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Report finds that Robinhood ‘s customers are hedge funds like Citadel and others as backlash grows

Editors note: Let’s consider this article part of our “Series” article series where we do our best to teach and inform our readers (you) of something we think you should directly know about. In this article, we’re going to fully explore Robinhood and how it makes money through its relationship with a firm called Citadel. Citadel is a billion-dollar hedge fund.

It’s important here that people understand how exactly Robinhood makes its money because it is not quite how they make it seem (although the practice itself is fairly common.) Robinhood makes its money by selling its user data and orders to large firms like Citadel for a pretty check. The assumption that brokerage firms like Robinhood work for the big guy isn’t an assumption at all because it is very accurate.

The formula for Robinhood ‘s unwritten success is that of PFOF (Payment for Order Flow) which just simply means in normal people terms that they’re selling your order form to the highest bidder. In subsequent human terms, this means that before your trade/buy/sell is executed on the Robinhood platform — they make money off of it by selling it and then it is executed.

A report published by the Financial Times brilliantly lays out how it works here.

explaining how it works

Citadel Securities pays tens of millions of dollars for this order flow but makes money by automatically taking the other side of the order, then returning to the market to flip the trade. It pockets the difference between the price to buy and sell, known as the spread.

Easy access to the market against the backdrop of wild swings in prices have led to higher trading volumes for stocks and options this year—increasing the raw material Citadel Securities uses to turn a profit. At the same time, the rise in volatility has forced spreads wider, increasing the potential income for market makers.

This is where Citadel and its crappy history comes into the picture. Despite the fact that Citadel is supposed to be “honest” they’re in fact not. Years ago, Citadel was fined $22m by the SEC for being just that: dishonest over order forms.

What some may not realize (especially considering Robinhood ‘s customer base is fairly on the young side) is that the the technique they used was invested firstly by Bernie Madoff. For those that are a little young and investing, Bernie Madoff is a notorious Wall Street scam artist that bilked people out of unbelievable amounts of money using grimy tactics. He is currently serving a life sentence in federal prison. He invented pretty much the PFOF formula that has over the past two years or so made Robinhood just north of $180m.

This quote from a Motherboard story stands out perfectly.

“If the service is free, you are the product. Robinhood users thought the service was accountable to them, but actually it exists to serve giant Wall Street institutions like Citadel and other market makers,” J.E. Karla, editor of the business newsletter Contention, told Motherboard. “They will suicide bomb their own business models to protect the real powers from the consequences of their internal contradictions. When a system approaches a terminal crisis, its institutions will break their own rules to suppress elements that threaten the system’s continued viability. That’s what’s happening here. This specific episode may be over in a week or two, but it’s a symptom of something very ominous.”

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