The investment landscape has undergone a significant transformation in recent years, with the emergence of zero-commission brokers disrupting the traditional brokerage industry. These platforms, which allow users to trade stocks, ETFs, and other securities without paying any commission fees, have democratized investing and attracted millions of new investors, particularly from younger generations. But how do these zero-commission brokers make money if they don’t charge trading fees? In this article, we will explore the rise of zero-commission brokers and examine their various revenue streams.

The Story of Money-Making

The Evolution of Zero-Commission Brokers

Zero-commission brokers first emerged in the early 2010s, with Robinhood being the pioneer in this space. Launched in 2013, Robinhood aimed to make investing accessible to everyone by offering commission-free trading on a sleek, user-friendly platform. The company’s success quickly caught the attention of both investors and industry incumbents, leading to a surge in new entrants and a widespread shift towards zero-commission trading.

Today, several zero-commission brokers compete in the market, including Webull, eToro, Public, and SoFi Invest. Even traditional brokerage firms, such as Charles Schwab, Fidelity, and TD Ameritrade, have been compelled to eliminate commission fees to remain competitive.

The growth of zero-commission brokers can be attributed to several factors, including advances in technology, changing investor preferences, and increased price competition. By leveraging technology to streamline operations and reduce costs, these platforms can offer commission-free trading without sacrificing profitability.

Revenue Streams of Zero-Commission Brokers

Despite not charging commission fees, zero-commission brokers have developed alternative revenue streams to support their business models. Here are the primary ways in which they generate income:

a. Payment for Order Flow (PFOF)

One of the primary sources of revenue for zero-commission brokers is payment for order flow. This practice involves selling customer orders to market makers or other trading firms, who then execute the trades on behalf of the broker’s clients. Market makers pay brokers for order flow to gain access to retail order flow, which they use to offset their risk and maintain liquidity in the market.

Payment for order flow can be a controversial practice, as it raises questions about potential conflicts of interest and the quality of trade execution. However, regulators in the United States, such as the SEC, permit the practice as long as brokers meet certain disclosure and best execution requirements.

b. Interest Income

Zero-commission brokers also generate revenue by earning interest on uninvested cash held in customer accounts. When users deposit funds into their brokerage accounts but do not immediately invest them in securities, the broker can invest this idle cash in short-term interest-bearing instruments, such as Treasury bills or money market funds. The interest earned on these investments represents a significant source of income for the broker.

c. Margin Lending

Another revenue stream for zero-commission brokers is margin lending. These platforms allow users to borrow money to purchase securities, using their existing investments as collateral. Brokers charge interest on the borrowed funds, which can vary depending on the amount borrowed and the duration of the loan.

Margin trading can be a risky practice for investors, as it amplifies both potential gains and losses. However, for brokers, it represents a lucrative source of income, particularly during periods of high market volatility when traders may be more inclined to use margin.

d. Subscription Fees and Premium Services

To supplement their income, some zero-commission brokers offer subscription-based services or charge fees for premium features. For example, Robinhood Gold, a subscription service offered by Robinhood, provides users with access to margin trading, larger instant deposits, and in-depth market research. The subscription costs $5 per month, generating a steady stream of revenue for the company.

Similarly, Webull offers a subscription service called Webull Apex, which grants users access to larger instant deposits, real-time data, and Nasdaq TotalView, a premium market data service. These subscription plans provide a consistent revenue source for zero-commission brokers while offering added value to customers seeking enhanced trading tools and features.

e. Ancillary Fees

While zero-commission brokers do not charge fees for trading stocks and ETFs, they may still impose fees for other services and transactions. Examples of ancillary fees include fees for wire transfers, account inactivity, paper statements, and expedited customer service. Although these fees may be relatively small, they can add up over time and contribute to the broker’s overall revenue.

f. Forex Spreads and Cryptocurrency Trading

Some zero-commission brokers also generate revenue through foreign exchange (forex) trading and cryptocurrency trading. In the case of forex trading, brokers typically earn money through the spread, which is the difference between the bid and ask prices of a currency pair. By charging a slightly higher spread, brokers can profit from each trade without imposing a separate commission fee.

In the realm of cryptocurrency trading, zero-commission brokers often make money by charging a spread or a small transaction fee. As the popularity of digital assets continues to grow, this revenue stream has become increasingly significant for brokers looking to diversify their income sources.

The Impact of Zero-Commission Trading on the Industry

The rise of zero-commission brokers has had a profound impact on the brokerage industry, forcing both new entrants and established firms to adapt their business models and pricing structures. This shift has led to several notable outcomes:

a. Increased Competition

The elimination of commission fees has intensified competition among brokers, as firms must now find alternative ways to differentiate themselves and attract customers. This increased competition has spurred innovation in the industry, with brokers launching new features, tools, and services to stay ahead of their rivals. In turn, investors have benefited from enhanced offerings and improved trading experiences.

b. Growing Investor Base

By lowering the barriers to entry for retail investors, zero-commission brokers have contributed to the expansion of the investor base. The lack of trading fees has made investing more accessible and affordable for individuals who may have been deterred by high commission costs in the past. This democratization of investing has fostered greater financial inclusion and enabled more people to participate in the stock market.

c. Shift Towards Passive Investing

The rise of zero-commission brokers has coincided with a broader shift towards passive investing, as investors increasingly favor low-cost index funds and ETFs over actively managed mutual funds. By offering commission-free trading on these products, zero-commission brokers have facilitated this trend and made it more cost-effective for investors to build diversified portfolios.

Conclusion

The emergence of zero-commission brokers has transformed the investment landscape, making it more accessible and cost-effective for retail investors to participate in the stock market. While these platforms do not charge commission fees, they generate revenue through various means, such as payment for order flow, interest income, margin lending, subscription fees, and ancillary fees.

As competition in the brokerage industry continues to intensify, zero-commission brokers must constantly innovate and evolve to remain successful. However, for investors, the rise of these platforms has undoubtedly been a boon, offering an affordable and convenient way to access the financial markets and achieve their investment goals.

It is important for investors to understand how these zero-commission brokers make money, as this knowledge can help them make informed decisions when selecting a brokerage platform that aligns with their needs and preferences. Ultimately, the rise of zero-commission brokers has fostered a more inclusive and competitive investment landscape, benefiting both investors and the industry as a whole.