Robinhood’s next adventure: Stealing market share from the rich

But he also has other transitions on his mind. A father of two, Tenev explains that his younger child is in the final stages of potty training—a milestone that feels especially significant given Tenev’s own upbringing. “When I grew up, in Bulgaria, there were never enough diapers available,” he recounts. “So there was huge pressure to move on from diapers.”

 Though he now lives in tony Palo Alto, Tenev brings up his childhood experience with Communism frequently, invoking the economic hardships and deprivations that the system inflicted. In his view, the failures of Communism validate Robinhood’s über-capitalist mission, which is to help neophyte investors build wealth by buying stocks.

Robinhood is only seven years old, but its pursuit of that mission has shaken up the brokerage industry in profound ways. Its sleek app-based features have made it the go-to investing platform for people under 40. The upstart boasts 15 million accounts, according to investment bank JMP Securities, on par with decades-old rivals like Charles Schwab and TD Ameritrade; it added 5 million accounts in the first three quarters of 2020 alone. Its rapid rise has forced incumbents to emulate its innovations, most notably zero-commission trading, which virtually all brokers now offer. And its ease of use and unabashed cheerleading for stocks have made it synonymous with a new species of investor dubbed the “Robinhood trader”—a cohort disparaged by many financial pros, but one whose influence is reshaping assumptions about how to invest.

For Tenev and his 35-year-old cofounder, Baiju Bhatt, long-term success—including profitability and a public offering—depends on guiding those traders toward affluence. Robinhood believes it can emulate what Schwab did two generations earlier, acquiring younger customers that the rest of the industry has ignored, then providing more lucrative financial services as those customers mature. 

For this strategy to work, however, Robinhood must prove it can attain maturity itself. The company’s stumbles on tech execution, regulatory compliance and customer service have prompted skepticism about its ability to offer products and advice to wealthier clients. Other critics have faulted the Menlo Park, Calif., startup for promoting risky trading. Even as Tenev wrangles toddlers at home, he’ll need to bring discipline to a company prone to behaving like a hormone-addled teenager.

Signing up for Robinhood can feel like navigating a lazy mobile video game. Exuberant screens promise, “There’s free stock waiting.” Others offer a “Robin’s reward” digital scratch-and-win ticket—which in my case deposited $3.24 worth of an obscure health care stock into my new account. Within 10 minutes, I was able to trade stocks and stock options. It’s all a quantum leap from the last time I opened a brokerage account, five years ago. That process took days, involved fax machines, and, needless to say, offered no scratch-and-win prizes.

I’ve since experienced the design nudges that Robinhood uses to encourage trading. Flurries of notifications arrive, unbidden, to alert me to price moves in stocks I own. (I receive frequent pings about that health care stock.) When I do something new, an on-screen confetti shower celebrates my move. 

 Little wonder, then, that Robinhood has grown so quickly and generated such feverish activity. In the second quarter, its users traded nearly 60 billion shares of stock, a 150% year-over-year increase, eclipsing totals at Schwab and E*Trade. In June, the startup outstripped its rivals for the first time on a widely watched metric called daily average revenue trades, posting an average of 4.31 million, half a million more than runner-up TD Ameritrade.

Robinhood’s dominance is no fluke. It caught on by deploying the right technology at the right time: It launched in 2013, just as smartphones became ubiquitous. Bhatt and Tenev, who met at Stanford University, also absorbed the Silicon Valley ethos that design is king. The pair labored over Robinhood’s interface, teaching themselves typography and iOS design while riding Caltrain commuter rail and fine-tuning the app by asking countless strangers to try it. They also pulled off the startup trick of persuading early customers to refer friends, creating buzz without the expense of a marketing campaign. It didn’t hurt that their Stanford circle featured a who’s who of future Valley moguls, including Snapchat founders Evan Spiegel and Bobby Murphy, Instagram’s Kevin Systrom, and media gadfly and venture investor Josh Constine, who could serve as the duo’s informal brain trust.

Robinhood also employed customer-acquisition tactics that other brokerages had seldom tried. Commission-free trading has attracted the most attention but equally important was requiring no minimum investment, which meant customers with very little cash could immediately assemble stock market stakes. 

Its strategy is reminiscent of San Francisco–based Charles Schwab, the former upstart that made stock trading accessible to smaller investors in the 1970s with lower commissions and everyman marketing campaigns. Incumbents took a dismissive view of Schwab, says Chip Roame of Tiburon Strategic Advisors; heavyweights like Merrill Lynch let Schwab hoover up small investors while they catered to “priority households” with far more assets. “Now, Schwab has four times as many clients because they grabbed them while they could,” says Roame. “That’s what Robinhood is doing.”

Five decades later, the pattern could be repeating itself—dismissiveness included. In interviews, executives from older brokerages praise Robinhood’s app but express doubt that the company can provide the guidance customers will demand. “Gamification and confetti might get new traders in the door, but investors need a lot more from a firm they trust with their money,” says Barry Metzger, SVP of trading and education at Charles Schwab. “The app is just one part of it.”

In a year of unprecedented financial shocks, few were more surprising than the wave of retail investors—investors trading from personal accounts—that sloshed into stocks in 2020. Piper Sandler’s Rich Repetto, a veteran brokerage-stock analyst, estimates that retail investors’ share of trading has jumped from a longtime baseline of 10%–15% up to 20%–25%, as amateurs homebound by the pandemic ride the ups and downs in stocks. That leap is one reason the average daily volume of shares traded soared from 7 billion in 2019 to 11 billion this year.

Tenev and Bhatt’s company has undeniably contributed to that increase, so much so that “Robinhood traders” has become disparaging shorthand for investors who pile into stocks without regard for business fundamentals. And indeed, Robinhood users helped fuel recent bubbles in shares of bankrupt brand names like Hertz and J.C. Penney. Still, Robinhood insists that caricatures of its customers are unfair, and that most aim to buy and hold stocks—behaving like investors, rather than traders. 

Robinhood customers are younger than the industry norm, with a median age of 31; 70% are millennials or Gen Z. They’re also more ethnically diverse. According to a survey Robinhood commissioned, 60% of their customers are white, compared with 78% at other brokerages. Nineteen percent of Robinhood users are Hispanic, 10% are Asian, and 9% are Black—figures close to the makeup of the U.S. as a whole. (Women remain underrepresented at Robinhood and its rivals, accounting for about a third of customers.)

This young clientele may be buying stocks, but they’re not building much wealth yet—at least not at Robinhood. Investment bank JMP Securities estimates that the average Robinhood account balance is less than $5,000. Robinhood declines to comment on this estimate, but if accurate it’s a far cry from its competitors: The average balance at Schwab, for instance, is $255,000. Still, Robinhood executives say that their young customers have a different approach to investing than earlier generations—and that Robinhood’s tools could suit their needs well as they acquire more assets.

Schwab has four times as many clients [as older competitors] because they grabbed them while they could. That’s what Robinhood is doing.

Chip Roame, Tiburon Strategic Advisors

Inexpensive, low-maintenance index funds and ETFs were the democratizing force in investing in the 2000s and 2010s. But Howard Lindzon, an early Robinhood backer and founder of investing site Stocktwits, says that many young investors avoid index funds—which may own controversial assets like oil or tobacco stocks—and instead buy shares of brands they trust, like Netflix and Disney. Tenev, meanwhile, notes that buying fractional shares of pricey stocks like Google and Amazon is particularly appealing to this generation. Through Robinhood, they can arrange to automatically purchase partial shares of such blue chips every payday.  

These à la carte tactics don’t offer the diversification and protection against risk that index funds do. But with zero-commission trading, building a portfolio by buying dozens or hundreds of individual stocks is no longer cost-prohibitive. And customers who prefer funds and ETFs can still buy them on Robinhood. Whatever approach they employ, Tenev says he anticipates more customers will direct automatic paycheck deductions into Robinhood accounts, the way savers do with IRAs and 401(k)s. That will keep them in the fold as they grow wealthier, offering Robinhood an opportunity to sell them profitable products and services.

Robinhood executives are tight-lipped about what those products and services will be or when they’ll arrive. But Tenev tells Fortune that Robinhood could eventually take a more active role managing customers’ assets, and a 2019 deck about the company’s future describes plans to offer IRAs, mortgage lending, and property and life insurance. “When you see the products roll out, it will fit into a coherent long-term narrative,” says Tenev.

Those who knew Tenev and Bhatt at Stanford say the pair were more bookish than boorish. Tenev says personal wealth has never been their primary motivation—notwithstanding that they will likely become billionaires if Robinhood goes public. “We both wanted to be physics or math professors,” says Tenev. “You don’t do that because you want money.” (Bhatt was on paternity leave and unavailable for interviews during the reporting of this story.) When they launched Robinhood, the duo said they were inspired by the ideals of Occupy Wall Street; their corporate namesake, of course, is a folk hero who stole from the rich. 

 Still, like many of their tech-startup forebears, the founders have been criticized for forsaking populist principles in the pursuit of hyper-growth. For Robinhood, that criticism has revolved around both its gamified, casino-like design and its business model. And in the arena of options trading, the combination of those factors has put the startup on the defensive.

 Robinhood earns more than 70% of its revenue through a process called “payment for order flow” or PFOF, which generated $453 million for the startup in the first three quarters of 2020, according to securities filings. (The remainder of Robinhood’s revenue comes primarily from lending securities and from Gold, a $5-a-month premium service whose features include margin trading and more-detailed market data.) PFOF involves routing customer trades through market-making firms, in return for a fee; the market makers benefit by earning money on the spread between bid and ask prices when they execute the trades. Routing orders through market makers can also help customers get more favorable prices on their trades, but it’s usually an either/or proposition; if the brokerage gets a PFOF fee, the customers won’t get price improvement. 

While controversial, PFOF is commonplace: Larry Tabb, a markets analyst at Bloomberg Intelligence, notes that PFOF fees are what allow brokerages to offer free trades in the first place. The situation is murkier, though, when it comes to PFOF for options—contracts that give investors the right to buy or sell shares at a fixed price in the future. Options offer alternative ways to profit from share-price movements, but their pricing can be fiendishly complicated, and trading them is usually the province of professionals. Market makers offer considerably higher PFOF payments for options trades, in part because they generate higher margins—and options-related fees account for 62% of Robinhood’s PFOF revenue, according to Piper Sandler.

Not coincidentally, Robinhood’s app frequently reminds users that options are an option. During my test-drives (albeit after I selected “I know what I’m doing” during sign-up), hitting “trade” on any stock called up a large “Trade Options” button that appeared above the more pedestrian “Buy” or “Sell” choices. Selecting “Trade Options” leads to invitations to select puts and calls—the most basic contracts—but also to try exotic “multi-leg” strategies involving multiple contracts, with names like “straddle,” “strangle,” and “Iron Condor,” tactics that wouldn’t sound out of place at a pro-wrestling match.

These nudges irk critics, who say the options game is one novices shouldn’t play, not least because pros can take advantage of newbies’ inexperience. Ranjan Roy, a former Bank of America options trader, wrote a widely shared essay explaining why veterans refer to amateurs as “the gravy.” “If you trade options all day, you’re going to lose money,” Roy tells Fortune. Benn Eifert, founder of an investment fund that uses options to ride out market volatility, says that successful options trading requires sophisticated software and substantial math proficiency. He expresses dismay over Robinhood’s tempting interface. “It’s totally shocking to me that it’s not a major legal issue for them,” he says. 

Read an excerpt from Jeff John Roberts’s forthcoming book, Kings of Crypto, here.

Robinhood has, in fact, been fined by industry group FINRA for issues related to its PFOF practices, while the SEC is poised to impose a fine of its own. And scrutiny of how it encourages options trading has increased in the wake of the June suicide of one of its customers, who left a note blaming the company for letting him accumulate over $700,000 of debt while trading options. (It later emerged that the 20-year-old had failed to understand that the negative balance he saw on-screen was much higher than his actual debt.)

Most people aren’t yearning for a call to customer support. They don’t want to talk to an agent. They just want the quickest solution to their problem.

Vlad Tenev, CEO, Robinhood

Robinhood has promised to overhaul its options platform and to offer better disclosure about PFOF practices and more educational material for traders. Tenev says that stories about options trading don’t reflect the habits of most customers: Only 13% trade options, and fewer than 2% of those try multi-leg strategies. Others connected to Robinhood are less apologetic, seeing condescension in the criticism. “There’s a shocking level of sophistication in the order flow,” says an executive at one of Robinhood’s market-making partners. “It’s not like it’s Aunt Millie in Nebraska trading puts and calls.” Lindzon, the early Robinhood backer, acknowledges that some customers make bad decisions—but argues that it’s paternalistic to stop them. “You’re going to let a kid drive a car or buy a Juul, but you’re not going to let a kid decide what stock they’re going to buy?” he asks.

Other public relations scrapes have dented Robinhood’s reputation, as have technical meltdowns that left users unable to access the site during peak trading days. By mid-July of this year, Robinhood had been the subject of 473 complaints to the Federal Trade Commission, compared with 126 for Schwab and 69 for Fidelity—which have comparable numbers of customers. The discontent has arguably been aggravated by Robinhood’s approach to customer service. Unlike traditional brokerages, which field armies of agents to hold clients’ hands, Robinhood does not provide customers with even a phone number, leaving them to seek help via the app. 

Tenev appears to have internalized the tech credo that automated solutions are preferable to the old-fashioned (and expensive) alternative of hiring humans. “Most people aren’t yearning for a call to customer support,” he says. “They don’t want to talk to an agent. They just want the quickest solution to their problem.” Nonetheless, in a bow to reality and to its own future ambitions, Robinhood is hiring hundreds of agents to staff call centers in Arizona and Texas. The company says these agents are now making outbound calls in response to digital requests for help—but it has no immediate plans to publish a phone number.

Robinhood’s awkward adolescence hasn’t kept it from raising very grownup sums. In September, the company announced it had raised $660 million in a new funding round from prominent venture capital firms including Andreessen Horowitz and Sequoia Capital. Following two earlier rounds this year, Robinhood has raised $2.2 billion in total, with a current valuation of $11.7 billion. The gusher of cash amounts to a bet that Robinhood will challenge or even eclipse the old guard. 

It is also a bet that Tenev is ready to run a public company. Robinhood is expected to announce an IPO in the coming months, and the company said on Nov. 20 that Bhatt would step down as co-CEO, leaving Tenev as sole chief. (Bhatt will remain on Robinhood’s board and work on product development.) Tenev is reading history to find leaders to emulate. “Alexander the Great was a leader who led from the front,” he enthuses. “That courage and boldness is inspirational. Alexander was on his horse and going to battle while his generals were still talking.” His own supporting cast of generals, meanwhile, now includes more seasoned executives, including Jason Warnick, an Amazon veteran who became CFO in 2018, and Dan Gallagher, a former SEC commissioner who is now Robinhood’s top lawyer.

For now, the team has momentum on its side. The pandemic-driven surge in trading has produced a bigger pie for all brokers: TD Ameritrade and E*Trade recently posted record quarterly trading revenues (each had PFOF in part to thank). Even so, Robinhood’s progress stands out: Investors are downloading its app at a pace 10 times as great as those of rivals. 

 Still, impressive scale doesn’t guarantee Robinhood will evolve into a Fidelity or Charles Schwab. Those companies’ diverse, profitable revenue streams include asset management and banking services, as well as interest earned from customers’ cash balances. The incumbents are also beefing up their offerings by consolidating: Charles Schwab is in the final stages of acquiring TD Ameritrade, while E*Trade has just been absorbed into Morgan Stanley.

Building a comparable suite of services at Robinhood will take time and money—and it’s no sure thing that current customers will embrace them. Some market-watchers suspect that many investors use Robinhood for entertainment, wagering small amounts on its zippy platform while keeping the bulk of their wealth elsewhere. Robinhood’s small account sizes lend credibility to that theory. “A lot of people use it as a secondary brokerage—like a play account,” says Casey Primozic, who runs a site called Robintrack that compiles data about the most popular stocks on Robinhood. (Robinhood stopped sharing data with Robintrack in August, in part because the site’s users included hedge funds scanning for trading patterns they could profit from.)

Financial threats loom, meanwhile, for all brokers. Repetto, the brokerage analyst, predicts that trading volumes will decline as the pandemic eases. And payment for order flow, Robinhood’s main artery, may itself be at risk. Tabb, the Bloomberg Intelligence analyst, expects that pressure from consumer advocates will lead the SEC to require brokerages to display prices differently for the “odd lots” that include many retail trades. Those changes would narrow the bid-ask spread on such trades—hurting market makers’ margins and leaving less revenue for PFOF. Tabb says that such changes, along with fierce competition, may eventually even lead brokerages to reimpose commissions, undoing the era that Robinhood ushered in. 

Warnick, Robinhood’s CFO, flatly rejects the idea that the company might charge commissions. But for now, Robinhood continues to keep its actual revenue-generating plans close to the vest, even as it grabs customers at a breakneck pace. 

The likelihood of Robinhood turning those traders into profit-generating, long-term customers seems uncertain—especially given the incumbency and deep pockets of its competitors. But Joe Grundfest, a Stanford Law School professor and former SEC commissioner who knows Tenev and Bhatt, says such skepticism underestimates the power of a true innovator. “By that logic, Walmart should be kicking Amazon’s ass, CBS should be wiping the floor with Netflix, GM should be kicking the corn out of Tesla,” he says. 

All Vlad Tenev has to do now is execute like Jeff Bezos, Reed Hastings, and Elon Musk. 

CORRECTION: An earlier version of this story incorrectly said that the SEC had fined Robinhood. That fine is still pending.

A version of this article appears in the December 2020/January 2021 issue of Fortune with the headline, “Stealing (market share) from the rich: Robinhood’s next adventure.”