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Robinhood makes millions selling your stock trades … is that so wrong?

July 8, 2020, 3:13 PM UTC

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PFOF. If you say it out loud (P-fof!), the acronym sounds like a dessert topping or a rude way of telling someone where to go. But PFOF is becoming critical to how the stock-trading app Robinhood, as well as old-school brokerages, make money.

The acronym stands for “payment for order flow” and describes the fees Robinhood and others receive from electronic market makers for passing on customer orders. For example, when you buy a share of Tesla on your phone, Robinhood sends that order to a trading giant like Citadel Securities and receives a few pennies in return—the PFOF. Citadel, meanwhile, completes your trade and makes a few pennies itself.

For Robinhood, those pennies add up. A recent SEC filing, first cited by The Block, reveals Citadel Securities and a handful of other firms paid Robinhood nearly $100 million in the first quarter of 2020 alone. These payments are the company’s primary revenue stream—far outstripping what it earns from its premium service, Robinhood Gold, or from the interest it makes on cash balances in customer accounts.

All of this raises the question of whether PFOF is fair or ethical. Namely, should a brokerage—especially one like Robinhood that brands itself with an anti-Wall Street Everyman gloss—be selling its customers’ trades?

As it turns out, in most cases, there’s nothing nefarious about PFOF. In fact, the practice can help retail investors get a better price on their trades. As Bloomberg wiseman Matt Levine explained in late 2018, amid an earlier controversy over Robinhood and PFOF, it’s actually hedge funds and other institutional investors who ultimately pay more when brokerages outsource their retail orders. (Levine also explains what the likes of Citadel Securities get from paying Robinhood—in short, he says, Citadel pays to execute retail trades because it lets them avoid getting squeezed by something called “adverse selection” by professional traders).

That doesn’t mean PFOF arrangements are always above board. Former SEC Commissioner Mary-Jo White has warned that the practice can create conflicts of interest, leading brokerages to betray their “best execution” obligations to their customer in favor of higher kickbacks. And indeed, regulators last year fined Robinhood for doing exactly that. The infractions in question, however, occurred several years ago and there is no indication the company has played fast and loose with PFOF since then.

The most interesting recent development when it comes to PFOF, though, does not relate to Robinhood. Instead, it’s about how the old guard brokerages have come to rely on it as a revenue stream too. Annual reports show that Charles Schwab, eTrade and TD Ameritrade all pulled in record PFOF revenues in 2019—$135 million, $188 million and $492 million respectively.

None of this is surprising given the commission-free trade environment that Robinhood pioneered, and that the rest of the industry has since embraced. PFOF, that funny sounding acronym, appears poised to power the brokerage industry’s profits for years to come.

Jeff John Roberts

@jeffjohnroberts

jeff.roberts@fortune.com

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Debits

China imposes withdrawal checks after bank runs ... A new speech-suppressing security law in Hong Kong goes into effect ... GPIF, Japan's (and the world's) biggest pension fund, lost $165 billion in a single quarter ... Brazil bans crypto market Binance from offering derivatives there ... Philippines' SEC calls Ethereum's biggest app a possible ponzi scheme ... Elon Musk taunts the SEC ... Gen Z is the group hardest hit by the coronavirus crash ... Coronavirus is causing a nationwide coin shortage.

BUBBLE-O-METER

$7 million

The amount Jan Marselek, COO of imploding German fintech Wirecard, invested in Telegram's planned cryptocurrency system, according to documents seen by the Wall Street Journal. Marselek has now reportedly disappeared, which might have something to do with his close ties to Wirecard partners, including a company called Al Alam, which according to an FT investigation reported deals with nonexistent clients.

Marselek's disappearance may mean he takes a big hit on that Telegram investment: the messaging company cancelled its public "Initial Coin Offering" in 2018 after the SEC got involved, but had already raised $1.7 billion from big-money private investors, likely including Marselek. Then this May, Telegram pulled the plug on its planned TON cryptocurrency entirely. Telegram in June said it would return investor funds, but if Marselek is in hiding indefinitely, his $7 million could be tough to get back to him.

FOMO NO MO'

"I share this to help explain why some VCs are so terrified of someone like @TaylorLorenz. Someone who actually thinks reveals their intellectual nudity. Someone who pursues the truthful description of the world is incomprehensible to them, because to them ideas are power grabs."

Anand Giridharadas, whose insight might be the only positive thing to come out of a petty and stupid online fracas between crypto founder and former Andreessen Horowitz partner Balaji Srinivasan and New York Times reporter Taylor Lorenz. As detailed in all its pointlessness by Input Mag, the battle unfolded after Lorenz tweeted about the ongoing unraveling of another tech-adjacent figure, Away cofounder Steph Korey, whose employees are now in revolt over working conditions and Korey's public behavior.

Among other contributions to elevating the discourse, Srinivasan offered bounties for memes attacking Lorenz and journalists in general. Lorenz also reported a surge of harassment and accounts impersonating her on social media. Input describes the broader fallout as "using the pile-on tactics of Gamergate and echoing the baseless attacks aimed at the press spouted regularly by Donald Trump."

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This edition of The Ledger was curated by David Z. Morris. Contact him at david.morris@fortune.com.