On 1 July US-based free stock trading app Robinhood released its prospectus ahead of a planned stock market listing on the US Nasdaq exchange, laying bare the underlying fundamentals of the business.

Robinhood was valued at $11.7 billion in last September’s funding round, and reports suggest it is targeting a $40 billion valuation as a listed company.

Even before the app was launched in 2015 it had attracted 700,000 customers via a waiting list. Customer numbers surged to 5.1 million in 2019, rising to 12.5 million in 2020 and then hitting 18 million customers as of the end of March 2021.

Robinhood is probably most famous for the role it played in the WallStreetBets Reddit social media forum battle against hedge funds where thousands of activist investors bought GameStop shares, forcing hedge funds to buy back their ‘short’ positions.

This has led to the so-called democratisation of investing with retail investors calling the shots in ‘meme stocks’ and posting sassy videos on social media.

Controversially the company doesn’t charge any commissions on client trades for the basic account. Instead Robinhood passes on orders to market makers such as Citadel Securities which aggregate them to secure a better price.

Robinhood gets paid for its order flow, raking in around $700 million in 2020, representing 75% of total revenues of $959 million. The percentage shot up to 81% in the three months to March 2021.

While other US brokers also sell customers’ order flow it generally makes up a much smaller proportion of revenues according to BrokerChooser.

Critics of the payments for order flow system say the arrangement incentivises Robinhood to find the highest price rather than best execution.

That’s one of the reasons why the practice has been banned in the UK and Canada and even the US regulator the SEC (Securities and Exchange Commission) is said to be taking a closer look and consulting on a change in the best execution rules.

In addition, Robinhood has come under scrutiny for the ‘gamification’ of investing, whereby it uses in-app prompts, rewards and bonuses to encourage frequent trading.

The company’s business model means it makes benefits financially from more frequent trading. And it seems to be working; in the first quarter of 2021 revenue per customer increased 65% year-on-year to $137.

It has drawn the attention of various US regulatory bodies and on 30 June the company was fined $70 million by the Financial Industry Regulatory Authority for causing ‘widespread and significant harm’ to customers over the past five years by giving them ‘false or misleading information’ and for ‘systematic supervisory failures’.

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