JIM WATSON/AFP via Getty ImagesRobinhood provides free trading because a large portion of its revenue comes from a practice called payment for order flow.Questions about the practice have been brought back to the forefront a week after the volatile IPO of the brokerage app.Insider spoke to retail investors, advocacy groups and market makers in order to understand the dynamics and sentiment surrounding PFOF.Subscribe to our daily newsletter 10 Things Before The Opening Bell.Kayla Kilbride didn't expect the stampede of angry commenters when she filmed a TikTok video in February explaining how Robinhood makes its money.Insider was told by the creator of financial content that it was "insane." "I felt so hated that I removed the video immediately because I believed I was wrong."Shortly thereafter, she received a message from experienced traders confirming that she was correctly explaining payment for order flow. Kilbride said that the heat surrounding PFOF was rapidly eclipsing her light. The practice, which accounted to 81% of Robinhood’s revenue in the quarter ended March 31, according to the S-1 filing filed by the company before the long-awaited IPO, was not fully understood by any commentators.A week after the app's volatile launch, questions about the practice and its impact on users are being brought back to the forefront.Andrew Park, senior analyst at Americans for Financial Reform (a left-leaning organization that opposes PFOF), stated that Robinhood is "free" in the same way Facebook was 'free. You're not paying out of pocket for something and you still have the product.Park claims that market makers like Citadel Securities or Virtu who pay for order flow only do this because they have control. Trading against a Robinhood user aged 25 is much less risky than trading against a hedge-fund investor, for example.Robinhood brokers, on the other hand, are in business to make as much money as they can by sending market makers as many orders possible. Critics say that this practice is harmful to retail investors because they get higher trades while market makers make a profit.Park stated, "The customer ends-up none the wiser – but poorer."These concerns prompted the UK and Canadian governments respectively to ban PFOF. An analysis of the UK's ban in 2016 found that it resulted in retail traders receiving higher prices. The authors claimed that eliminating conflicts of interest from PFOF would create more efficient and competitive markets.Robinhood was also fined $65 million by the SEC for not offering consumers the best prices. The agency determined that larger trades were more expensive than normal and users would have been better off if they had paid a commission to obtain standard prices.Doug Cifu, CEO Virtu, says this is bunk.He stated that the fraction of a penny being refunded to the broker is de minimis when compared with the commission dollars you are saving.Cifu believes that the PFOF idea is a scheme to make retail investors rich. Market makers compete to execute the best trades. This is a tough business of managing risk, building technology and managing risk. He said that even Fidelity, although it doesn't do PFOF routes to Virtu or Citadel because of their superior execution.Park countered, saying that Fidelity routing money to market makers is a demonstration of the need for financial reform other than banning PFOF.Retail traders are more mixed. Many people see PFOF simply as another company selling consumer data, according to Derrick Fung CEO of Cardify, an analytical outfit that focuses on Millennials and Gen Z customers. It is now up to the customer to determine what they receive in return.Fung stated that Robinhood's value is free from commissions.Cifu disagrees that PFOF is similar to selling consumer data. Cifu sees PFOF as a cost to business that is beneficial for everyone. Virtu claims that $3.5 billion was returned to retail investors by 2020 thanks to higher prices from market makers.Insider spoke with Danny Devon, who leads a financial Discord group of 70,000 people. He said he does not recommend Robinhood because he does not believe it offers traders the best prices."We are asking ourselves, are we getting a good price?" Devon said that it's not Robinhood alone, but every broker who does free-commission."David Keller, Chief Market Strategist at StockCharts.com, stated that even though PFOF can help retail investors, Robinhood is still affected by negative perceptions such as Devon's. He said that widespread skepticism could lead to a revival in commission-based models with clear fees structures.Devon would welcome such a change. He stated that zero-commissions encourage inexperienced investors trade too much, often to a point where they lose money.Devon stated, "If you go the casino, the casino has the most money in the slots machines." "People play until they lose, and keep going."
