[LiamMcCalloway]

Let me see if I can rephrase.

Robinhood solves a collective action problem for its users. Unbeknownst to some people, they are unsophisticated and cheap to provide liquidity to: market makers can trade with them and reliably offload their positions, reducing the risk premium necessary to make market making profitable. Robinhood advertises in a fashion that enables self-selection of unsophisticated buyers. Once the platform is sufficiently large, they can auction off the liquidity business. By regulation, the users can never be worse off than they would have otherwise been, because liquidity providers must run their bid-ask spread within the larger market's spread.

So Robinhood earns the difference in risk premium between the larger market and that of its user base, minus operating costs and profits of the liquidity provider.

I suppose the question is: what is the mechanism by which that profit margin can be transferred to users?

[treis]

>By regulation, the users can never be worse off than they would have otherwise been, because liquidity providers must run their bid-ask spread within the larger market's spread.

But TFA clearly demonstrates how they are. By removing retail investors the order flow to public market makers is much riskier. Those market makers will respond by increasing the spread to account for the increased risk. So yes, the retail investors get a price that is (very slightly) better than public price but the public price is dramatically worse than it otherwise would be. It's a net loss for the retail investor and public market maker while being a win for the internalized market makers.

[LiamMcCalloway]

I don't know enough - merely rephrasing a blog post here - but it sounds fair to say that this reduces the primary benefit of network effects of market activity, higher liquidity/lower spread, at the expense of the rest of the market.

Could we construct a reasonable scenario where the liquidity from segregated order flow would have displaced the core business of liquidity providers, because the volume is so large?