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.
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?
One 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).
As 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.
