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A deep dive into Coinbase’s stock

Deep dive into Coinbase stock

Deep dive into Coinbase stock

In light of Coinbase’s ($COIN) direct listing, I wanted to share a deep dive post on the company

Almost all of the data I provide here comes from the company’s S-1 filing, website, latest Q1 2021 report, and Meritech’s breakdown of Coinbase’s S-1

What is Coinbase?

  • Founded in 2012, Coinbase is mainly known as a company that allows you to buy and sell cryptocurrencies regardless if you’re an everyday investor or a hedge fund.
  • The company serves 43 million retail users, 7,000 institutions like hedge funds, and 115,000 ecosystem partners in over 100 countries.
  • On the retail side, Coinbase’s main products are its mobile app which has a super easy-to-use interface, and then there’s Coinbase Pro which is more for advanced traders.
  • On the business side, Coinbase also offers a lot of really interesting services, including trading for institutions, listing assets on Coinbase which probably comes at a high cost, enabling businesses to accept cryptocurrency payments, cryptocurrency custody which just means helping institutions store crypto assets securely, and a venture capital arm that invests in crypto startups.
  • Main point: Coinbase is much more than just a place to trade crypto and the company is creating an ecosystem where different parts of the business feed off each other to make the entire platform stronger.

The Coinbase business model

To understand where Coinbase sees its business going, it’s important to first go over some context about the crypto market in general. I bring up the data below to show you that the crypto market is still in its early stages and is highly volatile. Since 2010, there were 4 major price cycles with peaks and troughs and each cycle lasted anywhere from 2-4 years. Crypto was also uncorrelated to the equities market until Feb 2020 when COVID hit and now there seems to be some correlation

Coinbase currently profits the most during periods of high volatility and high bitcoin prices and makes less during lower periods of volatility and low bitcoin prices. This is precisely why since 2018, Coinbase has been making a concerted effort to diversify its revenue streams in order to decrease its reliance on market volatility. Since 2016, 7 of the 8 new products have been subscription and services which really just shows you Coinbase’s focus on building a more stable business which as a potential Coinbase investor will be important to pay attention to over time.

This strategy seems to already be producing results, with monthly transacting users appearing to be less correlated to crypto volatility but still related to bitcoin prices. For example, you can see that volatility was at a 9 in both Q1 2020 and Q4 2020 but the number of users is much greater in Q4 which was also when bitcoin began rising dramatically

Market statistics

  • Over the past 3 years, Coinbase has been able to more than double its users from 23 million to 56 million which is really amazing growth.
  • As a result, the company has been able to grow its market share from 4.5% to 11.3% over the past few years which is also quite impressive.
  • In terms of the total market, from the end of 2012 to the end of 2020, the cryptocurrency market grew from $500 million to $782 billion which represents a 150% CAGR
    • Astonishingly, in just a few months, the market cap has grown by about 181% to ~$2.2 trillion as of today
    • Simply put, of all the industries I’ve personally seen so far, there is none that is growing as quickly as the cryptocurrency market.

The Bull Case

  • First off is Coinbase’s branding;
    • Especially for those in the states, Coinbase is one of the top go-to crypto exchanges for the average retail investor and many institutions.
    • This in large part is due to the company’s intense focus on following regulations and the company dedicates 15% of its full-time staff to legal, compliance, finance, and security functions.
    • From the start, Coinbase also created one of the easiest interfaces for trading a very complex product and that has continued to be its edge ever since.
    • Personally, I believe that this first-mover advantage may erode over time as Coinbase charges the highest fees per trade, but I also believe the company benefits heavily from its branding due to its security and easy-to-use interface and may be able to charge a premium for a while, just as Apple does with its products which in many instances are less powerful machines than PCs.

  • Second is what is called the company’s flywheel
    • Because customers trust Coinbase, the company is able to attract more and more customers
    • This allows the company to continue scaling the company while also adding more assets onto the platform that customers can trade.
    • Coinbase can then understand their customer’s needs and create more innovative products that help keep customers on the platform.
    • This entire process makes the overall platform stronger which extends Coinbase’s leadership in the marketplace and allows the company to grow its market share.
    • To give you one concrete statistic of this flywheel taking effect, Coinbase stated that 21% of users used a non-investing product in 2020 leading to an average net revenue increase per user of 90%.

And then there is 2 more reasons

  • A third reason to be bullish on Coinbase is the rapid growth of the crypto market due to strong use cases and institutional trading.
    • This graphic may be a bit outdated since it’s from 2018, but the point still stands. Even if the crypto market is $2.2 TN, that amount is pretty small if you believe that crypto is going to be a significant form of currency in the future.
    • Personally, I’ve had to transfer from US banks to banks in China and Korea for my last business and the process is extremely painful and expensive.
      • If you’ve ever sent money through crypto to other people, the only tricky part is figuring out the addresses to send to but other than that, it’s basically instantaneous and cheap.
      • As a result, it’s very easy to imagine crypto growing just based on that use case alone although there are other arguments to be made as well such as Bitcoin being a store of value.
    • In addition to this, I believe a big reason the crypto market is growing so fast is because institutions, like hedge funds which are the ones that move equity markets, are rapidly joining the crypto market.
      • At just Coinbase alone, institutions grew from 1000 in 2017 to 7000 in 2020 and even Tesla recently made a $1.5 billion investment into bitcoin.
      • These institutions increasingly validate crypto and a rapidly growing market will greatly benefit Coinbase.

  • The fourth reason to be bullish is that Coinbase has so many more markets it can enter and assets to add.
    • The company is extremely deliberate and that’s a reason the company is so well trusted as a crypto exchange.
    • Coinbase is currently ranked 2nd for spot exchanges on and that’s pretty impressive given Coinbase is in much fewer markets and offers fewer coins.
      • This is because Coinbase is the number 1 exchange in the US which is where a lot of the world’s capital is.
    • But the point is, there is a lot of room for Coinbase to expand which will further expand the company’s revenue and scale.

The Bear Case

  • First is Coinbase’s dependence on the highly volatile crypto market;
    • Now, everyone knows the crypto market is volatile, but the reason this is such a big issue for Coinbase is that as a public company, Coinbase now needs to manage investor expectations every quarter.
    • As you can see here, Coinbase’s revenue has been super lumpy over the past few years.
    • What this basically means is that as an investor, you’ll need an iron stomach to deal with a stock price that will likely rise and fall sharply with the crypto market.

  • The second risk involves competition;
    • Because crypto is such a lucrative industry, there is constant competition from multiple fronts.
    • First, there are other crypto exchanges that provide the most direct competition and while Coinbase is highly regulated, many non-US exchanges are not.
      • This provides non-US crypto exchanges with a competitive advantage because they are able to offer popular products and services with less regulation while still serving the US population.
    • Second, are from financial incumbents like TD Ameritrade, Schwab, or even financial institutions like JP Morgan.
      • If any of these companies start offering crypto trading then that could meaningfully take share from Coinbase.
    • Third, are from fintech companies which are already starting to see significant trading volume
      • Robinhood and Square’s CashApp are big players in the space and PayPal has also recently started to get into the mix.
    • Fourth are decentralized trading platforms that allow users to directly buy and sell without the need for a centralized exchange like Coinbase.
      • These platforms currently are not as easy to use and aren’t as fast and liquid, but over time, the models are going to improve rapidly with Coinbase even admitting in its S-1 that the company has seen transaction volumes rivaling its own.
    • So Coinbase is very well positioned especially in the US market, but there’s a ton of competition to be wary of, especially given Coinbase charges the highest fees and those fees are likely going to lower over time.

But there is more

  • The third risk is mixed sentiment;
    • Overall, Coinbase is generally regarded as the most trusted crypto exchange in the US, but there’s still a lot of hate the company gets.
    • On Coinbase’s subreddit, there are constant complaints about funds being locked out and accounts not working and users seem to complain most about the lack of customer service and also the company’s high fees.
    • Every crypto exchange has its issues and Coinbase likely has to charge high fees because it’s operating in the US which is highly regulated and expensive, but, I do think Coinbase needs to vastly improve its customer service in order to maintain its customer base (there are talks the company plans to open a customer service center in India).

  • The fourth risk is the lack of shareholder voting rights;
    • As is the case with many tech companies these days, the vast majority of voting rights are going to be held by a small number of Class B shareholders.
      • Class B shareholders own 99.2% of voting rights while directors, officers, and 5% shareholders own 60.5% of voting rights which puts a lot of power in the hands of the few.
    • To give you an example of why this could be a problem, Coinbase’s CEO Brian Armstrong actually took a lot of heat for recently not allowing political and social discussions at work.
    • Things like this and potential scandals with high-level management could lead to potential unrest in the company while shareholders really won’t have the power to do much.

So is Coinbase a Buy or Sell?

Sorry to leave on a bit of a cliffhanger but this requires an overview of Coinbase’s financials and some extensive thoughts on valuation, which I’ll write up later and post as soon as I can.

In short, though, I personally believe Coinbase is a buy from $250-$313 (or at least that’s my target range at which I would start a position), which implies a ~$60-$80BN valuation.

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