This is explained in the article. You can find it in the section "Payment for order flow"

> If you could somehow make markets without informed traders—if you were guaranteed that Goldman could never trade with you—your risk (of being run over) would be lower and you could, therefore, provider tighter spreads. There is a way to do this; it is to trade exclusively with retail traders. They can’t run over you; they don’t have the informational edge or the capital to do so.

Yep. If it isn't explicit enough: the reason you sell liquidity is that people pay for it, hopefully more than it costs you to provide.

You collect, approximately, half the spread less your losses to adverse selection and hope to cover the (pretty formidably high at this point) essentially fixed costs of operating in the market by taking that small margin and parallelizing it over an _extremely_ high number of trades.

Let me see if I can rephrase.

Robinhood solves a collective action problem for its users. Unbeknownst to some people, they are unsophisticated and cheap to provide liquidity to: market makers can trade with them and reliably offload their positions, reducing the risk premium necessary to make market making profitable. Robinhood advertises in a fashion that enables self-selection of unsophisticated buyers. Once the platform is sufficiently large, they can auction off the liquidity business. By regulation, the users can never be worse off than they would have otherwise been, because liquidity providers must run their bid-ask spread within the larger market's spread.

So Robinhood earns the difference in risk premium between the larger market and that of its user base, minus operating costs and profits of the liquidity provider.

I suppose the question is: what is the mechanism by which that profit margin can be transferred to users?

>By regulation, the users can never be worse off than they would have otherwise been, because liquidity providers must run their bid-ask spread within the larger market's spread.

But TFA clearly demonstrates how they are. By removing retail investors the order flow to public market makers is much riskier. Those market makers will respond by increasing the spread to account for the increased risk. So yes, the retail investors get a price that is (very slightly) better than public price but the public price is dramatically worse than it otherwise would be. It's a net loss for the retail investor and public market maker while being a win for the internalized market makers.

I don't know enough - merely rephrasing a blog post here - but it sounds fair to say that this reduces the primary benefit of network effects of market activity, higher liquidity/lower spread, at the expense of the rest of the market.

Could we construct a reasonable scenario where the liquidity from segregated order flow would have displaced the core business of liquidity providers, because the volume is so large?

Is selling more liquidity at a tighter spread that much more advantageous than participating in some amount x fewer trades with a looser spread?

In other words, I don't understand if or why it is the case that HFTs would like to, in general, offer tighter spreads than looser ones.

Edit: is it just that volume decreases super linearly in relation to the price of liquidity?

Market makers sell liquidity, and the spread is the price they sell it at, so they'd prefer to sell at a higher price (larger spread). The reason that spreads tighten is competition: there are a few wholesale market makers, and the brokerages send more of their orders to the MM willing to guarantee the smallest spread. In fact, there's been something of a price war for the last few years, and retail spreads have come way down.