How Do Commission-Free Brokers Make Money?

In 2023, Robinhood generated $1.8 billion from Payment for Order Flow (PFOF), one of the ways commission-free brokers turn "free" into substantial profits. The rise of zero-fee trading has lured millions: over 10 million users flocked to platforms like Webull and eToro in the last two years alone. But here’s the catch: if you’re not paying, you’re the product.

These brokers don’t rely on your fees, they profit from your trades in ways most users never see. From selling order data to market makers to pocketing interest on your idle cash, the real money isn’t in commissions. It’s in the fine print.

So, how does this model work? And who pays the price? Let’s break it down.

What Are Commission-Free Brokers?

Commission-free brokers are investment sites that enable you to trade and sell financial products, like stocks, ETFs, and even cryptocurrencies in some instances, without a charge per transaction. Conventional brokerage firms used to earn their profits by levying a commission for each transaction. Commission-free plans eliminate this cost, making investments accessible to the general public.

Well-Known Examples

The most well-known commission-free brokers are:

• Robinhood: Trailblazers of taking commission-free trading to the mainstream in the U.S

• eToro: Renowned for commission-free stock trading and social investment features.

• Webull: Offers zero-commission trading with advanced charting features.

• Charles Schwab: A historic broker who adapted a zero-commission business strategy as the times changed.

• Fidelity: Yet another big legacy brokerage that started commission-free trading.

Why They Became Popular

Such brokers disrupted the traditional brokerage business by banning trading commissions and making it easier to invest, especially for beginners. Their easy-to-use apps, lack of minimum account requirements, and fractional shares convinced a large number of new retail investors to invest and forced existing firms to follow suit.

This combination of low cost and easy accessibility led to huge user expansion, especially in red-hot markets when individual investors were highly active, causing many successful companies to copy similar business models just to be competitive.

How Commission-Free Brokers Earn Their Revenue

Commission-free brokers aren't running charities. They're not making you pay for trades, at least not directly. But they've found other ways to make a profit, usually in ways you might not even know. Here's how they generate income:

Payment for Order Flow (PFOF)

When you enter a trade, your broker doesn't necessarily send it on to the stock exchange itself. They sell your order to big market makers like Citadel or Virtu. These companies fill your trade and make money on infinitesimal differences in price, and then pay the broker a fee to send the order their way. You get free trading, but you're in an argument regarding whether or not you're getting the best possible price on your trades.

Spread Markups

This is far too common with forex, crypto, and CFD trading. Brokers take the normal spread between buying and selling prices and expand it ever so slightly, keeping the extra amount for themselves. You don't see this as a separate fee on your statement. You just pay a bit more when you buy or get a bit less when you sell, and most investors are not even aware it's happening.

Interest on Cash & Margin Lending

That cash sitting in your brokerage account? Your broker is probably making money off of it by moving it to affiliated banks or money market accounts. They also make good money with margin trading. When you borrow from them to buy additional shares, you pay interest rates that are usually significantly higher than what you would get on an ordinary loan.

Premium Services

All of these websites have premium paid versions like Robinhood Gold or Webull Level 2. These give you access to things like professional research tools, higher margin limits, or real-time market data. It's a profitable strategy for brokers because they earn ongoing monthly income from users who are in search of advanced features.

Stock Lending

This is not known to many: brokers can lend your shares to other traders who want to bet against such shares (short selling). The broker earns a commission for this. Some websites will share a little of what they earn with you, but most take all the profits from loaning your shares.

Other Revenue Streams

Brokers also gain from affiliations, e.g., getting paid if they send you to a crypto exchange or to an opening an account. They can also sell anonymized user trading information to research companies. These aren't large money makers on their own, but they add up and make brokers profitable without necessarily costing you directly.

Controversies & Dangers of Commission-Free Trading

Commission-free trading opened investment for many more people, but it is full of controversies. Regulators, investors, and financial experts are raising serious concerns about how these platforms work.

Analysis of Payment for Order Flow (PFOF)

The biggest scandal is something called Payment for Order Flow. That's where they pay the brokers to route your trades over to certain market makers instead of others. It all fell apart in the GameStop debacle back in early 2021, when Robinhood and the other apps just shut off the buying of certain stocks.

They started asking themselves, who exactly are these brokers working for? The SEC has been probing whether or not this system indeed hurts regular investors by keeping them from getting the best available prices on their trades. No one knows right now if they'll outlaw the practice or just create more rules about it.

Conflict of Interest

Here's the thing that gets a lot of people upset: your broker is being paid by market makers, not you. So there's always this looming over everything question: are they sending your trade where it's best for you, or where they get paid the most? All the brokers promise you they will get you the best deal. But there is little openness in how exactly this entire process works, and there is no uniform regulation. As a private investor, you have no means to know whether you are treated fairly.

Gamification of Trading

Trading apps have also been criticized for presenting investing as a video game. Robinhood is the worst offender of these; they use bright colors, confetti on placing a trade, and constant alerts to get you to return.

The problem is that this makes trading appear fun and easy, something that will convince people to trade much more than they should. Especially if you're new to investing, it's simple to be swept up in the excitement and overlook the fact that you're working with real money. When markets get absurd, that can lead to very large losses.

The bottom line is that while commission-free trading removes one barrier to investing, it creates new ones when it comes to transparency and how these platforms influence your behavior. It's something to think about before you start using these apps.

The Future of Commission-Free Brokers

Commission-free trading is today's industry standard, but now brokers face new hurdles to clear. Regulators are asking hard questions, and competition keeps rising. The business model that upended how regular folks invest is now coming under attack from all corners.

Will Regulators Crack Down on PFOF?

Nobody has any idea what happens to Payment for Order Flow (PFOF). The January 2021 GameStop debacle caught regulators' eyes, especially at the U.S SEC. They worry about whether or not trades are really being completed fairly and honestly. Others think PFOF prevents customers from getting the best price on their trades. The SEC has already made new rules, which would change how brokers handle customer orders or even ban them altogether.

Will Traditional Brokers Go Entirely Commission-Free?

Robinhood gave everyone else notice. Industry players like Charles Schwab, Fidelity, and E*TRADE were compelled to drop their stock and ETF commissions just to remain competitive. Free trading is what traders desire nowadays. Any broker who persists in charging commissions will lose customers. The holdouts won't last for many more months.

New Alternative Models of Revenues

Since PFOF may not be eternal, brokers are finding alternative models of revenue: Premium subscriptions like Robinhood Gold enable customers to pay for extra features Banking features like debit cards and savings accounts that earn decent interest Money management tools and robo-advisors help people manage their money outside the bounds of trading. They make a steady revenue without depending on the number of people trading or dealing with market makers.

Commission-free trading is not going away. Just how brokers make their money, though, is changing fast. The future hangs on what regulators decide, what innovative ideas companies come up with, and if and how long people demand more disclosure about how the game is truly played.

Final Thought

Fee-free brokers changed the game by removing trading commissions, but they have to make some money otherwise. They do this by using Payment for Order Flow (PFOF), which means they pass your order information on to market makers to sell. They also make money from the bid-ask spread, interest on your deposited cash in accounts, margin loans, and subscription models.

The reality is, "free" trade costs you something you don't quite see; it's just another way of doing business. When you look at how such brokers work, you will be able to make better decisions on where to invest and spot concealed fees that could chew away your profits.