Market Microstructure: Who Really Earns What When You Trade
What I learned about who's really on the other side of your trade.
8 min readWhen I placed my first trades, I had no idea who was on the other side. I knew there was an exchange, a broker, and somehow a price, but I couldn't tell you who earned what, or why my "free" trades weren't really free. I spent some time digging into the actual mechanics, and honestly a lot of it surprised me. This is what I found.
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
This confused me for a while. I assumed the exchange set the spread, like a shop putting a markup on goods. But that's not how it works. The exchange doesn't create the bid-ask spread. Market makers do.
Think of it this way: market makers compete to buy and sell a stock. They post bids and asks. The gap between the best bid (say, 100.00) and the best ask (100.02) is the spread, 2 cents here. That spread exists because market makers take on inventory risk every time they trade, and they need compensation for it. More competition narrows it. Volatility widens it.
The exchange? It just displays and matches these prices. It's the venue, not the player.
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
The important thing here: the exchange earns from fees, not from the spread. Two completely different revenue streams, and I kept confusing them at first.
4. Market Maker Economics
Market makers earn money from:
- Bid-ask spread
- Maker rebates
- 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
They do this millions of times per day. The margin on each trade is tiny, but at that volume it adds up fast. Virtu Financial reported positive trading revenue on something like 1,277 out of 1,278 trading days over a five-year stretch.
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
- You place a buy order
- Robinhood routes it off-exchange
- A market maker receives the order
- The market maker executes internally
- The market maker pays Robinhood PFOF
- The market maker hedges on an exchange
- 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
- You place an order
- IBKR routes it to exchanges or ECNs
- Your order interacts with real order books
- Another trader or market maker is your counterparty
- 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. What I Take Away From All This
The thing that took me the longest to internalize: the exchange doesn't trade, it just hosts the venue. Your broker doesn't set prices, it routes your order. The market maker is the one actually on the other side, setting prices, taking risk, and earning the spread. Everyone else is earning fees for facilitating.
Once I understood this, a lot of things clicked: why "free" brokers aren't free, why spreads widen during earnings, and why your limit order sometimes sits there unfilled even when the price looks right.