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On Friday, 29th January, Robinhood Markets Inc. announced raising emergency funding of over $1 billion, with participation from existing investors Sequoia Capital and Ribbit Capital, among others.
You may remember Robinhood Markets Inc. as the company in the middle of the short squeeze mania that overtook Wall Street last week. The Menlo Park, California, US-based company enables average US citizens to buy and sell (fractional) stocks instantly, at zero commission, via its app.
Why raise so much money? At the height of the mania last week, Robinhood received a lot of flak for preventing users from buying shares in GameStop, and at least 12 other company stocks, because it deemed them too volatile. The move was perceived to be in solidarity with Wall Street bigwigs – who were looking to short-sell GameStop – as opposed to the commoner whom the company claims to serve.
But according to Robinhood co-founder, Vlad Tenev this was not the case. You see, when Robinhood launched in 2013, it made use of third party clearinghouses regulated by the US Securities and Exchange Commission (SEC). Essentially middlemen in the stock market, clearinghouses are tasked with ensuring brokerage firms, like Robinhood, have funds available to back up trades they facilitate.
However, in 2018, in a bid to save on expenses and scale faster, Robinhood cut off the middleman when it launched its in-house clearinghouse facility. Of course, with great power comes great responsibility, so Robinhood became expected to meet daily deposit requirements that match trading figures within its platform. But with exponential spike in trading volumes last week, Robinhood couldn’t meet these requirements, Tenev explains.
Hence the $1 billion cash injection which was secured at break-neck speed. About half of the amount came as loans from 6 banks. The plan is to lift all restrictions as soon as possible, as Robinhood wraps up plans to go public this year.
Under the hood. There are theories making rounds which suggest that, contrary (or in addition) to the official explanation, Robinhood possibly faced intense pressure from SEC and Wall Street bigwigs to place said restrictions.
Robinhood still relies on other middlemen called market makers to execute user trades. Usually, these market makers charge brokerage firms for their services but with Robinhood, the reverse is the case; they charge the market makers. Without going into too many details, this is how Robinhood is able to offer commission-free trading to it users (who are essentially the product).
Market makers are usually financial institutions like banks and, yes, hedge funds; the very same subjects of the user-targeted short squeeze. One of such hedge funds is Melvin Capital which was at the risk of losing billions of dollars and reportedly needed a $2 billion cash injection just to stay afloat. A bulk of that money came from Citadel Execution Services, which happens to be Robinhood’s biggest revenue source. Citadel Execution Services has since denied having anything to do with Robinhood’s restrictions.
Also during the week, NASDAQ CEO, Adena Friedman was seen on CNBC uncharacteristically calling for regulation to manage the situation.
And former US SEC chair, Arthur Levitt Jr. has called for an investigation into online stock trading which will examine “the science behind today’s day-trading platforms and “rules of behavioural psychology undergird all social media and successful internet platforms”.
Meanwhile, back home. Nigeria’s SEC is also looking to regulate local investment tech apps like Chaka, Trove and Bamboo. Brace up!
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