While diversifying revenue streams with prediction markets and subscription services amid sluggish cryptocurrency trading, Robinhood is still considered sensitive to trading enthusiasm.
Robinhood's stock price surged over 16%, leading Wall Street to re-evaluate the company as one with numerous growth avenues beyond crypto trading. Indeed, Robinhood's Q2 earnings report showed a 38% decrease in cryptocurrency revenue, yet overall revenue reached an all-time high. Notably, revenue from prediction markets, which trade outcomes of events like sports games, surpassed crypto revenue.
It's essential to examine whether an increase in earning methods translates to more stable income. Based on its Q2 earnings report released on July 29 and new business ventures, Morgan Stanley upgraded Robinhood's investment rating from 'Equal-weight' to 'Overweight' on September 1. The target price was also raised from $124 to $150, reflecting the view that there's room for growth in other businesses even with sluggish crypto trading.
The perception of Robinhood can vary depending on whether it's seen as a company that profits when crypto trading is active, or as a financial firm that earns from customers' overall investment and savings activities. In Q2, Robinhood's revenue was approximately $1.31 billion, a 32% increase year-over-year, while cryptocurrency revenue decreased by 38% to $100 million. This gap was filled by prediction markets, which the company calls 'event contracts,' generating $156 million in revenue, surpassing crypto revenue.
Looking at the revenue structure of the prediction market business, customers pay a trading fee upfront when, for example, they bet $60 on Team A to win. If Team A wins, they receive $1, including their principal, so the actual profit is the amount minus the fee. Conversely, if Team A loses, they lose both the principal and the fee. Since Robinhood earns a fee every time a customer trades, regardless of the accuracy of their prediction, the trading volume itself is more crucial for the company's revenue than the customer's prediction accuracy.
While sports lotteries in Korea can only be operated by legally designated entities, in the U.S., brokerage firms like Robinhood also serve as platforms for trading sports outcome predictions. However, within the U.S., regulatory agencies are clashing over whether to classify this business as a financial product or sports gambling. The prediction market business has grown rapidly to the extent of such debate, with event contracts traded on Robinhood in Q2 reaching $13.6 billion, more than a tenfold increase year-over-year.
With small transactions repeated on a large scale, prediction markets have grown into a business that now generates more revenue than crypto. However, it's difficult to say that Robinhood has effectively transformed into a prediction market company. Prediction markets account for only about 12% of total revenue, and options revenue and net interest income are both larger than prediction markets. Furthermore, approximately 59% of total revenue is still transaction-based. Currently, it's necessary to simultaneously examine what Robinhood earns the most from and what it aims to earn more from in the future.
While not yet large enough to represent the entire company, prediction markets are a rapidly growing business that fuels future expectations. Simultaneously, Robinhood is developing other business avenues, employing a strategy to encourage customers to retain their funds for longer, beyond merely frequent trading. As of the end of Q2, subscribers to 'Robinhood Gold,' its paid subscription service, totaled 4.8 million, and customer assets in retirement accounts surged to $34.5 billion, an 82% increase year-over-year.
There's a significant difference in customer relationships between an app used briefly for trading and one that holds retirement funds and offers continuous paid services. During the earnings call, management presented a structure where customers receive salaries and use cards through financial services provided by Daeu Bank, with card benefits then linking back to investment accounts. This strategy shows a commitment to engaging with customers across their entire financial lives, not just for a single transaction. Therefore, describing Robinhood solely as a company that replaced crypto with other speculative products misses the actual transformation.
The growth of subscriptions and retirement accounts is a clear business diversification, but we need to delve deeper. Does revenue diversification mean that risks are also diversified? The answer lies in interest income. In Q2, Robinhood's interest income from customer stock investment loans was $215 million, an 89% increase year-over-year, accounting for about 55% of total net interest income. This means that income not only from trading fees but also from customers borrowing money to invest has significantly increased.
If customers trade a lot, Robinhood earns money through trading fees, and if customers borrow money to invest, it also earns interest income. In other words, it profits from both trading and lending money. But what if customers reduce their trading and repay their borrowed funds? Both trading income and interest could decrease. While recorded as different income streams on the books, both are heavily influenced by customer investment activity.
This is similar to how buying multiple stocks doesn't necessarily mean diversification is complete; different stocks can still be influenced by the same industry or investment sentiment. Therefore, when evaluating a company, it's crucial to closely examine how each revenue stream grows or shrinks under various circumstances, rather than just the number of products. In July, cryptocurrency trading volume continued to be sluggish, decreasing by 62% year-over-year.
Conversely, July's event contract trading volume surged approximately 20 times year-over-year, showing rapid growth. However, July's trading volume decreased by 5% compared to June. This suggests that even rapidly growing businesses can see monthly fluctuations. The key is to continuously monitor whether trading persists after a specific event changes, if initial customers remain and trade repeatedly, and how much revenue those trades generate. Additionally, customer assets under management should be analyzed by separating valuation changes from actual fund inflows.
Although platform assets decreased by 4% in July from the previous month, net deposits in the same month were positive at $5.6 billion. This means a decrease in asset valuation doesn't necessarily imply customers withdrew their money. Therefore, to understand long-term customer relationships, one should not only look at total assets but also consider net deposits, the number of paid subscribers, and the increase in retirement account assets. Furthermore, in prediction markets, there's another crucial variable separate from customer trading enthusiasm: regulatory issues. Robinhood states it provides event contracts through an exchange supervised by the Commodity Futures Trading Commission (CFTC).
On the other hand, some state governments maintain that if an activity involves betting on sports outcomes, it must comply with state gambling regulations. The Massachusetts Attorney General's lawsuit against prediction market firm 'Kalshi' is for this very reason. This argument asserts that it must follow the licensing and protection regulations required by state governments. This debate goes beyond defining prediction markets as financial products or gambling, also determining who can sell these products in specific regions.
Such regional sales restrictions already exist. While prediction markets currently account for only about 12% of total revenue, an expansion of sales restrictions could lead to a re-evaluation of the future growth potential anticipated by the market. Therefore, when assessing Robinhood going forward, it's crucial to continuously monitor whether prediction markets maintain trading and revenue despite event changes, if net deposits for subscriptions and retirement accounts continue to increase, deepening customer relationships, and how the regions and conditions for actually offering sports event contracts evolve.
Trading persistence, customer relationship longevity, and a supportive regulatory environment are key factors. So, as asked initially, can Robinhood continue to grow even if individual investor enthusiasm for trading wanes? This quarter's results showed it can grow even with declining crypto revenue. However, whether it can grow even if overall trading enthusiasm cools needs further verification. The fact that prediction markets filled the void left by crypto is evidence of growth, and the expansion of subscriptions and retirement accounts indicates deepening customer relationships.
However, to immediately assess these two positive changes as a transformation into a stable financial company would be premature, as the proportion of revenue tied to trading remains significant. While Robinhood is diversifying its revenue methods, what needs to be observed now is whether these methods can perform their roles effectively under different circumstances. That is, it's important to remember that having multiple revenue streams is not the same as having diversified risk. This criterion would be useful not only for Robinhood but also for other companies you invest in.
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