TLDR; question answer: An HFT makes money because they see you want to buy 100 shares of Apple. Their servers are located in the exchanges, so they can buy the 100 shares of Apple for $99.99 each quickly, then flip them to you for $100 each, effectively giving them a risk free profit of $1. The HFT then gives Robinhood a small reward for sending them the order data. Multiply that times millions of trades a day.
If you are curious where the average broker routes orders to, they all file Rule 606 documents with the SEC.
Here is Robinhoods for Q1 2019:
https://d2ue93q3u507c2.cloudfront.net/assets/robinhood/legal...
These filings show exactly how much each HFT, aka market maker, got routed by robinhood.
Here is Schwabs: https://www.schwab.com/public/schwab/nn/legal_compliance/imp...
What you will notice is that both have roughly similar distribution across execution venues, and the same can be said about many retail brokerage firms (Fidelity, Etrade, and the like). The difference is that Robinhood makes quite a bit more money from Payment for Order Flow than the typical brokerage.
Back in 2016 when Robinhood was gaining traction, I was pretty suspicious that they were either directly front-running their own users, or they were selling order flow to HFT's. Back in that day, both of the founders still had a LinkedIn that showed that they both worked at an HFT! before starting Robinhood. Since then they have removed that history from their profiles, but it's definitely not a good look if you are saying you are commission free! Selling order flow is the norm in the industry, but there is certainly a special relationship between Robinhood and their execution venues that isn't completely clear.
Overall, I am in the boat that Robinhood should at least be required to say that they aren't perfectly commission free. It seems that the commission most users pay is just indirectly being paid to an HFT, then kicked back to Robinhood.
With all of that being said, unless you are making huge block (100's of shares) trades, it's probably still cheaper to use Robinhood than a retail firm.
My hypothesis is that Robinhood gets higher kick backs because:
1) The user base is typically not financially savvy.
2) Users are more likely to do "market" orders leading to more profit for HFT's
3) Since there is no commission fee, users feel like they can buy or sell with 0 friction meaning the average user will end up in and out of positions much more frequently.
All of those things mean more profit margins for HFT's to kick back to Robinhood.
Robinhood certainly is "free", but the issue is that without friction, e.g. $10 trade fee, you as an investor will hop in and out of positions quickly, meaning more profit for the HFT, and indirectly, Robinhood. However, for most of us Robinhood is still cheaper than a brokerage even with this hidden tax.
I recommend avoiding options, penny stocks, and cheap-per-share stocks if you want to avoid paying a higher hidden tax to HFT's.