This guest post was written by Luis. Luis is 32 years old and a backend developer. He started his FIRE-journey three years ago and uses eToro as his online broker.
I’ve been a happy eToro user for a while now. Recently a friend of mine asked: “how does eToro make money?”. Although I knew 50% of the answer I wasn’t completely sure. So, I decided to do some research on how eToro makes money. I’m going to share my findings with you.
It’s actually not that complicated. Compared to other social trading systems out there, the revenue-generating model of eToro is pretty transparent and relatively easy to understand.
What Is Social Trading?
eToro is a social trading network. Maybe you’re wondering what social trading is? Social trading is a latest-generation investment instrument that allows investors (experienced and beginners) to replicate professional investors’ financial transactions or trading strategies within a trading network. Traders or investors can copy other investors’ positions by observing their track records of their performance or by interacting with other investors inside the same social trading platforms.
How Does Etoro Make Money?
Before I get into the detailed discussion—at a glance, eToro makes money basically in three ways:
First, eToro is a market maker like most other online brokers, but it follows a STP-NDD hybrid model. A Direct Market Access (DMA)/Straight Through Processing (STP)/No Dealing Desk (NDD) is a broker that functions as an intermediary between (Forex) markets and traders. Said that eToro makes money from losing positions, but unlike other brokers, they do it ethically, like balancing it by avoiding over-exposure trades. Furthermore, they are regularly audited for fairness.
Secondly, through fees and commissions related to CFDs, or The spread (more on that later).
And lastly, through fees and commission not-related to trading or non-trading fees like withdrawal fees and inactivity fees.
Hybrid Market Maker Model
Unlike other online brokers, eToro is a hybrid market maker using STP and NDD features. It makes the operation of this social trading platform different from regular market maker brokers significantly.
In general, a typical market maker will profit from your losing positions. This can be frustrating for investors assuming that brokers are profiting from their losses arising questions about conflict of interest. This is a major reason why rifts between the brokers and traders exist. But this doesn’t imply that eToro doesn’t make any profits from your losses. It just does it differently from other market makers.
See, I previously mentioned that eToro is one of the most transparent market makers in the industry as they operate under a hybrid model. eToro will still profit from your losing trades; there is no denying that, but it retains part of the balance by avoiding over-exposure. eToro uses the STP model to release some of the trade’s volume to the liquidity providers. eToro executes this action if there is no way to balance it with opposing orders from other traders when the risk level exceeds the acceptable limit.
For example, if you open a trade to ‘BUY’ AUD/USD, eToro will match your trade with a trader with a ‘SELL’ order. If the order is unbalanced, for example if there is an excess of trades on one side, they’ll hedge using liquidity providers. That said, eToro will also bet on the other side of your trade, so they can also profit from your losing trades, similar to any market maker.
However, all of these actions involve no dealing desk, which means eToro will not interfere in your trades or its outcome whatsoever.
The simplest way eToro makes money is through the spread. The spread is the difference between the buy and sell prices. The spread is applied to every trading operation executed on the eToro trading platform. Whenever a trader opens a position like a BUY or SELL—an automatic fee is paid.
For example, when you open a BUY trade, the system lists it at a price which will be the SELL price. Likewise, when you open a SELL trade, the system records it at a price which will be the BUY price. There is a small difference between the BUY and SELL price—the spread, where eToro profits. The spread allows eToro to maintain the platform and offer features like Copy Trading and Social Trading services.
A spread is applicable for both manual trading and copy trading. Copy trading is more profitable for eToro because every time a ‘popular investor’ or a trader opens a new position, the same trade will be replicated across all the accounts automatically.
Non-Trading Fees And Commissions
Lastly, another major source of revenue for eToro is through non-trading related fees and commissions. This applies to every broker in the industry. However, they keep things competitive, and the fees and commissions are pretty low.
For instance, eToro charges a $10 inactivity fee for accounts that have been inactive for 12 months. Then there is the usual $5 withdrawal fee, which is deducted every time you make a withdrawal from your eToro balance. However, eToro US account holders no longer require to pay any withdrawal fees.
And last but not least, eToro charges a commission for cryptocurrency transfers. If you have cryptos in your eToro e-wallet, you can transfer them to eToro’s proprietary crypto wallet, called eToroX. eToroX is a trading platform by eToro, that supports many cryptocurrencies. The fees vary depending on which currency you deal with and where you send it.
So there you’ve it! It’s always great to know about your broker before you start trading on their platform, and I hope this article has answered the fundamental questions about how eToro generates profit.
Interested in using eToro? Consider using my affiliate link. This is of no extra cost to you and helps me run this blog :)