What PFOF is
Payment for order flow is an arrangement in which a broker routes its customers' orders to a wholesale market maker, and the wholesaler pays the broker for that flow.
It is the reason commission-free trading is economically viable at retail brokers. The customer pays no commission; the broker is compensated by the firm receiving the order.
Why anyone pays for orders
Because retail orders are, on average, better business than institutional orders.
A market maker profits from the spread between what it pays to buy and what it receives to sell. That works well against uninformed order flow, where buys and sells arrive in a roughly balanced stream and the position can be turned over repeatedly. It works badly against informed flow, where a large buyer is buying because they know something, and the market maker ends up holding an inventory that keeps moving against them.
Retail flow is small, diversified and largely uncorrelated with short-term price moves. Institutional flow is not. A wholesaler will pay for the first kind because it can be internalised profitably at a spread narrower than the public quote.
Price improvement is real, and so is the conflict
Both halves of this are true simultaneously, which is why the argument never resolves cleanly.
Retail orders routed to wholesalers frequently fill inside the public quote, better than the best displayed bid or offer. This is price improvement, and it is not a fiction; it happens because the wholesaler can afford to give up part of the spread and still profit on flow it values.
At the same time, the broker choosing the route is being paid by the firm receiving the order, and the amount paid varies between destinations. A broker has an obligation of best execution to its customers, and a financial interest in routing where payment is highest. Those can point the same way. They need not.
The measurable question (whether retail investors end up better off) depends on the counterfactual, which is the difficulty. Comparing an internalised fill against the displayed quote is a comparison against a quote that might itself have been different in a market structure where that flow reached exchanges. Reasonable analyses reach different conclusions, and disclosure requirements exist precisely because the answer is not self-evident.
Why it matters more in options
The economics are sharper in options than in equities.
Option spreads are wider, so there is more to share. Option series are numerous and often thinly quoted, so the value of internalising a balanced stream is higher. Per-contract payments in options are correspondingly larger than the per-share equivalents in equities.
There is also a structural consequence for anyone reading flow data. When a retail order is internalised, it prints (the trade appears on the tape) but the routing tells you something about what kind of participant it likely came from. The very large, urgent, multi-exchange orders that show up in flow scanners as sweeps are, almost by construction, not internalised retail flow: they went to the exchanges precisely because they were too large or too urgent to be filled quietly.
That is part of why sweeps attract attention. It is not that the sweep is inherently informed. It is that the routing choice excludes the largest category of uninformed flow.
Its relationship to dark pools
The two get conflated and are different mechanisms.
A wholesaler internalising retail orders is a market maker taking the other side of your trade off-exchange. Dark pools are venues where institutions trade with each other without displaying quotes, principally to avoid signalling a large order.
Both are off-exchange, and both mean the trade did not interact with the public order book. The participants, purposes and economics are otherwise unrelated. The aggregate most often quoted from off-exchange short volume is DIX, which we publish daily on our dark pool page; the block tape shown beside it there is modeled rather than a licensed print feed.
The regulatory picture
PFOF is permitted in the United States subject to disclosure: brokers must publish routing statistics and execution quality reports.
It is banned in the United Kingdom, and the European Union has legislated a phase-out. Those jurisdictions concluded the conflict outweighs the benefit. The US position has been to require disclosure rather than prohibit the practice, and it has been repeatedly reconsidered rather than settled.