The Hedge Fund Citadel Does Not Buy Robinhood Data, Citadel Securities is a Different Company, and Other Misconceptions

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It's been a wild week, and if there's anything I've learned, it's that no one knows what a Hedge Fund is and what a Market Maker is.

First, off, people are conflating Citadel Securities with Citadel. Yes, that is confusing. Citadel is indeed a Hedge Fund, but as such, they obviously don't buy order flow from Robinhood. Or data, for that matter. When people say "buy data from Robinhood", they mean order flow, which does contain data, technically.

But what is a Hedge Fund?

A hedge fund is an investment fund that trades in relatively liquid assets and is able to make extensive use of more complex trading, portfolio-construction and risk management techniques to improve performance, such as short selling, leverage, and derivatives. Financial regulators generally restrict hedge fund marketing except to institutional investors, high net worth individuals and others who are considered sufficiently sophisticated.

It's basically a pool of money from rich people that are actively managed by people who try to get that pool of money to grow as much as they can. They do fancy stuff, more than just buying promising stocks, like, say, shorting Gamestop.

In the analogy of Poker games, Hedge Funds are professional poker players.

Then, what is a Market Maker?

A market maker or liquidity provider is a company or an individual that quotes both a buy and a sell price in a financial instrument or commodity held in inventory, hoping to make a profit on the bid–ask spread, or turn. The U.S. Securities and Exchange Commission defines a "market maker" as a firm that stands ready to buy and sell stock on a regular and continuous basis at a publicly quoted price.

Alright, that's a little less obvious. Essentially Market Makers are the people you actually buy stock from when you press the "BUY" button on your broker, and the people who buy your stock when you press the "SELL" button.

They purchase stock from people who want to sell at market price, then sell that stock to people who want to buy at market price. The difference between that is the bid-ask spread the Wikipedia definition refers to. Well, that's somewhat recursive given in many ways that they determine the market price, but it's enough to understand.

But the important thing is that they are not making positions on the stock market. They don't earn money when a stock grows, or falls. Rather, they make money from each transaction.

In the same analogy, Market Makers are the Casinos.

Citadel vs Citadel

There are two Citadels - one is indeed a Hedge Fund, but the other, Citadel Securities, is a Market Maker. It is securities that buys order flow. And they're completely separate LLCs now, although I believe that's somewhat recent - before they were under the same LLC but had a Chinese Wall between them.

What is Payment for Order Flow, a.k.a Citadel Buying Data From Robinhood

When you submit an order for a stock, it needs to go through a market maker. Payment for Order Flow is the practice of Market Makers paying Robinhood to execute your orders. There's a number of reasons why they might do this: for one, it's business - executing orders is how they make money. And two, naturally orders are data.

This is controversial - after all, what if Citadel pays Robinhood so that Robinhood gives you a shittier deal (the shittyness of the deal goes into Citadel's pockets)? But it also doesn't have much to do with Gamestop.

Also, you can see that Hedge Funds do not pay for order flow... because what would they even do with them? They can't execute trades. If I want to buy some Apple, maybe Melvin has Apple stocks, maybe not, and if even if they do have it they probably own it because they're long on the company, they're not going to sell it to me for no reason.

Citadel and Robinhood

The connection between the two companies is between Securities and Robinhood, because Securities is one of (the majority, in fact) of Robinhood's payment for order flow revenue. And that, in fact, is kinda shady depending on how you view payment for order flow.

But, again, separate company from the hedge fund. Securities most definitely is not shorting Gamestop - market makers are not long or short on anything. Not what they do.

And I'm pretty sure that is like 90% of why Citadel is even in this story. Because they've never publicly stated that they even have a short position on GME. The other 10% is their revenue share in Melvin, which does have a short position on GME (or at least did - they said they closed).

But it's pretty tenuous connection once you realize they're two separate LLCs.

This Tweet

A screenshot of this tweet was at one point the highest post on Reddit /r/all, and it's just a beautiful encapsulation of wrongness.

  1. Citadel does not own Melvin Capital Management - certainly Citadel Securities doesn't own Melvin, and while Citadel did bailout Melvin in return for non-controlling revenue shares, a) this is obviously a minority share b) it's noncontrolling
  2. This is correct; Melvin did short GME, and no doubt lost bucketloads of money. But Citadel does not own Melvin. And it is unkown whether or not Citadel, the hedge fund, has short positions on Gamestop - ownership of Melvin and/or ownership of short positions themselves is the implied motive for Citadel.
  3. Citadel(HF) does not own Robinhood. This is easily verifiable. Robinhood is currently owned in some unknown proportion by the founders, employees (via RSUs), and a16z, Ribbit, Sequoia among other VCs.
  4. Since Citadel does not own Robinhood, they did not hault buy orders on Robinhood

The Conspiracy

I can't tell you if there is a wallstreet conspiracy to save the hedge funds that shorted $GME. I certainly can't say that it didn't happen. But at least get the facts right. It is possible that the establishment of Wall Street called up the Robinhood execs to stop buy orders to save face or to save the hedge funds still short on GME. I'm not saying it's not. But please for the love of god do not say "THE HEDGE FUND CITADEL PAYS FOR ROBINHOOD ORDER FLOW" like I saw earlier. That makes zero sense.

Additionally I'm sure Citadel #1 and Citadel #2 have friends in leadership. Maybe Citadel #1 called up Citadel #2 to pressure Robinhood. But I would note that no one actually knows if Citadel #1 has short positions on GME to begin with. And no, "my dad works at Citadel and he told me that Citadel shorted GME" on Twitter is not a source.

I think in these moments, Occam's razor and Hanlon's razor are good to keep in mind

the simplest explanation is usually the right one

never attribute to malice that which is adequately explained by stupidity