In this feature:
The folklore of Robin Hood
The rebirth of Robin Hood through fintech
A Meta Moment: How Robinhood’s model evolved in Web3
Folklore has been a key mechanism to carry forward history, morals and motifs. Some of these stories have provided the backbone to our social code today.
One story that has been adapted over time is Robin Hood. Robin Hood, the protagonist of the aforementioned tale, has been consistently depicted as a heroic individual who stands up for the defenseless.
New Hood Who ‘Dis
Fast forward many centuries, the modern day has brought forth a new iteration of this hero - a tech company that has leaned into the lore and has branded itself as Robinhood. This modern adaptation has a mission statement: to democratize finance for all.
During the company’s growth period, it appeared to achieve just that. It revolutionized the brokerage industry by eliminating transaction fees for buying and trading stocks within its app. This led to a domino effect in 2019 of large incumbent players following suit to stay competitive.
On the surface, it looked like a big win for investors everywhere. In time, however, questions started to surface of how the company was generating money as conventionally brokers would typically charge fees.
Robin Hood’s New GME
In 2021, the meme stock frenzy consumed headlines. One stock, in particular, gained traction because of the internet actioning on a contrarian view on a stock: Gamestop.
Given the tremendous amount of retail investor interest in this company, Robinhood became a destination platform to buy and sell this stock. One day, once trading was halted, its users became very vocal.
Robinhood made the move to restrict buying GameStop citing issues with volatile stock and regulatory requirements. This response led to users embracing their inner Robin Hood to identify the source of the problem. From their due diligence, a heightened focus around the Payment for Order Flow revenue model for stocks and options grew. (this was approximately 38% of Robinhood revenue per Bloomberg). Payment for Order Flow is the compensation a broker receives for routing trades when they operate at grand scale when working with a market maker.
This revenue model is not new. It is an entrenched part of the financial system. It is a behavior so native to systems built that it even made its way into the blockchain environment under a different name: Maximal Extractable Value.
Web3’s PFOF: Maximal Extractable Value (MEV)
There are systems that help power blockchains through shared computing power, which depending on the blockchain consensus mechanism, creates the prevalence of Maximal Extractable Value.
When transactions in a blockchain are executed, they’re done so in a sequential and public manner, which makes it possible for miners to prioritize certain transactions over others and in doing so, they can extract from the ordering of transactions. This value extraction opportunity is referred to as Maximal Extractable Value. Similar to the premise of Payment for Order Flow, the beneficiaries are usually behind the scenes and are often invisible to the end-user.
Progress Not Perfection
Examples of where MEV can surface depend on the consensus mechanisms of a blockchain.
One of these mechanisms is called Proof of Work (PoW). You can view the Proof of Work mechanism like a game where you have to solve a really hard puzzle. When you solve the puzzle, you get a prize, which is usually some value in return for the work. This helps to make sure that the network is working correctly.
Within solving this puzzle, however, there is flexibility in how to stack the order of transactions per block, as mentioned. This can allow miners, or the systems behind powering the blockchain, to front-running or back-running trades on decentralized exchanges or prioritize transactions with higher gas fees. This can result in a higher payout for the miner that’s solving the puzzle.
Another type of consensus mechanism is called Proof of Stake (PoS). You can view Proof of Stake as the same aforementioned game, however, your ability to play is based on how much of the in-game currency you have. The more currency you have, the more you can play and win prizes.
This process removes the need for miners and instead prioritizes validators that are incentivized through their holdings of their “in-game currency” to keep the blockchain operating efficiently and fairly. While MEV is not removed entirely, efforts continue to be made to help reduce it through innovations to consensus mechanisms.
Embracing What it Means to be Human
Similar to the appeal of Robin Hood’s character, there are certain human tendencies that repeat over time. The light through all of this, can be found in the collective innovation to mitigate the need for these intermediaries, while at the same time innovating new incentive mechanisms to enable transactions in a more fair, transparent and open manner. Like humans, these new systems may not be perfect, but they show promise and flexibility in the pursuit for better.
For more resources on the topics discussed, you can check out:
Payment For Order Flow (Investopedia)
What is MEV? (Chainlink Blog)
What is Proof-of-Stake in Crypto? (Investopedia)
Proof-of-Work Explained (Forbes)