trade with retail customers than it is to trade with professional investors. In general, when you trade on a public stock exchange, you don’t know who’s on the other side. If there is an order to buy 100 shares, and you take the other side and sell 100 shares, you don’t know if you’re trading with a hedge fund or a retail investor; you don’t know if it’s the start of a flood of buy orders or just a random blip. But if you could know who was on the other side — if, say, you could know with certainty that everyone on the other side of your trades was a Robinhood customer — then that would be better. You could make a lot more money trading only with Robinhood customers than you could trading with everyone.
And so what you do is you go to Robinhood and say “when your customers give you orders to buy stock, don’t send those orders to the stock exchange, where they will be indistinguishable from orders from hedge funds and institutions — send them to me.” In return, you offer Robinhood three things: