New disruptive models have for a long time been threatening to put paid to the whole concept of financial intermediation. Now improved cost management and the widespread use of advanced algorithms are also starting to call into question the need for stock trading commission.
By Simon Guigue October 21, 2014
Today electronic trading and modern high-frequency trading firms do not pay any charges for making stock market transactions – quite a number carried out per second – while non-professionals have to pay several dollars per transaction. This is what led Vlad Tenev and Baiju Bhatt, two Stanford University graduates who used to work on Wall Street as programmers, to set up Robinhood. The startup is looking to attract first-time investors with a downloadable mobile trading app that will charge no commission for making stock market transactions. The Robinhood duo are hoping their B2C business model will be able to capitalise on the limitations of traditional brokers – firms which act as intermediaries between punters and marketplaces in the finance and insurance worlds – who charge for broking deals, whereas algorithms can place clients’ buy/sell orders free of charge.
Robinhood is not aiming to attract professional traders and Tenev and Bhatt certainly have no ambitions to set themselves up in opposition to the financial markets. At the moment only equity (company shares) can be bought and sold on their platform, though the founders are planning to add derivatives at a later stage. The duo stress that simplicity of design and a user-friendly experience are the central planks of their value proposition. The app is actually a consultancy tool which enables users to react rapidly to movements on the stock markets. You can activate a number of alert/action systems to help run your share portfolio: automatically triggered buy or sell orders when prices hit pre-determined highs or lows or an alert at a given threshold of losses or opportunities. By contrast, E*Trade and Scottrade, two online brokerage services which may be seen as competitors to Robinhood, insist on a $500 deposit before you start trading on their platforms and then charge $7 to $10 on each trade you make. Among other innovative startups in the online investment field, Hong Kong-based private social network and global trading platform 8 Securities enables users to closely monitor their share portfolios, taking a 0.5% commission on investors’ transaction totals. UK-based Numtek also uses state-of-the-art algorithms to provide investment advice to small investors (from £1,000 upwards), and, like US startup Forest, promises good returns on its mutual funds. Prior to registering with the US Securities and Exchanges Commission (SEC) and then receiving approval from the Financial Industry Regulatory Authority (FINRA), the Robinhood team had previously created an initial app designed to attract investors with a ‘crowdsourcing’ approach, simply enabling users to bet on stock values rising or falling.
The Robinhood app is still under development, but two rounds of fund-raising have enabled the firm to refine its business model as it survives on investor money. When the company launched in 2013, already at that time numbering Andressen-Horowitz and Google Ventures among its panel of investors, the founders already planned to monetise their app by opening up their API to developers so that other firms could offer intermediary services, e.g. lending capital to investors or carrying out trades for them. However, Tenev and Bhatt believe they can earn revenue by directly charging stock exchanges looking to bring higher transaction volumes to their marketplace. The Robinhood lean trading strategy means the startup can take an innovative approach to getting paid. The company currently has a team of around ten software engineers developing algorithms to help them save on transaction costs and the operating overheads – such as office rental and marketing expenses – that more traditional firms incur. Robinhood claims that its rather provocative name is basically linked to the idea that the status quo can be changed, and that its philosophy is not about robbing the rich to give to the poor but making the fruits of capitalism available to all. With this in mind, the firm is carefully regulating the number of new clients it takes on at a time: close to half a million applicants were on the Robinhood waiting list in September.