Robinhood Is the Facebook of Investing. You’re the Data, Not the Customer

A lot of people are mad at Robinhood. The trading app has been at the center of the run-up of GameStop and a few other highly shorted stocks over the past week, as retail investors have piled into the stocks. The move is mostly fueled by the WallStreetBets subreddit, which has targeted stocks with large short positions held by hedge funds. 

One of those hedge funds, Melvin Capital, lost billions after having to close out its position as the price of GameStop’s stock continued to soar. That comes after it received $2.75 billion from Citadel and Point72 to help it cover losses over the first few weeks in January.

On Thursday morning, however, Robinhood no longer accepted requests to buy shares of a handful of companies because of what it called “market volatility.” That’s after shares of GameStop went from around $45 on Monday to a high of $469 Thursday morning. 

As you can imagine, people were mad. That’s understandable. If you’re buying stocks because you’re trying to get the price to go up as high as possible, that strategy fails if you’re no longer able to buy more shares.

Robinhood would only allow you to sell your shares or close your position. If you tapped on the “Trade” button for those stocks, sell was the only option available. You can imagine that people started to sell. As a result, the stock is down 44 percent today. 

For whatever you think of hedge funds, or GameStop, or Reddit-inspired day traders, there’s actually a far more important story: Robinhood. 

My take, as I expressed earlier on Twitter, is that the best way to understand Robinhood is that it’s the Facebook of investing. What I mean by that is that you are the user, not the customer.

A customer is someone for whom a service is provided, almost always in exchange for compensation. A user is someone whose data can be collected as a service for someone else, usually for a business that can monetize it.

You don’t pay anything to Robinhood to use its service, someone else does. It turns out, that makes all the difference in how the company treats you.

See, Robinhood doesn’t charge a commission for trades. That’s not terribly unusual, just like free social media platforms and digital services aren’t unusual. However, executing trades is something that requires infrastructure, systems, and people. The fact that you have access to all of that, without paying for trades, is one of the reasons apps like Robinhood became so popular among ordinary retail investors who want to try their hand at buying and selling stocks. 

But those investors aren’t Robinhood’s customers. Instead, the company sells its order flow, or information about the transactions of its customers, to third parties. Those third parties are the ones who execute the trades, but they also get access to the data. 

That can be very valuable to high-frequency traders who make money off the tiny spread in pricing during the time between buy and sell orders. Making even a penny or two off of enough trades every day is real money. 

I’m not an expert on financial markets or hedge funds. I do, however, have a little experience writing about companies that collect data and monetize it by brokering it to others. Here’s looking at you, Facebook.

It’s not entirely wrong to run a business this way–if it’s transparent. It turns out it’s pretty profitable, at least in the case of the tech giants. The problem is that it means that the company’s interests aren’t aligned with yours, they’re aligned with those of their customers.

Honestly, none of this should really be a surprise. 

When you think about it, it makes total sense that Robinhood shut down trading of GameStop and others. Robinhood’s largest customer for order flow is Citadel, one of the firms I mentioned earlier had invested in the hedge fund that took the biggest hit from the short squeeze. 

It wasn’t lost on people that the app, named after the outlaw hero who stole from the rich and gave to the poor, was quick to shut it all down with one phone call from the rich. I have no idea if that’s how it worked, but it certainly looks like that’s exactly how it worked.

For Robinhood, that’s a very real problem. Perception matters. If people don’t trust you to do the right thing for your customers, especially when the thing you do relates to people’s finances, you’re pretty much done.