Robinhood’s payment for order flow backlash

When Robinhood Markets, Inc. launched in 2013, it promised to “democratize finance” with zero-commission trading, attracting millions of retail investors. Behind the scenes, however, Robinhood pioneered a revenue model that would become both wildly profitable and deeply controversial: payment for order flow (PFOF).

By 2021, amid the GameStop short squeeze and a surge of retail trading, Robinhood’s reliance on PFOF drew intense scrutiny. Critics argued the practice created conflicts of interest, disadvantaged retail investors, and undermined market fairness. Supporters claimed it lowered barriers to entry and expanded participation in financial markets.

The resulting backlash placed Robinhood—and PFOF itself—at the center of regulatory, political, and ethical debates.

1. What is Payment for Order Flow?

Payment for order flow is the practice where brokerages route customer trades to market makers (large firms that execute trades) in exchange for compensation.

Here’s how it works:

1. A retail trader places an order to buy or sell a stock on Robinhood.

2. Instead of sending it directly to an exchange, Robinhood routes it to a market maker such as Citadel Securities or Virtu.

3. The market maker executes the trade and pays Robinhood a small fee for the order flow.

4. Robinhood earns revenue from this arrangement, while customers enjoy “free” trading.

The system underpins Robinhood’s business model: in 2020 alone, over 70% of its revenue came from PFOF.

2. The Allure of Zero-Commission Trading

Before Robinhood, most brokerages charged fees ranging from $5 to $10 per trade. By eliminating commissions, Robinhood attracted a new generation of investors—young, mobile-first, and often trading smaller dollar amounts.

Competitors like Charles Schwab, TD Ameritrade, and Fidelity eventually followed suit, making zero-commission trading the industry norm. But the economics of this “free” trading were built on the controversial foundation of PFOF.

3. The Backlash: Key Criticisms

Conflict of Interest

Critics argue that brokers like Robinhood have an incentive to route orders to the highest-paying market maker, not necessarily the one providing the best price execution for customers.

Hidden Costs to Retail Investors

While trades appear free, opponents say investors may be losing money through slightly worse trade execution—fractions of a penny per share that add up across millions of trades.

Dependence on Market Makers

By relying heavily on Citadel Securities and a few other firms, Robinhood is accused of contributing to market concentration and reducing transparency.

GameStop Fallout

During the January 2021 meme stock frenzy, Robinhood restricted trading in GameStop and AMC, citing liquidity and clearinghouse requirements. Retail traders saw this as protecting hedge funds and market makers—the very entities paying Robinhood for order flow. This perception intensified the backlash.

4. Regulatory Scrutiny

The U.S. Securities and Exchange Commission (SEC) has long monitored PFOF, but Robinhood’s rise amplified concerns.

• SEC Chair Gary Gensler signaled in 2021 that banning or restricting PFOF was “on the table.”

• In 2020, Robinhood paid a $65 million fine for misleading customers about how PFOF impacted execution quality.

• Lawmakers at congressional hearings questioned whether PFOF created a “rigged” market stacked against retail traders.

Globally, PFOF has already faced restrictions. The U.K., Canada, and Australia effectively ban the practice, citing conflicts of interest.

5. Robinhood’s Defense

Robinhood has consistently defended PFOF, arguing:

• Better Prices: Market makers often provide price improvement, executing trades at slightly better prices than the market quote.

• Access to Markets: Zero commissions enabled millions of new investors to enter the market, many for the first time.

• Transparency: Robinhood discloses PFOF arrangements and insists execution quality remains competitive.

Executives argue that banning PFOF would force brokers to reintroduce commissions, hurting small investors.

6. Broader Industry Impact

Robinhood may be the face of the PFOF backlash, but it’s far from alone. Schwab, E*TRADE, and TD Ameritrade also rely heavily on PFOF. However, Robinhood’s demographic—young, retail, meme-stock traders—made it particularly vulnerable to criticism during the GameStop saga.

The backlash also spurred innovation in alternative models:

• Subscription-Based Trading: Some platforms explored charging flat monthly fees instead of PFOF reliance.

• Direct-to-Exchange Models: New startups aim to route trades directly to exchanges for transparency.

7. Lessons for Investors

The PFOF backlash highlights a crucial lesson: “free” trading isn’t really free. Investors must consider:

1. Execution Quality: A fraction of a cent per share can impact returns, especially for active traders.

2. Transparency: Understand how your broker makes money—if it isn’t from commissions, it’s likely from order flow.

3. Market Structure: Retail trading sits within a complex web of brokers, market makers, and clearinghouses.

8. The Future of PFOF

The future of PFOF in the U.S. remains uncertain. Potential outcomes include:

• Tighter Disclosure Rules: Brokers may face stricter reporting on execution quality.

• Partial Restrictions: SEC could limit PFOF in certain asset classes.

• Complete Ban: Less likely but possible, following global examples.

• Adaptation: Brokers may pivot to alternative revenue models if regulation tightens.

Conclusion

Robinhood’s use of payment for order flow helped spark the commission-free trading revolution, but it also ignited one of the fiercest debates in modern finance. To supporters, it opened markets to millions of new investors. To critics, it masked conflicts of interest and tilted the playing field toward Wall Street intermediaries.

As regulators weigh the future of PFOF, Robinhood finds itself at a crossroads: will it adapt its model, or fight to preserve the system that made it a household name?

One thing is clear—the backlash over payment for order flow has forced a reckoning about the true costs of “free” trading and the balance of power between Wall Street and Main Street.

ALSO READ: Did Elon Musk intentionally manipulate Dogecoin markets?