Gamestop madness reveals risks: is Robinhood gambling its way into financial problems?

The insane gamestop bet makes Robinhood's tills ring. The startup then raised $ 3.4 billion from its investors within two days. However, this may not be a good sign, but rather evidence of an extremely risky business model.

The crazy gamestop roller coaster ride has produced many losers, but also winners. Keith Gill is one of them. The 34-year-old family man from Massachusetts, better known by his YouTube name Roaring Kitty, put $ 56,000 on the badly running video game chain many months ago, turning it into $ 46 million.

In spite of all prophecies of doom, at least one professional Wall Street speculator has also made a substantial profit on the insane plan of the Reddit Army: the New York hedge fund Senvest raised $ 700 million from the breathtaking suicide mission. Of course, Robinhood, the beloved trading tool of risk-taking small investors, is also one of the winners. Because the neobroker does not charge its customers any fees, but rather earns its money mainly with a system that Payment For Order Flow is called.

"There are market makers or trading venues who pay neobrokers to give them orders to buy or sell shares," explains David Rüffer, Speaker for digital banking and financial services at the digital association Bitkom in the ntv podcast "Wieder was learned". In most cases, the amounts involved are tiny, in the cents range. As is so often the case in the digital economy, quantity is decisive: "If you process millions of trades (daily), you can generate decent income even with very small amounts."

More trades, more sales

Market makers often stay in the background, but are responsible for ensuring that the financial market runs smoothly. They ensure that every buyer always finds a seller and vice versa. Because it would be next to impossible to go looking for someone on your own who would like to buy the ten stocks that are on your hit list right now. That works much better if there is a middleman who simply buys all the shares and then holds them until a buyer shows interest.

"Basically, market makers pay for their risk," says Rüffer. "The price may fall until you find a buyer for the shares." In the vast majority of cases, however, they resell the securities with a tiny premium in the four-digit decimal range and, in turn, earn money with this high-frequency trading.

Robinhood founder Vlad Tenev currently has to answer many unpleasant questions.

(Photo: REUTERS)

Brokers like Robinhood typically take a little less than a dime on this model on each transaction. But the demand is high, with every purchase or sale of stocks, ETF funds or options, several market makers compete with each other for the order. The startup writes on its website that every order is always sent to the intermediary who, historically, offers the best prices for this type of transaction. The more customers trade, the more money Robinhood makes.

The perfect storm

For this reason, the gamestop madness should have been the perfect storm for the startup. Official sums do not circulate because the neobroker is still in the private hands of its founders and investors and therefore only has to publish limited numbers. But presumably the last two weeks of January caused the account balance to swell like a flood. This is indicated by the data that are available: In May 2020, the company had 13 million customers. This January, the app was downloaded another 3.7 million times. More than 2 million of them in the last week of January, when suddenly the whole world was discussing Reddit, Wallstreetbets and hedge funds in a nosedive and the army of hobby investors the price of the Gamestop share within 24 hours with a "short squeeze" of Catapulted 72 euros to 307 euros. Almost 180 million Gamestop shares changed hands on that day, although only a good 70 million are available in free trading.

Robinhood's bread and butter business is bulk and small amounts. The neo broker wants to live up to its name and democratize the financial market in this way. The money is to be redistributed from wealthy stock market professionals to inexperienced small investors who can often only invest a few hundred euros or dollars. These, however, also proportionally in shares that are much more expensive.

"This is a niche in the market that many neo brokers have recognized and filled," says Bitkom's financial expert Rüffer. "Now basically anyone can participate in any company regardless of the value of an individual share."

Reward or lifeline?

Robinhood wants to enable every investor, no matter how small, to participate in the financial market free of charge anywhere and anytime, and this business model is on a wave of success. Even if there is trouble because trading in Gamestop shares had to be suspended in the meantime. But lawsuits and hundreds of thousands of one-star ratings from customers on Google can be coped with if you collect $ 3.4 billion from your investors within 48 hours in order to be able to feed the "incredible growth of the platform" with the necessary change. as announced by CFO Jason Warnick.

But this view could be deceptive. It is possible that the billions are not a "bonus" for excellent entrepreneurial performance, but a lifeline. A lifeline to be able to deposit collateral required by regulators for the risky business model. Because according to reports, the startup needs more money and is currently negotiating loans totaling a billion dollars. In addition to $ 500 million in loans that had to be taken out in late January when the gamestop craze peaked.

"Noticeable despair discount"

There is no evidence of this, but rumor has it that another source of income for Robinhood may have fallen dramatically on its feet. Because the company doesn't just earn money Payment For Order Flow Money, but also with so-called Stock loan. With these securities lending, Robinhood lends money to its financially inexperienced but risk-averse customers so that they can buy even more shares.

But what if the entire clientele suddenly invests, partly on credit, in highly volatile securities such as Gamestop, the price of which not only rises quickly but also crashes quickly? Then, in the worst case, Robinhood would be faced with a huge mountain of outstanding orders and loans that the young customers may no longer be able to service. And might also be ready to offer its investors particularly favorable terms in the latest round of financing. A "noticeable desperation discount", as it is called in the industry.

The Reddit Army's next wacky bet is bound to come. For every trade carried out, Robinhood customers are showered with digital confetti in the app. It is quite possible that the one at Robinhood Headquarters will feel more like a cold shower.

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. (tagsToTranslate) economy (t) financial betting (t) financial investors (t) financial markets (t) financial regulation (t) stock prices (t) stock trading (t) Wall Street