Robinhood’s IPO: The First Inning for the Democratization of FinTech and Investing

by David Arslanian

Robinhood achieved its $32 billion IPO by democratizing trading.

© Koonsiri Boonnak/iStock/Getty Images Plus

 In the early 2000s, the financial markets seemed inaccessible. High frequency trading firms staffed by “quants” and armed with algorithms competed for nanoseconds of advantage. By the early 2010’s transaction fees declined, and commissions decreased significantly, but the simple act of opening an account had barred many people from even thinking of trading.

Then, a company called Robinhood eliminated commissions and fees for retail traders by selling order flow to the high frequency trading firms and making the account opening process simple and straightforward. In doing so, Robinhood forced established brokerages to scrap their fees as well and compete for the ‘long tail’ of investors. Rather than restricting its IPO to institutional funds, Robinhood welcomed retail investors to its roadshow and even offered 35% of the IPO shares to its own users.

Arguably, Robinhood achieved its $32 billion IPO by democratizing trading. Detractors, however, view Robinhood as a mobile casino – a gamified mimicry of responsible investing. These detractors believe that a market correction will cull the new herd of retail investors.

More likely, the democratization of FinTech and investing is only in its first inning and even a market pullback will only serve as a reset to a ‘new normal.’ The freedom to trade and transact has produced a movement. Whether or not Robinhood succeeds, everyday people will continue to invest and participate in communities whether on Reddit or WallStreetBets, these new information (or misinformation) sites will grow. This movement has the potential to improve markets, self-correct regulatory issues and renew competition.

Supply and demand reach equilibrium

On an Econ 101 level, democratizers like Robinhood bring sources of supply and demand closer together. They remove inefficiencies that make financial services and products less accessible to the masses. The impact of these inefficiencies may only be apparent in retrospect but to be clear, they exist. 

Thanks in large part to Robinhood, an estimated 10 million brokerage accounts were opened in 2020, and another 10 million were opened in the first half of 2021. In June, retail traders accounted for 10% of trade volume on the Russel 3000 index – or about $38 billion daily – down from a COVID-induced peak of 15%. Retail trading is now responsible for more volume than hedge funds and mutual funds combined.  

Robinhood demonstrates that accessibility to the markets could be lynch pin to a more equal trading environment. In the same spirit, companies like SharesPost, Forge, and SeedInvest are trying to do for private equity what Robinhood did for public markets. If retail traders can buy into the deals once reserved for elite angel and venture capital investors, then no market is immune to democratization. Every barrier between supply and demand is a business opportunity.

More efficient markets self-correct regulatory concerns

Critics argue that the democratization of investing presents dire regulatory problems, particularly around perfect information. Wall Street knows far more than novice retail traders and therefore can take advantage of them. It is true that most retail traders can’t afford a Bloomberg terminal for over $20,000 a year, let alone the other resources Wall Street has. The issue then is access to information, not access to the markets.

Retail traders are overcoming that problem organically. As one Reddit trader wrote in The Conversation, “There is also the realization among institutional investors that social media users working collectively are capable of exposing carefully hidden information and spreading it like wildfire.”

Put differently, retail traders are developing asymmetric information sources through social networks rather than through subscriptions to Bloomberg or Thomson Reuters. The democratization of trading doesn’t necessarily create victims in need of regulatory protection. Just as Hollywood studios underestimated the power of a YouTuber with a smartphone, critics of democratization underestimate the Robinhood trader with a Reddit account.

Ease of access renews competition      

Until COVID-19 forced businesses to introduce contactless payments and digital services, few people cared about the inefficiencies of physical commerce. A similar realization is occurring in fintech broadly. Technology firms like Robinhood highlight how cumbersome it is to open a brokerage, banking or merchant account.

Understandably, the financial system wants to prevent money laundering, identity theft and other crimes. Compliance departments therefore go to extreme lengths to shield their institutions from liability. Even though fax machines belong in museums, a brokerage might require applicants to fax paperwork or sign documents with ‘wet ink.’ After navigating that gauntlet, customers feel stuck because the cost and complexity of switching (or opening) is too high.

If these inefficiencies limit choice, then accessibility has the potential to renew competition. Improvements to user experience – including digital paperwork and automated compliance – can enable people and capital to move more freely. From wire transfers and payment processing and to car loans and mortgages, democratization might force entire verticals to offer better value and service.    

A populist movement
Until recently, commentators might have said that Robinhood “disrupted” rather than “democratized” investing. The change in verbs could be clever PR. But perhaps “democratize” is the right word when everyday people gain access to services and products once reserved for the privileged.

In that sense, the democratization of FinTech is a populist movement. It is about enabling people to build wealth and financial security. It is about renewing social mobility in stratified societies. It is about creating economic opportunities that don’t require a degree or pedigree.

Democratization in finance will persist because it stems from deep, human aspirations. And if markets work better as a result, finance professionals should celebrate.

David Arslanian is a Managing Director at Progress Partners and the President of Progress Acquisition Corp.