Sunday, March 3, 2019

Marquette FinTech course examines how the start-up firms can offer zero commissions, high yields on cash balances and free trades – They learn there is no ‘free lunch’

The students in Krause's FinTech Topics course are learning how FinTech start-up firms can offer such attractive products and services at low (or no) costs

An article in Quartz helps explain how FinTech firms like SoFi and Robinhood offer “free” stock trading.  

The students in Dr. David Krause’s FinTech Topics course at Marquette University have been learning about the highly competitive offerings of the new FinTech start-ups.

Fintech firms like SoFi and Robinhood offer “free” stock trading. What’s the catch?

For instance, online lender Social Finance (SoFi) has rolled out an array of new features, including commission-free brokerage trades,  zero-fee exchange traded funds ETFs) and crypto trading – in addition to paying competitive yields on cash balances.

The student know that the buying and selling securities is not free - so how does SoFi and the other FinTech make a profit?

Image result for so fiOne way start-ups can offer low prices is by buying market share – let’s face it, Amazon’s venture capitalists and early investors  did not see any early profits and essentially allowed them to buy market share. For investment brokerage services, there’s also the Robinhood model, which makes a spread on what they earn and pay on customer deposits, charging traders who buy stocks on margin, and “selling” clients’ stock orders to the market makers who handle the trades ( a practice known as the payment for order flow).

Image result for robinhoodAs Quartz pointed out, San Francisco-based SoFi, which began in student-loan refinancing, knows it will lose money on brokerage services in the short term. Its stock-trading business model (which closely resembles Robinhood’s) will likely make a profit spread from the interest on customer accounts, securities lending, and a small amount from payment or rebates for order flow. 

The company hopes over the long-run that it will be able to convince customers attracted by its brokerage services to buy other higher-margin products.

“Commission free” trades usually  mean that the actual cost is hidden somewhere else, such as payment for order flow. Market makers post updated bids and asks, which is helpful for investors because it means there’s a ready market of up-to-date prices available when they want to buy or sell a stock. Some market makers (SoFi uses Apex who decides which market maker gets the order) offer to buy retail-investor orders from the broker and execute the trades for them – this is also done by established brokers like TD Ameritrade and E*Trade.

For more detail on the mechanics of this, go to the March 1, 2019 Quartz article found here.