On 24 January 2025, the United States Securities and Exchange Commission (US SEC) published a pivotal working paper titled “How Does Payment for Order Flow Influence Markets? Evidence from Robinhood Crypto Token Introductions.” The study, authored in collaboration with researchers from Miami University and Wayne State University, provides a detailed examination of how Payment for Order Flow (PFOF) impacts cryptocurrency markets. It analyses Robinhood Crypto’s staggered introduction of tokens and its broader implications for market quality, trading costs, and regulatory frameworks.
The paper focuses on the role of PFOF, a practice where brokers receive payments from market makers for routing orders. This study revealed a distinct lack of transparency in crypto PFOF practices compared to equities and options, coupled with substantially higher fees, approximately 4.5 to 45 times higher. The findings indicate that the introduction of tokens on Robinhood Crypto led to reduced trading volumes for most crypto assets (excluding Bitcoin and Ethereum), increased bid-ask spreads, heightened volatility, and a shift in order imbalances towards net sales. These changes resulted in an estimated daily cost of $4.8 million to market participants. The report draws comparisons with equity and options markets, discussing the challenges posed by crypto PFOF practices.
The study’s backdrop lies in the growing scrutiny of PFOF globally. While jurisdictions like the UK, Canada, and the EU have banned or limited PFOF due to concerns over conflicts of interest and market fairness, the practice remains legal and widely used in the United States. The research was prompted by the lack of comprehensive data on PFOF in crypto markets, which are significantly less regulated than their traditional financial counterparts. The US SEC sought to investigate whether the adverse effects observed in equities and options markets extend to cryptocurrencies, a market characterised by high trading volumes and substantial retail investor participation.
The research leveraged Robinhood Crypto’s token introduction timeline to assess the impact of PFOF on market quality. Between January 2018 and October 2022, Robinhood introduced 19 cryptocurrencies, beginning with Bitcoin and Ethereum and concluding with Aave and Tezos. The platform, known for its predominantly retail clientele, generated significant revenue from PFOF, reporting $420 million in crypto-related fees in 2021 alone. During this period, Robinhood facilitated an average of 1.2 million daily revenue-generating trades.
The findings revealed several issues. The lack of transparency in crypto PFOF practices stands out, as there are no mandatory public disclosures akin to those required for equities and options. Furthermore, the fees associated with crypto PFOF are disproportionately high, with wholesalers paying up to 35 basis points per dollar of trading volume compared to just 0.8 basis points for equities. This disparity exacerbates the costs borne by traders and raises concerns about the fairness of execution practices. The study also demonstrated that token introductions on Robinhood Crypto led to wider bid-ask spreads, increased volatility, larger average trade sizes, and substantial order imbalances, collectively reducing market efficiency.
The US SEC paper proposes regulatory measures to address these challenges. It calls for greater transparency in PFOF practices within crypto markets, suggesting the implementation of disclosure requirements similar to Regulation NMS Rule 606 for equities and options. Enhanced oversight is also recommended to mitigate conflicts of interest and ensure fair pricing mechanisms, particularly for retail investors. By shedding light on these issues, the study aims to contribute to the ongoing debate over the need for stricter regulation of cryptocurrency markets.
Robinhood Crypto introduced its first tokens, Bitcoin and Ethereum, on 25 January 2018, gradually expanding to include 19 cryptocurrencies by October 2022. During this period, the platform solidified its position as a leading player among US retail investors, facilitating billions in trading volume and PFOF-related revenue. The US SEC’s Division of Economic and Risk Analysis (DERA) played central role in conducting the research, while Robinhood Crypto served as the primary case study. Academic collaborators from Miami University and Wayne State University contributed to the analysis. The study also references the regulatory approaches of the UK, Canada, and the EU, highlighting the contrast between their stricter stances on PFOF and the relatively lenient framework in the United States.
(Source: https://www.sec.gov/files/dera_wp_payment-order-flow-2501.pdf)
