Robinhood, the stock trading and investment app used by Reddit users to trigger a meltdown on Wall Street, can’t seem to keep out of the headlines, and not for good reasons.
Robinhood is being sued for wrongful death and is facing over 30 class-action lawsuits. What’s more insidious is how Robinhood makes money, and more importantly, who’s benefiting from it.
Why do hedge funds and high frequency traders love Robinhood?
How does Robinhood gamify the stock market?
Why is front-running a concern?
Despite multiple lawsuits and questionable tactics to lure novice investors, it seems that having a myriad of wealthy venture capitalists in their corner is serving Robinhood well.
Robinhood, the stock trading and investment app used by Reddit users to trigger a meltdown on Wall Street, can’t seem to keep out of the headlines, and not for good reasons.
Robinhood is being sued for wrongful death and is facing over 30 class-action lawsuits. What’s more insidious is how Robinhood makes money, and more importantly, who’s benefiting from it.
Why do hedge funds and high frequency traders love Robinhood?
How does Robinhood gamify the stock market?
Why is front-running a concern?
Despite multiple lawsuits and questionable tactics to lure novice investors, it seems that having a myriad of wealthy venture capitalists in their corner is serving Robinhood well.
Henry: Hey everyone. It's Henry Mike and Chris of the decentralists and it's Hot Topic Time again. But we had such an interesting reaction to the previous one, I guess it was last week about game stop. We need to continue because if you recall what enabled all of that was an app called Robin Hood and there's been an awful lot of information. That's come to light regarding Robin Hood in the interim and Mike's been tapping me on the back and saying, let's do this. So, Mike, why don't you lead us off? Because I know you're rather invested in this
Mike: Absolutely Henry.
Henry: Cool choice of words.
Mike: I know exactly. Oh, the irony is not lost on our listeners. I'm sure. Well, Henry we talked about, I think it was last week, we talked about game stop and this Reddit versus wall street battle with all the hedge fund guys, the billionaires losing billions and this little guy and all this other kind of stuff and the regulatory pressures and all of this, I mean you can't not talk about it and I think we even said at the end of that last one I'm putting my money on the fact that we're going to do another one and so we are right. We are and the reason why is because, this thing is clearly so complicated and we got a lot of really good kudos on taking the time to explain the effect of what was going on.
Okay. So, what was the short selling and what was the fewer and all these other things, but as we got deeper into it. You start to look at the tools that caused the problem. So, in this case, it's a trading, a free trading app called Robin Hood. Robin Hood is and I'll let Chris take this one in a sec, but basically in a nutshell, Robin Hood is an app that you can download on your phone. That allows you to make trades, like the ones that kind of caught all the short sellers by surprise for free and normally, right. I mean, for those of you that have ever gone, have ever had a brokerage account, or bought a security or an RSP or anything, there's either an administration fee or there's a transaction fee.
Henry: Well, exactly. I mean, Mike, I have a legitimate trading account that's been around for, well, it was originally on a computer like 15 years ago. Now it's of course an app for the last, I don't know, close to 10 years but the point is I have to pay for my trades when I make them and there are an awful lot of legalities that I have to adhere to and all that sort of thing. But you said something really interesting in the last podcast, and you said that this Robin Hood app is gamify. I'm not really sure what you mean by that, but between you and Chris, I'm sure I'm going to find out.
Mike: Absolutely. So, what basically what Robin Hood is so there's two important things you got to realize about Robin Hood first it's an app that is gamified. You just mentioned it and so what does gamify mean? Gamified means that if you've ever looked at any kind of; when you were making your stock trades, Henry, it probably looks like some crazy two-point font Excel spreadsheet. With a bunch of check boxes and paper and fill this out and all that. Robin Hood is not that, Robin hood is something that's like playing Tetris, but you're buying and selling shares. It's, that's what gamified means. It literally means we have set this up so that people will take this app and they will take this concept of buying and selling. So, stocks and options and shorts and all of these different, really complicated financial instruments and turn it into a game of Tetris.
Henry: But that's serious business.
Mike: This is crazy, serious business and one other thing, and this is where I'm going to lead into Chris, because I know he is chomping. The other thing is it follows this same centralized software as a service free. I call it a BS business model because Robin hood. You could download the app for free and you could trade for free. So, how do they make their money? Chris, how do they make their money?
Chris: They make their money through what used to be called Front Running. What used to be called Front Running. So, the way it works is back in the day before we had computers and fibre optics and all that, right. People used to have to buy and sell their stocks by lining up at a bank and what Front Running is during the lineup, what would happen is you would overhear somebody say what stock they were going to buy. So, a Front Runner would take that bit of conversation, relay that to somebody at the front of the line and the guy, the front of the line would be able to get in and buy at a lower price than the person on the back of the line.
Henry: Is that right?
Chris: That's right. So, this is how it worked be before the internet. Now, the way it works with Robin hood is all this stuff is done in microsecond. So, a kid he's playing around with Robin hood, he decides I want to buy a game stop. So, he puts in his transaction in Robin hood, Robin hood sends this data to Citadel. Remember our friend Citadel from last week.
Henry: The hedge fund.
Chris: That's right and Citadel puts in their transaction before our little gamer friend does.
Henry: So, wait a second so who's making the money there?
Chris: Well, Citadel's making the money and so is Robin hood and so is the retail investor, but the question is question is who's profiting more.
Mike: Because by and this is, you mentioned this in the last episode, right? Chris, where these Citadel guys are one of the hedge funds. So, basically Robin hood gives the retail little guy and girl, this app to play Tetris with stocks, they go out and they say, I'm going to buy game stop and right now when they press the button. The game stop share is, say $20. That transaction goes to Citadel and these hedge funds literally all they do; they don't even have people anymore. Basically, they have like three guys it's a computer program. So, they invest in Robin hood had literally, sold that when you press the button Henry for your $20 share, it goes out and says, I want to buy a hundred shares at $20. Citadel buys it at $20 and sells it to you for $20 and 5 cents.
Henry: No, is that how it works?
Mike: That is exactly how it works.
Henry: I didn't know that.
Mike: That is exactly how it works. So, the idea with these hedge funds. Is they have two ways that they make money? They make razor, thin margins, like 5 cents, 1 cent, 10th of a cent.
Henry: But they do it every time.
Mike: But they do it on a billion transactions a day, or what I mean? So if you take a billion times, 5 cents, you just made yourself $50 million or something for doing nothing for front run a stock and so it's also remembered but it's even more insidious, because we've been talking a lot about this effect of these things and that we've, it's been beaten over everybody's head and but this idea that if you are not paying for the product, you are the product.
So in this case, these retail investors are downloading a free app that is addicting them and making it super crazy, easy to buy shares or options or crazy instruments and it's, and they're not paying for, even for the transaction itself and so you got to think, well, wait a second, how's Robin hood making money. Guess what? They're selling all of that trade data on a real time basis to banks and investment banks and hedge funds who are, it's just skimming the cream off the top.
Henry: What a scam. Mike.
Mike: It's a crazy scam.
Chris: I just want to talk about this whole notion of gamification because not necessarily everybody listening may be familiar with that term. The reason why it's called gamification is because when you go to an arcade, there is incentives for you to keep playing the game. You want to get that high score. You want to beat the boss. You want to get to the next level. These are all incentives, at a certain point technology company that they could take these same incentives from video games and apply to getting them to behave a certain way in their apps, for example, with Facebook, one of the ways that they keep people hooked to Facebook is essentially you get a reward, for filling out a status update. You get a comment.
Mike: That's exactly. That's the thumbs up and the like, and the replies and the four.
Chris: These, are all gamification techniques. It's supposed to shoot a little bit of dopamine into your brain. To make you want to keep going further. Now, the way Robin hood specifically gamifies their app is when you make a transaction on Tesla. For example, and it goes down, they send a little notification that says, I think it's going down with a little icon that's pointing down and they give you advice on what to do next, buy a put, sell a coverage call, put a debit spread in.
Mike: Oh, my god I even know what those are. And I mean, and I may study this stuff.
Chris: I say, actually, what it is Mike is it's walking into a casino. You put in your money into the one-armed bandits. The slot machines. You might not know what the icons and the slot machines mean, but they light up. Same deal with Robinhood. That's how they gamify you. This is how they get you addicted.
Henry: So, one of the things that I read in the briefing for this, and I quiet, I wasn't actually aware was that Robin hood was responsible for a young man's suicide. Now you talk about an example of centralized apps. Absolutely. Ruining the world. Is that obviously the case or should the young man have known better?
Mike: So, basically the story, this one's actually really sad. So, the sad thing is we're getting desensitized to this, right? Because you could basically, we've been reading stories almost on a weekly basis about teens and young girls and young boys killing themselves because they get trolled on social.
Henry: It's unbelievable. That alone totally is why even have the internet?
Mike: This is exactly the point. But what you're seeing here is this is now taking a different turn. So, there is this young, man in the United States. What's his name here? Alex Kerns and so he's got Robin hood and he's playing, like, he's basically doing stock trading and on all this stuff and it's around maybe this game stop, maybe not whatever, because it wasn't clear in the article that I read. But basically, what ended up happening was this young man got a note from Robin hood, basically a call. They said, hey, you've been doing all these put spreads and things that Chris was talking about that is basically Greek to me and you now owe us $730,000, and we need 120 grand in the next 24 hours, or we're going to, or we're going to call the authorities on you.
This is real money, real money and so he basically, loses his nut because he's a young kid. He's 25 or something that.
Henry: Oh, he's 20.
Mike: He's 20 years old. He's been sitting around playing a video game, slot machine in his house and all of a sudden, the guys are the lone sharks at the front door and so he he's fast and furious. He, goes in it's a free app. So, guess what? The support sucks, he starts trying to contact Robin hood, going. I think there's a mistake. This can't be right. What are you talking about? Da, da, da, da. Doesn't get any responses, doesn't get anything back from the chat bot that they use to support this is not free app, ends up killing himself.
Henry: Oh, how a tragedy.
Mike: Because he doesn't want to tell his parents and you know what, the worst part of it is Henry. They come back 24 hours after the kids killed himself, said, we made a mistake. Send it to the wrong person.
Henry: Yeah. Oh, because I'm, my next question was, well, if he was in the hole for $700,000, where did he get that money? Well, it wasn't even him.,
Mike: Well, because you don't need money anymore. With short selling specifically there is an infinite amount of money you can and lose.
Henry: Yeah. That's right. Yep.
Mike: Well, because you don't even need money to make the money. I mean, you could, you can go on to some of these things that Chris is talking about these put option things and all this stuff. They're actually instruments where you're putting a bet down Henry like a craps table and you got to wait for the crepes, you're got to wait for the real wheel to stop so you can literally go to the table with Robin hood in some of these instruments and say, I want to do this and unbeknownst to you, you've just said, I'm going to sell short a million shares of Tesla, which somebody literally behind, without even knowing it has given you the thing, you press the little red jewel on the Tectrix game, you've now praised a short and it costs you nothing for 30 days. At the end of that 30 days, you got to pay the price. Right. So, you don't even know, you don't need any money.
Henry: Then actually Robin hood has created a monster.
Mike: But it's even worse. Okay. So, I want to just get in because I know Chris has got stuff on this one. So, one of the other things that's happened. So, Chris pointed out last time that we talked and we just mentioned it a little bit briefly is this thing that most people don't know is that one of the investors in Robin Hood is the Citadel capital guys, the hedge funds that are front running and making all the money. So, one of the other things that happened, I was reading I read an article, I think it was in Gizmodo and they were reporting that after. So, Robin Hood is being used by all these people on Reddit to kind of run after the short sellers. The short sellers start freaking out. The stock goes from 20 to $400. They're freaking out cause they're losing all their money and all of a sudden Robin hood pops up a warning notice in the app and says these 15 stocks game, stop AMC bunch of these Blackberry, a bunch of these kind of companies that were heavily shorted were now being restricted from any game stop purchaser. So, the little guy and girl could no longer purchase game, stop shares. They could only sell them.
Chris: When we talked about that in the last hot topic about this.
Mike: So, what that means is a bunch of short sellers who've invested in the company have now put pressure on the company to stop people from buying so that it stops them from bleeding. As much as they're bleeding, cause every time somebody else buys, it makes their price to buy back and cover the short more because they lose more money. So, this happens, then all of a sudden you get like a class action lawsuit gets filed by all of these game stop people. They're joining this class action lawsuit saying you are interfering with my right to free speech, my right to freely do what I want with my money. Sound familiar It's been going on for all month and they complain about all this and they file 100,000 negative reviews of Robin hood in the Google play app store.
Henry: Are those are individual legitimate reviews?
Chris: Oh yeah.
Mike: Well, absolutely. So, a hundred thousand people are outrage because what was it, Chris? It was millions of people were in this Reddit group or something.
Henry: Sure, so these are legitimate thumbs down.
Chris: At this current count. I want to be clear. There are over 8 million people on the wall street bets, subreddit.
Henry: 8 million.
Chris: 8 million and they're all really focused on game stop.
Mike: So, imagine this now. You got 8 million people. Who've now been told they can't sell. They can't buy, but they can only sell which benefits who? The investor in Robin Hood. The hedge fund. Now these a bunch of these people file a class action lawsuit and then they in a hundred thousand of them out of 8 million, turn around file of a negative review of the Robin hood app because they've just been screwed by them and it drives Robin hood app from 4.7 stars on the Google play app store to 1.7 stars and Robin hood falls off the map. Google turns around and removes the hundred thousand bad reviews saying that they were suspiciously inorganic. So, they're basically saying this, some bought basically was hammering the thing, filing negative reviews that were fake.
Henry: But that's not true.
Mike: But this is an onion that you can keep peeling. I mean, it's literally like endless seriously. So, then I sit there and I'm like, wait a second. I just, I remember another connection in another article, I'd read a couple of days earlier where when Robin Hood had let all these guys start buying and doing all this stuff. They needed to basically they had billions of dollars’ worth of transactions going for the app and they didn't have enough money in their own trading account to fulfill the orders. So, Robin Hood turns around and they go to their venture account, capital Silicon Valley, venture capital backers, and they get a billion dollars, a billion-dollar cash transfusion to make, to fill these orders.
Then they ban all the trading. So, they basically put, they get a billion dollars from their VC. One of them is a, VC that's been around since the very beginning, it's called Sequoia capital they're on Sandhill Road. That they are literally the bullseye in the venture capital bullseye. Sequoia capital gives them a billion dollars because they invested in Robin Hood, Sequoia capital in June, 2020 celebrated the 25th anniversary of their founding 25 million investment in Google.
Henry: You're kidding.
Mike: Nope. So, you start to see this, hey, think of this see this onion, Robin Hood free trading gamified backed by the bunch of hedge funds who are front running S based off the hard work and back and purchases of people like you and me, they get into trouble. They turn to their other backer, which is a venture capitalist who then who basically backs them and says, I'll give you the billion, but you got to ban everybody from selling or from buying to stop the bleeding and then they make another phone call to Google and say, we put a billion into this app. I need you to remove the negative reviews.
Henry: So, the average person has absolutely no control and is basically used.
Mike: It is scary. What's actually wrapped up in this and this is why I think everybody's freaking out.
Henry: This is Why the world has to change to a decentralized world.
Mike: Absolutely.
Chris: So, the reason why all this stuff is able to happen is because the people in control of these things. I hate to sound a little bit out there, but it's true. The people in control of the things are few and far between, and they know each other.
Mike: Exactly. A lot of us, you hear a lot of people for many years. Have been complaining about the, how this, this kind of free market at gun Teton wall street kind of model of capitalism is unfair to the average person and usually they get laughed off the stage, like a bunch of left wings, socialist, quacks. But what's, you're actually, what's being exposed by this game. Stop Reddit, Robert Hood, Sequoia Capital, Citadel thing is that it's actually true. None of these people are legitimately making the money based on what my old economist’s economics pros to say, the free, and equal exchange of information. That's what the stock markets are supposed to be based on. None of this is true. These guys cannot even make an honest bet on a startup without having all of these other wires and fire alarms and second, and third and fourth and fifth layer of protection. It's all a big ball of string of collusion and manipulation and the only people that suffer just we've been saying for years about social media is the average human being.
Henry: So, that being the case, which it is, I'm going to ask both of you, we now know how Robin hood works, it operates, and how many people have been hurt by it, what needs to change in the future? So, this doesn't happen. Get as detailed as you want.
Chris: I think what we need to do is keep decentralizing. I know all you folks hear me. So, say that word a lot, but it's true. We need to decentralize the finance world and we need to decentralize the social media world because in 2021, these two very disparate industries are becoming aligned with each other. As in just this week, a social media, driven ETF was just announced.
Henry: ETF is?
Mike: Exchange Traded Fund. So, what mimic, it mimics an exchange. It mimics a stock exchange.
Chris: What I mean by a social media driven ETF? I don't mean that this is an ETF composed of social media companies. I mean, this is an ETF in which sentiment on social media is being measure, whether somebody likes a stock or hates a stock, somebody in a back room is compiling the data. Seeing how often Tesla gets mentioned on Twitter or Facebook and how often people seem happy or sad when comes to Tesla and then they build an ETF off of that. That's happening right now. What we need to do is decentralize to the point where, hey, if we want transparency of information, we can't have a middle man who is doing the Front Running and I mean, that both in the financial sense and in the social media sense.
Mike: I agree a hundred percent. I think the thing that everybody needs to keep in mind, so first, what you're hearing is the solution to this is regulation. That's what they've been saying about social media. That's what they're now saying about this kind of stock trading manipulation that happened they don't talk about it being Robin Hood, manipulating anybody it's talking about, the little guys manipulating of manipulating these hedge fund guys. So, they're talking about regulation. It's not the solution for social or media. It's not the solution for this stock trading stuff. It has nothing to do with that. It has to do with the fact that people are using and are subjected to these tools that are supposed to be used to accomplish something, to make their life more convenient. Those tools are riddled not even riddled; they're literally built on a foundation.
Henry: Designed.
Mike: Designed on a foundation, Henry of unbelievably complex, multiple PHD level algorithmic, mathematical equations with massive computing power behind them. You will, none of us will ever get out ahead of what these algorithms can do to us. If they want us to lose money, we are going to lose money and I guarantee you, they're not building an algorithm, Facebook and Robin Hood and all these guys are not going to build an algorithm to make the average person money.
Henry: Right. No,
Mike: They're not going to do that. So, the bottom line is as long we have a model where all of the apps. Apps that we use, all the services on the websites that we surf to, whether it's e-commerce or ordering a pizza, social media or stock trading is backed and designed on a platform of algorithms that are meant to do one thing and that is take money out of your pocket. Then it has to stop.
Henry: To that end. There is a bit of a solution, I think and I think that people generally have to completely change their perception and their mind, and start to think about paying a little bit of money. For an app, an app that is designed to do what it is, what they say it does, and it's not designed.
Mike: To take more money out of their pocket.
Henry: Fish and steal your data. In other words, I would be happy to, I mean, I don't go and want a free shirt because it has sensors in it that that some type of clothing company will know the temperature of my chest and my back, and then somehow make money from that, I would like to buy a shirt and get what I pay for. People have got to stop thinking that the only way to enjoy the internet is download a free app.
Chris: Well, I think people need to also understand that, without proper encryption they are going to be listened to at any time. That's part of the problem with Robin Hood is that these transactions, they're not encrypted, somebody's listening in on them.
Henry: Oh, fascinating. I didn't realize that. Of course, they're not they, how could they be?
Mike: Oh, of course not.
Chris: That's right. So, I think privacy is the killer feature and I think encryption is worth paying for.
Henry: As is a well-designed app.
Mike: Couldn't have set it better myself.
Henry: I didn't think we'd get that deep in to Robin Hood, but boy, I didn't realize there were so many layers that are kind of scary.
Mike: It's, he's got to a marry this Robin Hood's got a marry bunch, but they're, not Robin from the rich and giving to the poor they're. It's like Dennis Moore and Monte Python. They're taken from the poor and giving to the rich. It's sad.
Henry: Oh, that's a good way to, and Michael, thank you very much.
Mike: Thank you.
Henry: Chris, thanks for all your input. We'll have another hot topic soon. Thank you, gentlemen.
Chris: Thank you.
Mike: Thank you.