OpenAI should Steal from Robinhood and Give to the Poor
By: The Moral Economist
Tags: Investing, Artificial Intelligence, Finance, Computer Science, Economics

OpenAI should Steal from Robinhood and Give to the Poor

It’s time for OpenAI to enter financial markets

Robinhood started with noble intentions. To steal from the rich and give to the poor. Unfortunately, like many tales of good intentions, the truth isn’t as appealing as myth. I’m talking, of course, about the trading app, not the historical figure.

Ultimately, however, Robin Hood was quite possibly used as a stock alias for thieves. The moral of the story is that we shouldn’t allow names, myths, and folklore to distort the underlying reality. In this case, that thieves can pretend to be men of the people.

And Robinhood is certainly a financial thief, of the legal sort.

Robinhood started with a fairly radical idea: to allow anyone to buy or sell stocks commission free- $0.00 for any purchase or sale of financial instruments, including options, no questions asked. Traditionally, customers have had to pay $5–$10 every single trade.

Zero commissions have a significantly bigger impact on small trading values compared to larger ones. Buying and selling $100 of a stock while paying commission could cost 10–20%, making it virtually impossible to profit off of small trades.

In this sense, we can view a positive effect of Robinhood’s push for zero commission as encouraging small account traders to invest in more traditional stocks as opposed to penny stocks, since you don’t have to make as much profit to break even from commission costs. That’s also why the average account value of Robinhood customers is $1000-$5000, compared to tens or hundreds of thousands of dollars held in other brokerages.

The idea was that it only costs fractions of a penny for big Wall Street firms to execute a trade, so why not cut out the middle man and charge the direct cost of nearly nothing to the consumer? But alas, there’s no such thing as a free lunch.

Robinhood had to make money somehow. How? By selling their customer’s data and encouraging unsophisticated traders to take out leverage so they could lose their money faster.

Now, I might sound a little salty. So, to be clear of my biases, I personally lost over $10k day trading options on Robinhood; however, this is not my problem with the app. I probably would have lost that money on eTrade or Interactive Brokers!

Instead, my problem is with their business model. Since they don’t charge commission, they need an alternative to cover their costs and make a profit. They primarily do this through two means: Robinhood Gold, and selling customer data to high frequency traders (HFTs).

While they technically make some profits by earning interest and rebates, the bulk >40% of their revenue comes from re-routing and allowing high frequency firms to operate their own pools to take advantage of unwitting customers.

Logistically, there has to be a reason that HFTs pay for this kind of market control. Partially, this comes from arbitrage of purchasing from public markets at the lowest price and marking up to Robinhood customers. This is ostensibly to provide “liquidity” or “make markets.” But in reality, this is a tax on Robinhood traders.

But an even more nefarious reason that HFTs want this level of access is to take the other side of a trade against Robinhood customers. Since most traders are unsophisticated and lose money (according to most estimates, 80% of day traders are unprofitable over the course of a year) market makers and HFTs will gladly take the opposite trade as the average Robinhood trader and will on average be right.

This is especially true because they can exploit knowledge of Robinhood’s order book and individual customer history to know what kinds of mistakes the average Robinhood trader makes. They can access all sorts of data to backtest their models on.

Robinhood also makes money by charging interest for margin accounts. But this only exacerbates the aforementioned problems with HFTs. Since most traders lose money, lending out on margin just means they will lose more money more quickly.

I’m not 100% in principle against the concept of zero commissions in exchange for customized market pools that exploit their users. In other words, I don’t necessarily think the government should ban Robinhood’s business model. But we should be clear that HFTs don’t really add much value in terms of liquidity compared to traditional market makers, and by definition are making profits by taking money from Robinhood customers.

And since Robinhood customers are on average poor relative to rich HFTs, Robinhood in effect is taking from the poor to give to the rich. To repeat, Robinhood’s business model amounts to taking from the poor to give to the rich, when the initial goal of zero commissions was supposed to reduce income inequality.

What Robinhood needs is real competition. If only there was an institution out there with enough money and social consciousness to actually steal from the rich and give to the poor… Oh wait, OpenAI fits the bill!

OpenAI has a multi- billion dollar endowment. They have the financial resources to actually help the little guy in the financial world. They recently changed their non-profit status to capped profit (100x initial investment).

One of their first commercial ventures is GPT, their not open source super genius NLP algorithm. Sure, it’s not perfect; it recently told researchers to kill themselves. But hey, it’s not easy to create a cutting edge NLP model.

I see at least 3 ways that OpenAI could radically alter financial markets in a socially conscious way. First, they could simply analyze financial data and provide free or low cost technical analysis, including real time notifications of asset mis-pricings.

AI provides exponentially more returns the more data that is processed. This can be seen by comparing GPT-2 vs GPT-3, where billions of more parameters are analyzed. In fact, OpenAI claims they have only just begun to scratch the surface on the benefits of simply scaling up their models.

Financial markets operate under similar circumstances. What you as an individual running Tensorflow will uncover is not even a fraction of what is feasible at scale.

OpenAI could test out various algorithms, such as bayesian networks, LSTM models, etc. to see which algos are best at predicting price movements. By directly incorporating complete order book historic data into their models, as well as other economic data, perhaps sentiment analysis, etc., they could achieve orders of magnitude better accuracy than what an individual can do by accessing minute by minute prices.

Second, OpenAI could launch their own dark pool fund and become a market maker. Dark pools are a mixed bag.

Dark pools came about primarily to facilitate block trading by institutional investors who did not wish to impact the markets with their large orders and obtain adverse prices for their trades. Dark pools are sometimes cast in an unfavorable light but, in reality, they serve a purpose. However, their lack of transparency makes them vulnerable to potential conflicts of interest by their owners and predatory trading practices by some high-frequency traders.

— Investopedia

So, in theory, one can operate a dark pool in a socially altruistic way, hiding orders from predatory HFTs, but increasing market liquidity. OpenAI could operate such a pool.

While the lack of transparency might seem anathema to both social altruism and OpenAI’s core principles, there is a difference between transparent operation and hiding the order book from the public. In other words, OpenAI could publicly explain exactly how they match users with capital, while hiding those orders from HFTs.

Finally, OpenAI could launch its own technical only trading firm competing with the likes of Medallion Fund. By competing away profits from Medallion the Monopolist (more forthcoming), OpenAI could redistribute from the wealthy to the broader market/average market participant. Not literally a UBI, but by adding competition in the space, they compete away irrationality, making it easier for smaller players.

Financial markets are ripe for disruption, especially thanks to AI. It’s time for OpenAI to steal from Robinhood and give to the poor.

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