Investors waiting for the chance to buy shares of Robinhood, the online trading app that helped democratize stock investing by eliminating transaction fees, might have viewed the recent GameStop drama with apprehension.

Many traders blame Robinhood for the collapse of the video game retailer's stock after it soared some 1,700% in a matter of days only to lose 90% of its value over the following week. The fact that the online brokerage banned or restricted buying GameStop and other so-called meme stocks served to fuel suspicion it was working closely with the hedge funds that were losing billions of dollars on their short positions.

Robinhood has been hoping to go public this year through an IPO or some other direct listing (it hired Goldman Sachs for that purpose). Has the trading app damaged its reputation enough that a public offering won't be well received?

Robinhood app showing Robinhood stock on Apple Watch

Image source: Robinhood.

A volatile mix

Robinhood offered a very plausible explanation for its actions that has nothing to do with bailing out short-sellers.

When an investor buys or sells a stock, it takes some time for the trade to settle. Although it seems virtually instantaneous in your brokerage account, the T+2 requirement, as it's called, means the actual trade doesn't settle for two days (it used to be even longer in years past). Because the trading app's separate Robinhood Securities division is required to make deposits with the clearinghouses to cover the trades, the extreme activity of the massive short-squeeze trading forced Robinhood to limit buying certain stocks until it could raise enough capital.

Robinhood says it was just a handful of stocks that were driving virtually all of the volume in trading -- a situation that CEO Vlad Tenev described as an unprecedented event.

With such massive concentration in only a few stocks, Robinhood had to come up with ways to mitigate the risk. While the clearinghouses were originally looking for billions of dollars in deposits, imposing trading restrictions and depositing about $700 million was the outcome.

Colluding to protect the rich

But putting the toothpaste of rumor back into the tube is not easy. Market maker Citadel Securities is Robinhood's biggest client, generating around $12.4 million in market orders in December alone, while the separate Citadel hedge fund was helping to bail out fellow hedge fund Melvin Capital from sinking under the weight of its GameStop short bet. Therefore, many remain convinced that the trading app was pressured to block trades to give the hedge funds time to cover their short positions.

Although there are regulatory walls erected between the hedge fund and its securities business (and between Robinhood's trading platform and its securities side), many still believe those barriers were easily scaled when billions of dollars were at stake.

For an app named Robinhood that launched with the declaration "Let them trade!" it was a bit of irony that its actions saved billionaire hedge fund operators from ruin while slamming the door on small retail investors' ability to profit.

There's no greener grass

Many traders abandoned the app after it limited buying GameStop stock. According to one analyst, some 40% of Robinhood traders who left the app went to Square's Cash App, while Fidelity, Stash, and TD Ameritrade also saw an influx of new customers.

On the surface, it suggests potential problems with an eventual IPO. Robinhood suffered a few other glitches over the past year that caused dissatisfaction among users, but quelling this reputed investor uprising with what looked like an iron glove could be the most damaging.

Yet Robinhood shouldn't really worry. Even as some investors fled, many said they would return. As P.T. Barnum is alleged to have said, there's no such thing as bad publicity. Even at the height of the controversy the app was downloaded 600,000 times in just one day, suggesting the brouhaha simply gave Robinhood millions of dollars in free advertising.

App data outlet Apptopia says Robinhood remains the most popular trading app worldwide in terms of downloads, far outstripping No. 2 app Webull.

Short-term memory loss

Traders are already moving on to their next stock targets. Marijuana producers like Tilray and Aurora Cannabis just soared 50% and 21%, respectively, in one day, which one portfolio manager said was caused by "the Reddit army and friends."

Whether they used Robinhood to drive up the stock is unknown, but the trading app's popularity remains largely untarnished and its IPO will undoubtedly still be a hit.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.