Robinhood Is the New Juul
Since the coronavirus crisis sent markets into a tumble, I’ve received frantic phone calls from friends looking for stock tips. And I don’t blame them. As Baron Rothschild once said, “The time to buy is when there’s blood in the streets.” But the real opportunity isn’t for people like me and you, but for brokerages that are roping us in. A new generation of easy-to-use trading apps, led by Robinhood, Acorns, and Square’s Cash App, is gearing up for a massive explosion in user growth. These apps are doing the same thing that made the vaping product Juul a smash hit: attract young people by creating a beautiful, polished interface for something that is ultimately toxic.
In Robinhood’s own words:
Robinhood’s mission is to democratize finance for all. We believe that everyone should have access to the financial markets, so we’ve built Robinhood from the ground up to make investing friendly, approachable, and understandable for newcomers and experts alike.
The tent-pole feature for making Robinhood user-friendly has been zero-commission trades. However, a seasoned stock trader would immediately recognize that “free” comes at a price. The most obvious catch is that the brokerage will offset those fees by playing games with the bid-ask spreads in the order book, while also being loose with the list price that they show users. On Robinhood’s page where they explain how they make money, the company underplays these tricks, instead highlighting how they earn interest, much like banks do. But per the Wall Street Journal’s investigation, “If a customer buys 100 shares of Apple for $200 each — a $20,000 purchase — Robinhood could get up to $5.20 for routing that order to electronic-trading giant Citadel Securities LLC.” Getting fees for routing comes at the cost of getting the best price for your purchase orders, but since we’re talking about fractions of a penny per share, users aren’t going to notice much. It’s like the practice of online food delivery services offering “free delivery” but quietly raising prices by a dollar in the hopes that you won’t remember the exact cost of a burrito.
The comeuppance may have finally come, when in early March, as the markets were going haywire, Robinhood faced two major “outages.” A few days later, one of their clients filed a class action lawsuit, as traders missed out on an opportunity to avoid losses or seize on gains. Such is the problem with playing with the order book. To provide “free” trading, you have to batch orders and offer liquidity to the exchanges, all of which works when the markets are stable. When the markets go outside of these tolerances, trades will no longer execute. Unfortunately, the damage to the trading ecosystem has already been done, as other popular online brokerages, such as TD Ameritrade, E*TRADE, and Schwab, have followed suit with zero-commission trading, and will likely have their own outages in the future.
Part of the problem with user-friendly trading is that it appeals to people who don’t have sufficient financial literacy. Even before Robinhood, financial literacy among investors was already a known problem. In 2012, as directed by the Dodd-Frank Act, the SEC concluded a study on retail investors and found:
U.S. retail investors lack basic financial literacy. The studies demonstrate that investors have a weak grasp of elementary financial concepts and lack critical knowledge of ways to avoid investment fraud. Surveys also demonstrate that certain subgroups, including women, African-Americans, Hispanics, the oldest segment of the elderly population, and those who are poorly educated, have an even greater lack of investment knowledge than the average general population.
Nearly every investor I talk to, not just Millenials, believes that buying a stock of a company gives money to that company in some way. They think that by buying the letters AAPL, they are “investing in Apple.” To them, it’s like giving money to a friend to start a little tech company. Instead, what they’re acquiring is the right to profit from a company, which is an insidious proposition. Someone on Quora checked on Fidelity’s stock scanner and discovered that less than half (2387 of 5868) of publicly traded stocks offer some variety of dividends. And even if you choose stocks with high-yielding dividends, those companies can experience 50-percent or greater drops in value, wiping out whatever profits you might have gained. The stock market is best understood as a futures market, and investing is probably best re-labeled as trading.
There is something inherently appealing—American even—about “democratizing finance.” This impulse is what fueled the early adopters of Bitcoin. Satoshi Nakamoto, the pseudonymous creator of Bitcoin, scribbled the words, “The Times 03/Jan/2009 Chancellor on brink of second bailout for banks,” into the first block of the cryptocurrency. Investing in crypto was a way to “stick it to Wall Street and the Fed.” But at least with crypto, every “investor” I’ve met has been directionally correct in the Bitcoin’s risk-reward profile. Even the most optimistic traders frequently admit crypto could all evaporate one day.
Gold is an example of a similar plebian investment vehicle. Most people understand gold’s risks. When I meet a new gold investor, I challenge them by asserting, “Gold has no economic purpose!” to which they retort, with a twinkle in their eye, “Well, it might one day if everything goes to hell!” Even if on a low-level, their prediction is incorrect, that twinkle tells me that on a high-level, their mental model of the risks and rewards is in sync with professional investors.
So if the problem is financial literacy, why target Robinhood? Aren’t they doing us a service by taming something complex? Doesn’t great design benefit us all? Look no further than Juul, the darling of Silicon Valley, with its Stanford-groomed founders who touted its benefits for smoking cessation. What venture capitalists saw in Juul was the same transformative power of the iPhone. Before Juul arrived, the world of vaping was much like the world of SmartPhones circa 2007. After multiple iterations, Juul eventually struck on their hit pod design, which is often mistaken for a USB stick. In two years, Juul captured a third of the e-cigarette market, but more importantly, they expanded the addressable market. Investors gave Juul $112 million in funding, and a year later, vaping became an epidemic at schools. Likewise, the iPhone’s value was never going to be in capturing a fraction of the existing SmartPhone market, but in transforming the market into something unrecognizable.
But then again, modern SmartPhones are now understood as an epidemic of addiction. Does the stock market need a similar explosion in user growth? Should everybody become an investor, even if the vast majority of people fail on a basic understanding of the stock market?
As long as brokerages are making money, there’s nothing to stop Robinhood and its imitators. Acorns, which also employs a similar green-with-envy color scheme, doesn’t even try hiding the notion that “money grows on trees.” As their home page says, “Acorns helps you grow your money; Invest your spare change and grow from there.” The company’s name implies that if you plant an acorn, it’ll sprout into a tall oak tree one day. Never mind that there is no law which says that stocks, or even index funds, should keep going up. Where does the assumption come from that anybody who regularly plants pennies into the market will one day have them magically turn into dollars?
Cash App, formerly known as Square Cash, is another brokerage catching the wave. They used to be a competitor of Venmo, a popular app used by Millenials to compensate each other for dinner. Copying Venmo didn’t work out, so now Cash App has become a frictionless investment platform. As the eye-popping graphic on their home page says, “Now You Can Invest.” Investing is now as easy as picking up the check for dinner.
After the 2008 Recession, we should applaud any attempt to put the financial system into the hands of ordinary people. But in practice, democratizing finance has been an exercise in dark patterns, which, as Wikipedia defines them, are any user interface that has been carefully crafted to trick users into doing something. In this case, killer app design is being used to distract the new middle-class and whisk its emerging wealth.