Robinhood’s Role in the ‘Gamification’ of Investing

(Bloomberg) -- First came discount brokerages in the 1970s, which made it cheaper to buy stocks. Then trading became commission-free, and smartphone apps made it possible to buy and sell stocks from anywhere. In the latest step toward democratizing investing, online brokerages led by Robinhood Markets Inc. in the U.S. are seeking to make buying and selling shares not just cheap but seamless and even fun. That’s drawn a new class of U.S. retail traders into the market. It’s also raised worries about what happens when the “gamification” of investing obscures the connection between price and value, fueling the phenomenon known as meme stocks.

1. How is Robinhood different?

Founded in 2013, Robinhood offers trading of stocks -- and more exotic financial products, including cryptocurrencies -- on a sleek phone app that has proved popular with investors who are young and dipping into markets for the first time. Robinhood users who can’t afford, say, the $3,200 or so to buy a single Amazon.com Inc. share can purchase a fraction of one instead. More than half of people using the app are first-time investors, according to the company.

2. What makes it fun?

The app has a colorful, uncluttered layout and lets users begin trading with as little as $1. For a long time, new investors were congratulated for their first trade with a confetti animation. (That was scrapped amid scrutiny from politicians and regulators.) Investors who get a friend to sign up are offered a (tiny) chance of snagging a share of a high-price glamour stock such as Apple Inc. For inspiration, they can browse the 100 most-held stocks among fellow users. An entertainment ecosystem has risen up alongside Robinhood. TikTok videos under #robinhoodstocks have millions of views, and communities of at-home investors use online forums such as Reddit’s WallStreetBets to join forces on stock-buying campaigns, one of which shocked financial professionals over three weeks in January and February.

3. What was that stock-buying campaign?

Individual investors banded together on Reddit to drive prices of video game retailer GameStop Corp. and other meme stocks -- stocks bought for reasons other than the company’s performance -- to astronomical levels, triggering volatility that caused hedge fund short-sellers to lose billions. In the case of GameStop, the share price soared from less than $20 at the end of 2020 to more than $400 in late January. The volatility was too much even for Robinhood, which, along with other brokerages, temporarily halted trading in the stock. The episode fed worries that the battle between the “flows” generated by small investors and the “pros,” or professionals, can artificially pump stocks higher in a feedback loop that could lead to a collapse. A few months later, a similar trading frenzy inflated the price of another meme stock, that of movie theater chain AMC Entertainment Holdings Inc.

4. What’s the problem?

Regulators have accused Robinhood of failing its customers at various points. The Financial Industry Regulatory Authority, an industry-funded brokerage regulator, extracted a nearly $70 million penalty from the company for a sweeping set of allegations, including misleading investors about trading with borrowed money and lacking sufficient controls in its technology and its options trading approval process. (Robinhood neither admitted nor denied the claims.) Massachusetts securities regulators in December filed a complaint against Robinhood, calling out its “gamification” tactics, and more recently sought to revoke the brokerage’s license in the state for continuing “a pattern of aggressively inducing and enticing trading among its customers.” (Robinhood said it wouldn’t “succumb to unfounded, politicized allegations and unreasonable demands.”) At a hearing in the wake of the GameStop episode, U.S. lawmakers scolded Robinhood Chief Executive Officer Vlad Tenev over the brokerage’s business practices. Gary Gensler, chairman of the U.S. Securities and Exchange Commission, asked for public comment on gamification, a review that could lead to new rules.

5. How big a deal is Robinhood?

Robinhood has about 18 million active users, according to regulatory filings released in July ahead of its public debut. And Robinhood traders punch above their weight. A research paper by the Swiss Finance Institute reported that despite holding only about 0.2% of aggregate U.S. market share, Robinhood traders drove 10% of the variation in returns from stocks in the second quarter of 2020. That’s because they buy and sell more than their institutional counterparts in response to price changes.

6. How does Robinhood make money?

Its largest source of revenue is payment for order flow. That’s the system by which it sends users’ trades to financial firms like Citadel Securities, which in turn execute the orders and pay Robinhood for the opportunity. Overall, Robinhood earned about 75% of its $958.8 million in 2020 total net revenue from customer transactions.

7. Who else does what Robinhood does?

A Chinese-owned competitor, Webull, has become one of the fastest-growing retail trading platforms in the U.S., partly by following the Robinhood model of offering free stock trades with a slick online interface, while also providing the live customer-service hotline that Robinhood resisted adding until this year. EToro, founded in Israel in 2007, reported having 20 million registered users in dozens of countries as of early 2021, with plans to provide stock-trading service in the U.S. in the second half of the year. It brands itself as a social trading network, where investors can chat, see each other’s portfolios and even mimic those portfolios, a practice known as copy trading, with a simple tap on their smartphones.

8. Isn’t encouraging more investment a good thing?

That’s one argument offered by Robinhood and its supporters. “Those who dismiss new and younger investors, who come from increasingly diverse backgrounds, as unsophisticated or unserious perpetuate the myth that investing is only for the wealthy,” a company spokesperson said in response to the Massachusetts complaint. Even the concept of “gamification” has had its admirers. A 2018 Ernst & Young analysis said that adding game-like aspects to financial services could help reach users who might otherwise feel reluctant to try investing. “Gamification could be invaluable in educating clients,” it said.

The Reference Shelf

• How Robinhood made trading so easy it might be hard to resist.
• A Bloomberg News primer on the blistering rise of retail trading.
• Robinhood’s “About Us” page.
• The AMC meme stock phenomenon went global.
• A National Bureau of Economic Research working paper found that the typical Robinhood user’s portfolio is pretty boring.
• A look at eToro’s devoted following.

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