Robinhood and the Gamification of the Stock Market
Temporary closure of casinos and sports events, indefinite confinement, and one-time $1200 stimulus checks create a Robinhood heaven. Through a Candy Crush-esque UX design with additions like confetti showers to celebrate transactions, the app gamifies the stock market, sending millions of bored-in-the-house millennials into a trading frenzy through a seemingly playful environment with dangerously real consequences.
If you aren’t paying, you are the product. And with Robinhood receiving an average of $18,955 for every dollar in a user’s account, its amateur investors are a pretty profitable one at that. As the allure of commission-free trading with no minimum account balance wins over many, Robinhood's less-than-transparent revenue model has garnered increasing scrutiny. Robinhood makes a sizable share of its profits through order flow, a common yet controversial practice in which financial firms bid-on or buy an order from a brokerage firm and decide whether to execute the trade or pass it on to the open market for comparison with existing quotes. Although these payments are negligible for small trade volumes, as Robinhood users top ten million, order flow creates a significant revenue stream for the company. In addition to the profits from a large volume of transactions, firms have proven willing to pay Robinhood a high premium for its users' trades. With a notoriously bullish and amateur client base, the buyers profit from these risky and ignorant bets. While the practice is not illegal, there are stringent policies in place to protect the consumers’ interests, specifically with non-direct order flow - in 2019, The Financial Industry Regulatory Authority fined Robinhood $1.25 million for “best execution” violations. The regulator found that the brokerage firm had routed non-direct stock orders to a select few paying partners without searching for better-priced alternatives. Claiming rather “anti-Wall Street” founding principles, Robinhood has attracted heavy criticism for routing orders to high-frequency trading firms, and despite strict regulations on the practice, rising concerns about the transparency of this revenue model have many questioning the accuracy of the brokerage firm’s claim-to-fame as a commission-free trading platform.
But concerns about Robinhood’s opaque revenue model pale in comparison to effects of the erratic behavior of its self-proclaimed day traders. With half of its users composed of first-time investors, the Robinhood cohort is characterized by bullish attitudes and risky investments that fuel bizarre market trends.
On June 9th, FANGDD Network Group Ltd, a small Chinese real-estate firm, shot up from $10 to $130 a share in 4 hours. Robinhood investors mistook the firm’s shares for headlining FANG stocks, the Facebook Apple Netflix and Google cohort.
The Nikola corporation, an electrical vehicle producer lacking a viable prototype, was the number one stock on Robinhood for the month of June just one week after going public - many speculate in part due to its association with the famed engineer Nicolas Tesla. One of the latest in a series of inflated valuations, Nikola’s market cap skyrocketed to over $30 billion shortly after its IPO without expecting any revenues until 2021.
The now-dubbed “bankruptcy bubble,” fueled by penny-stock loving Robinhood day traders, saw investors piling into Hertz, JCPenney, and Whiting Petroleum stocks, sending share prices of these most likely worthless companies soaring.
Sky-high valuations based on blind speculation, rallies into companies filing under Chapter 11 Bankruptcy with little hope for a comeback, and hoards of retail investors rushing into any stock promoted by a Reddit post or a Twitter thread warns of another dot-com bust waiting to happen.
Although retail investors account for only 25% of the market volume, the nature of these volatile trades have an outsized impact on the market. Some firms’ sensitive algorithms even get sucked into these surges, pulling institutional investors into unprecedented rallies.
However amateur these investors may be, they have performed surprisingly well as a group. According to David Kostin, chief U.S. equity strategist of Goldman Sachs, “estimated retail investors in the U.S. outperformed American hedge funds (up 61 and 45 per cent, respectively) during the market comeback.” The Robinhood cohort and their tumultuous rallies may expedite the cyclical nature of the market, causing short-term gains of their own creation.
Yet despite an overall positive performance, the consequences for inexperienced individuals enticed by Robinhood’s addictive platform are dire. 20 year old Alexandre Kearns killed himself after seeing an (incorrect) balance of -$730,000 on the app, and Robinhood’s headquarters have installed bullet proof glass after several incidents with distraught users. While those in favor of a free market argue that we should let Robinhood investors make their own mistakes, the leverage available allows users to invest more than they have, and the subtle encouragement of high trade volume makes the app a thinly veiled gambling platform. Users find themselves pulled into an adrenaline-rush fueled high-frequency trading cycle without any formal education or training.
Although Robinhood advertises itself as a way for anyone to take part in the stock exchange, these users are also not privy to the same market information as institutional investors with their complex algorithms and developed strategies. Such asymmetry of information leaves these novice traders extremely vulnerable.
Studies have shown that the more often retail investors trade stocks, the worse their returns are likely to be. And yet, an increased volume of trades drives Robinhood’s revenue through order flow profits, incentivizing the company to encourage more trading. The brokerage firm provides unprecedented access to the market, and with such innovation comes intense scrutiny. But is Robinhood’s mission really noble as democratizing the stock market, or is the company, most recently valued at $8.6 billion, benefiting off of millions of amateur clients placing risky bets on a market-turned-casino platform?