Robinhood – Steal from the poor, give to the rich
Updated: May 14, 2021
If you search for Robinhood’s website, scroll to the bottom and click ‘About’ you’ll see a quippy slogan at the top of the page:
"We're on a mission to democratize finance for all."
That is unless you’re a retail trader looking to buy a highly shorted stock.
Robinhood has long marketed itself as a brokerage app for the people, but earlier in the year that all came into question.
On the 28th of January Robinhood, among other brokers, stopped retail investors from buying highly shorted stocks like Gamestop, AMC, BB and Nokia but allowed sellers to dump the stock.
Gamestop’s stock plunged, closing down 44.3% from the previous day’s closing price but snapped back 54% between Thursday and Friday as restrictions were somewhat loosened at a few brokerages.
There was widespread outrage as it appeared as though Robinhood was on the side of Wall Street – and for good reason.
Robinhood is in bed with, market maker, Citadel Securities who pays Robinhood for Order Flow (Citadel pays Robinhood to execute the trades its users make). Citadel Securities is not to be confused with Citadel LLC the hedge-fund. This disparity is a little confusing, let me explain.
Citadel LLC is $35bn hedge-fund founded by Kenneth Griffin. The fund (alongside Point72) invested $2bn in Melvin Capital as they were attacked by retail traders over their short position in Gamestop. Citadel Securities , however, is a market maker that buys and sells stock to provide liquidity in markets and pays Robinhood for its orders.
A lot of Reddit users failed to see the difference between the groups and were up in arms, submitting multiple posts condemning Citadel for not playing fair and forcing Robinhood to restrict trading to protect their own interests.
Citadel Securities actually stands to benefit from increased volatility in markets as they make money from bid-ask spreads (the difference between the prices they buy and sell stocks for) which widen when prices move erratically.
Citadel refuted Reddit user’s claims in a statement:
“Citadel is not involved in, or responsible for, any retail brokers’ decision to stop trading in any way,”
CEO of Robinhood echoed their sentiment and hit Twitter, tweeting:
"To be clear, this decision was not made on the direction of any market maker we route to or other market participants."
So why did Robinhood restrict trading on GameStop?
It probably has something to do with the DTCC, the Depository Trust and Clearing Corporation.
Robinhood is a member of the DTCC and has to deposit a certain amount of collateral with its clearinghouse, the NSCC (National Securities clearing corporation).
Clearing Houses act as an intermediary in a trade, managing the risk and ensuring trades are executed in case one party defaults. When traders make an order on Robinhood it takes 2 days for them to legally own the stock, in this time the price could move dramatically.
Here’s an illustration of the risks involved:
You own one share of GME and sell at $100, 2 days later the price moves to $400. If for any reason the seller can’t deliver the stock to the buyer the clearinghouse has to go into the market and purchase the stock at $400 to deliver it to the buyer, losing $300 in the process. Because of Gamestop’s crazy price movements, settlement risk was particularly high for clearinghouses.
Vlad Tenev revealed the NSCC had requested a $3bn deposit on Thursday the 28th. That same day Robinhood had drawn $1bn from its revolving credit line with a group of investment banks and 4 days later had added another $2.4bn to its balance sheet to meet its clearinghouse’s demands.
Few people took time to understand the financial plumbing; instead they took to Apple and Google’s app stores to leave 1-star reviews claiming Robinhood was just another Wall Street pawn. This fiasco is particularly poorly timed, Robinhood was set to go public this year.
Vlad Tenev is likely hoping the GameStop debacle won’t weigh down Robinhood’s flotation.