Market Microstructure: Who Really Earns What When You Trade

1. Core Actors in Market Microstructure

Actor	What they are	What they do
Exchange (Nasdaq, NYSE)	Neutral marketplace	Matches orders, publishes prices
Market maker / HFT (Citadel, Virtu)	Liquidity provider	Posts bids and asks, earns spread
Retail broker (Robinhood, IBKR)	Client agent or distributor	Routes client orders
Retail trader (you)	End investor	Wants fast execution

---

2. Who Creates the Bid-Ask Spread

The exchange does not create the bid-ask spread.

The spread is created by market makers competing to buy and sell.

Example order book:

• Best bid: 100.00
• Best ask: 100.02
• Spread: 0.02

Why the spread exists:

• Market makers take inventory risk
• They need compensation for speed and uncertainty
• Competition narrows the spread, volatility widens it

The exchange only displays and matches these prices.

---

3. Maker-Taker Model with Real Numbers

Typical US equity fees per share:

Item	Amount
Taker fee	−0.0030
Maker rebate	+0.0020
Exchange net	+0.0010

Example

You send a market buy order:

• You remove liquidity
• You pay the taker fee
• The market maker who posted the limit sell gets the rebate
• The exchange keeps the difference

Key point: The exchange earns from fees, not from the spread.

---

4. Market Maker Economics

Market makers earn money from:

1. Bid-ask spread
2. Maker rebates
3. Massive scale

Example:

• Buy at 100.00
• Sell at 100.02
• Spread earned = 0.02
• Plus rebate = 0.002
• Minus hedging and occasional taker fees

This happens millions of times per day with tiny margins.

---

5. Exchange Business Model

Exchanges do not speculate or take positions.

They earn from:

• Net transaction fees
• Market data sales
• Colocation and connectivity
• Listing fees

Example:

• 5 billion shares traded per day
• Exchange keeps ~0.001 per share
• ~5 million USD per day from trading fees alone

---

6. Robinhood Microstructure Flow (PFOF Model)

Robinhood is not an execution venue.

Step by Step

1. You place a buy order
2. Robinhood routes it off-exchange
3. A market maker receives the order
4. The market maker executes internally
5. The market maker pays Robinhood PFOF
6. The market maker hedges on an exchange
7. Execution is reported back to Robinhood

Who Trades with Whom

• You trade against the market maker
• Robinhood never takes the opposite side

Who Earns What (per share example)

Actor	Gain
Market maker	Spread + rebates
Robinhood	PFOF (~0.001)
Exchange	Fees from hedge trades
You	Small price improvement vs NBBO

Retail flow is valuable because it is predictable and low risk.

---

7. Interactive Brokers Microstructure Flow (Agency Model)

Interactive Brokers Pro works differently.

What IBKR Is

• Pure agency broker
• No PFOF
• No internalization
• Does not trade against clients

Step by Step

1. You place an order
2. IBKR routes it to exchanges or ECNs
3. Your order interacts with real order books
4. Another trader or market maker is your counterparty
5. Trade clears via DTCC

Fees and Rebates

• Exchange maker-taker fees apply
• IBKR passes them through to you
• IBKR earns only commissions and interest

Who Earns What

Actor	Gain
Market maker	Spread + rebate if maker
Exchange	Fee difference
IBKR	Commission
You	Transparent market pricing

---

8. Side by Side Comparison

Feature	Robinhood	Interactive Brokers Pro
PFOF	Yes	No
Trades against you	Market maker	Other market participants
Exchange access	Indirect	Direct
Broker incentive	Order flow value	Execution quality
Transparency	Lower	High
Who earns spread	Market maker	Market maker
Broker revenue	PFOF	Commission

---

9. Mental Model in One View

• Exchange builds the arena and charges entry
• Market makers set prices and earn the spread
• Robinhood sells access to retail flow
• IBKR sells execution and access

---

10. One Line Takeaway

The exchange does not trade.
The broker does not price.
The market maker does both — and gets paid for it.