Robinhood’s destiny now rests with Dogecoin – Nasdaq

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Commission-free stock trading platform Robinhood Markets (NASDAQ: HOOD) became a public company in July, finally giving people the opportunity to own a piece of the trade revolution driven by young first-time investors.

But the stock appears to have cooled off after an initial surge of excitement. The company’s earnings report for the second quarter showed an increasing shift away from the roaring options and stock trading deals Robinhood is best known for towards cryptocurrencies – especially a highly controversial joke coin.

Given the ongoing regulatory issues surrounding its business model, investors may fear that this sharp pivot point will fuel the fire even further as crypto is hotly debated among lawmakers. Let’s examine the size of this potential risk.

An investor looking at stock charts on his computer monitors with confusion

Image source: Getty Images

Is Robinhood a cryptocurrency platform now?

It seems to have happened in the blink of an eye: In the second quarter, trades in conventional markets like stocks and options are no longer Robinhood’s biggest source of income. Instead, given the growing interest in assets such as Dogecoin (CRYPTO: DOGE), a novelty sign that has been heavily promoted by social media personalities.

Transaction-based revenue

2nd quarter 2020

Q2 2021

growth

Options

$ 111.1 million

$ 164.6 million

48%

Cryptocurrency

$ 5.3 million

$ 233.1 million

4,298%

Shares (shares)

$ 70.6 million

$ 52.0 million

(26%)

Data source: company registrations

Crypto accounted for 51% of all transaction-based revenue, but what is worrying is that of the $ 233.1 million Robinhood generated from digital forex trading, more than 62% came from Dogecoin trading alone. That means Dogecoin made up just over 30% of transaction-based sales. Against the backdrop of declining stock trading, it signals that Robinhood customers are foregoing safer investments in favor of pure speculation in the crypto markets.

This could pose problems for the platform, which is already under government scrutiny to encourage risky behavior through its “gamified” features.

But even though they make up the lion’s share of sales, the crypto assets held by Robinhood clients only make up 22% of all assets under custody. This suggests two things. First, its customers may trade their tokens much more often than they do stocks. Second, crypto can simply be a higher-margin business for the company.

However, the amount of crypto assets held by Robinhood clients is growing almost 14 times faster than total assets.

Assets held in custody

2nd quarter 2020

Q2 20201

growth

Cryptocurrencies

$ 780 million

$ 22.69 billion

2.808%

Total assets

$ 33.42 billion

$ 102.03 billion

205%

Crypto as a percentage of total assets

2.3%

22.2%

1,990 basis points

Data source: company registrations. 1 basis point = 1/100 percentage point.

The risks continue to increase

Whether the trades in question are stocks, stock options, or cryptocurrencies, Robinhood makes about 80% of its money through a controversial practice known as paying for the flow of orders.

Robinhood became famous as a no-fee trading platform, but it still makes money off of its clients’ trading activities. The users’ market orders are sent to third parties known as market makers who execute the trades and repay some of the proceeds to Robinhood (i.e., they take payments based on order flow). That’s one of the reasons regulators are careful – the market makers and Robinhood themselves don’t exactly have the incentive to find traders the very best prices.

The Securities and Exchange Commission found that paying for the order flow cost Robinhood customers $ 34.1 million in hidden fees between 2015 and 2018, after accounting for the savings from the zero commission model. The practice is banned in other major markets including the UK and is considered a violation of European Union rules.

However, cryptocurrencies represent a whole new dimension of risk not only for Robinhood customers, but also for the company itself.

In its SEC filing for the second quarter, Robinhood warned that it could not purchase insurance to protect all of its customers’ cryptocurrency holdings due to security risks associated with cryptocurrency storage and trading. That said, if Robinhood were hacked or lost control of the crypto assets in its custody, these customers would have virtually no way of getting their losses back in full.

This risk is not unique to Robinhood. It affects most of the players in the crypto space. However, investors who bought shares in this company because of its image as a stock trading platform popular with younger generations must now consider the potential ramifications of Robinhood being (and growing) the custodian of more than $ 22 billion in cryptocurrency assets.

Why don’t I buy it

Robinhood has done what no brokerage firm has been able to do before – conquer the young people’s business. Stock investing was perceived as a game for the elderly until technology made it more accessible. Today Robinhood has 22.5 million customers – more than twice as many as last year. The problem is that users are getting further and further removed from the actual investments.

One of the biggest problems I have with Robinhood is that the business will likely be limited to the US. It can only offer commission-free trading if it is able to generate revenue by paying the flow of orders. Since this is banned in many other major markets, global supremacy seems to be completely off the table.

The question is whether the U.S. market alone is enough to bring Robinhood sustained long-term growth, especially since its stocks trade roughly 25x after 12-month sales – with sales growth expected to slow to 18% in 2022 Analysts. Compare that to the competition Interactive brokerswhich trades at 2 times sales and is highly profitable while Robinhood is still losing money on the bottom line.

Robinhood has faced regulatory challenges in many areas of its business throughout its brief history. It only increases the risk for the company that its users will get so heavily into cryptocurrencies at a time when the treatment of these assets is hotly debated among lawmakers.

But more importantly, users seem to have cared a lot less about stocks than they did before. Now, the fate of Robinhood’s growth trajectory depends on whether or not crypto has staying power. And at the moment the future of the company is particularly tied to Dogecoin – a sign that even its founder thinks is a joke.

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Anthony Di Pizio has no position in any of the stocks mentioned. The Motley Fool recommends Interactive Brokers and recommends the following options: Short September 2021 $ 70 puts on Interactive Brokers. The Motley Fool has a disclosure policy.

The views and opinions expressed herein are those of the author and do not necessarily reflect those of Nasdaq, Inc.


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