Forbes - USA (2020-10)

FORBES.COM OCTOBER 20 20

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by selling its customers’ trading data to the very sharks on

Wall Street who have spent decades—and made billions—

outmaneuvering investors. In fact, an analysis reveals that

the more risk Robinhood’s customers take in their hyper-

active trading accounts, the more the Silicon Valley start-

up profits from the whales it sells their data to. And while

Robinhood’s successful recruitment of inexperienced young

traders may have inadvertently minted a few new million-

aires riding the debt-fueled bull market, it is also deluding

an entire generation into believing that trading options suc-

cessfully is as easy as leveling up on a video game.

Stock options are contracts to buy or sell underlying

shares of stocks for a set price over a specified period of time,

typically at a fraction of the cost. Given their complexity, op-

tions trading has long been the realm of the most sophisti-

cated hedge funds. In 1973, three Ph.D.s—Fisher Black, My-

ron Scholes and Robert Merton—developed an options pric-

ing model that eventually won them the Nobel Prize in eco-

nomics. Today their mathematical model, and variations of

it, are easily incorporated in trading software so that setting

up complicated—and risky—trades is no more than a few

clicks away. Even so, making wrong bets is easy. According

to the Options Clearing Corporation, more than 20% of all

options trades expire worthless versus 6% “in the money.”

In June, Robinhood witnessed firsthand what can hap-

pen when such tools are marketed to inexperienced in-

vestors. While it’s impossible to discern every factor con-

tributing to suicide, one of Robinhood’s new customers, a

20-year-old college student from Illinois named Alexander

Kearns, took his own life after mistakenly thinking that one

of his options trades put him in debt to Robinhood for more

than $730,000. His death prompted questions from sever-

al members of Congress about the platform’s safety.

Despite these problems, millions continue to flock to the

addictive app, and Tenev and Bhatt sit on a potential gold

mine reminiscent of Facebook in its pre-IPO days. Amid its

Covid-19 business surge, Robinhood has raised $800 mil-

lion from venture investors, ultimately giving it a stagger-

ing $11.2 billion valuation, affording its cofounders a paper

net worth of $1 billion each. But in light of Morgan Stanley’s

success with its $13 billion acquisition of E-Trade in Febru-

ary and Schwab’s earlier purchase of TD Ameritrade for $26

billion, some think Robinhood could garner a $20 billion

valuation if it went public or were acquired.

The problem is that Robinhood has sold the world a sto-

ry of helping the little guy that is the opposite of its actual

business model: selling the little guy to rich market opera-

tors with very sharp elbows.

he rise of Vladimir Tenev and Baiju Bhatt is a fa-

miliar one in the era of technology disruption.

They met as undergrads at Stanford Uni-

versity in the summer of 2005. “We had some

astounding parallels in our lives,” Bhatt tells

Forbes. “We were both only children, we had both grown up

in Virginia, we were both studying physics at Stanford, and

we were both children of immigrants because our parents

were studying Ph.D.s.” Tenev’s family emigrated from Bul-

garia, Bhatt’s from India.

Tenev, the son of two World Bank staffers, enrolled in

UCLA’s math Ph.D. program but dropped out in 2011

to join Bhatt and build software for high-frequency

traders. That was shortly after Wall Street’s 2010 “Flash

Crash,” a sudden, near-1,000-point plunge in the Dow

Jones Industrial Average at the hands of high-speed trad-

ers. The extreme volatility exposed how financial markets

had mostly moved away from the staid, but stable, New

York Stock Exchange and to a smattering of opaque quan-

titative trading pools dominated by a handful of secretive

firms. These so-called “Flash Boys,” who worked millisec-

onds ahead of orders from both retail and institutional in-

vestors, had emerged from lower Manhattan’s back offices

and IT departments, as well as university Ph.D. programs,

to become the new kings of Wall Street.

At the same time Tenev and Bhatt were getting an insid-

er’s education in how high-frequency traders operate and

profit, the outside world was in turmoil, recovering slow-

ly from the battering of the 2008–2009 financial crisis. It

all played into the official Robinhood creation story: When

T

THE COVID-19 BULL MARKET HAS BEEN A

GODSEND FOR RETAIL BROKERS, BUT ROBINHOOD

AND ITS SWARM OF NEWBIE TRADERS ARE

SCHOOLING THE COMPETITION.

LORD OF THE BUYS

Sources: Robinhood financial disclosures and a person familiar with the company’s finances.

Premium Membership

Subscriptions

15%

Securities Lending

15%

Trading Volume at Online Brokerages (Number of Shares)

Robinhood Q1 2020 Revenue Breakdown

150 B

120 B

90 B

60 B

30 B

0

Robinhood TD Ameritrade E-Trade Schwab

Q1 2020

Q2 2020

139 %

GROWTH

76 %

56 %

24 %

Payment for

Order Flow

70%