Robinhood's Promise: Stop Paying Stock Market Commissions

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The idea of buying and selling stocks without paying a commission has long been the Holy Grail for investors. Though some brokerages have offered zero-commission trades in the past, all have failed. But a new startup, backed by some very famous people, claims that it will be able to deliver.

Robinhood is the brainchild of Vladimir Tenev and Baiju Bhatt, two Stanford graduates who aim to remove the "friction" between buyers and sellers, allowing for a more efficient process and creating a zero-cost transaction, which they then pass on to customers.

Greasing the Gears in the Stock Market

Part of that efficiency involves offering a mobile-only trading platform –- via an app currently available only on Apple (AAPL) iOS devices -– and providing only electronic confirmations, statements and tax forms. A more poetic take is on the company website:

Over the last decade, technology has enabled building the most efficient businesses in history. Building an automated, electronic brokerage from the ground up allows Robinhood to eliminate the costly touch-points where other brokerages require human intervention or paper receipts. Rather than relying on prime-time advertisements and costly brick-and-mortar storefronts, Robinhood maintains a lean bottom line, allowing it to attract and retain customers far more cheaply.

Some famous names in Silicon Valley and in Hollywood backing Robinhood include Google (GOOG) Ventures, Internet pioneer Marc Andreessen, musicians Snoop Dog and Nas and actor Jared Leto. The buzz around the company has enabled them, without spending a dime on marketing, to amass a wait list of almost a half-million people requesting to open an account.

Taking It Out for a Test Drive

Recently I was fortunate enough to get early access to Robinhood and found the product to be well-thought-out and intuitive. As one who has opened innumerable brokerage accounts over the years, I was shocked at how easy and fast the process was.

I was able to fill out my personal information, have my identity verified and connect my bank account in under five minutes, inside the app from my iPad. The initial transfer of funds into my account took longer than I would have liked -- almost a week -- but the customer service department informed me that it has since upgraded systems to allow funds to post in 24 hours.

Trading on the app is smooth and seamless, and like all brokerages today, executions are almost instantaneous. And true to its claim, I was not charged a commission on any transactions. But as they say, the devil is in the details. Robinhood does not offer margin accounts -- which eliminates the ability to sell short -– nor does it offer options trading, though the company says both are in the works.

Where's the Beef?

So how does Robinhood is make money? Its website answer:

Robinhood will offer margin trading as well as [application program interface] access, which will allow partnered developers to build applications in conjunction with Robinhood. Robinhood will also receive remuneration for providing trade volume in certain markets. In the future, we plan to offer premium services for active investors.

However the most likely way in which Robinhood will make money is no different than other brokerages.

For most major brokerages, retail trading is a loss leader, or at best a break-even business. The real money is made by marketing 401(k)s, index funds and other financial products to customers, most lured in by watching exciting commercials extolling the virtues of investing in the stock market.

My guess is that with backers, who have already invested $16 million into the startup, Robinhood will take a page from Amazon (AMZN) and undercut the competition on price to gain market share. Then once its customer base is up to critical mass, don't be surprised to see the company roll out its own suite of financial products.

But assuming that Robinhood stays true to its stated mission, ultimately this is a win for retail stock market investors and perhaps the beginning of a huge disruption in the brokerage space.

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