Zerodha Is Not India’s Robinhood And That Maybe A Good Thing

Earlier this month, controversial stock trading app Robinhood published prospectus for its initial public offering with the Securities and Exchange Commission of U.S. The company aims for a $40bn-plus valuation.

The upstart firm, often credited with transforming the brokerage world by pioneering zero-commission stock trading, has also faced criticism for what has been termed as “gamification” of investing

Back home, Zerodha, the Bengaluru-based discount brokerage, has been often dubbed the Robinhood of India and traders on its platform have been called “Robinhood traders”. However, apart from a few superficial similarities, Zerodha and Robinhood are starkly different from each other.

Let’s get the obvious out of the way first. Zerodha is a discount broker and not a zero-commission platform like Robinhood. Zerodha earns revenues by charging an extremely low percentage from the traders as brokerage.

On the other hand, Robinhood does not charge the traders on its platform. It earns through the Pay for Order Flow (PFOF) mechanism. The platform routes the orders to market makers who compensate the broker.

Market makers make money by exploiting the difference between the bid-ask spreads. Critics of this model argue that there might be a conflict of interest wherein a broker might route orders to whoever pays them the highest, rather than focusing on the best deals for their clients.

Nevertheless, Zerodha has been profitable for years now, whereas Robinhood has been running on losses so far.

Secondly, there is a difference between the worldview of both the brokers. Robinhood employs digital “nudge” mechanisms that subtly encourage traders to trade more. More trades imply more revenues for Robinhood.

Today, almost every company in the digital space has tried to “gamify” their apps using score systems, push notifications, game-like optionality and interfaces in order to boost usage. It is not unlike the “reward crates” in video games that give children a sense of achievement and happiness.

While other apps do not require users to risk their money, gamification of the Robinhood app certainly encourages users to do so.

In contrast, Zerodha has introduced a tool called Nudge, which encourages traders to not over-trade. It has introduced a new tool called the Kill Switch which disables trading and forces people to take a break.

A high portfolio churn will generate higher revenues for Zerodha, but is likely to reduce a trader’s return. Zerodha has taken steps against its self-interest, to benefit the traders on its platform.

Thirdly, the term “Robinhood trader” has been thrown around a lot. The term is used to refer to young newbie traders who join Zerodha’s platform without much knowledge or experience.

However, Robinhood’s actual traders behave quite differently from Zerodha’s traders.

According to Zerodha’s founder, Nithin Kamath, options’ trading has been one of the biggest volume-drivers for Robinhood. Robinhood’s traders pushed the call-option open interest in the US markets, to all-time highs. On the other hand, traders new to Zerodha’s platform have stuck to equity trading.

Lastly, Robinhood’s users were recently criticised for the GameStop controversy. Individual traders, most of whom were Robinhood users, met on Reddit and banded together to pump up the stock price of GameStop by 1900 per cent in under a month.

Several large hedge funds had a short position on the stock. With the rapid rise in the stock price, these funds might have lost money.

The incident sparked a debate on the legitimacy and effects of such pump schemes by retail investors. Despite what happened in the USA, it is unlikely that Indian retail traders will manage to pull off something like this.

Fortunately, India has multiple strong regulations in place which prevent any such activity. Any stock that doesn’t trade in the derivatives segment has circuit breakers in place.

True to their name, these circuit breakers stop the rise or the fall and allow the market to cool down. Most Indian traders and hedge funds do not take short positions through derivatives.

As you can see there are stark differences between Zerodha and Robinhood. The users of both platforms too behave quite differently when it comes to trading. With India’s strong regulations, it is unlikely that India’s “Robinhood investors” will be able to pull off something like the GameStop pump.

Lastly, Zerodha has placed the customer’s welfare before its own, a rare move in the digital start-up space, and for that it deserves applause.