The Bear Case for Coinbase

Breaking down the hype of Coinbase with a shot of realism

0xjim
0xjim
Apr 12 · 6 min read

U.S.-based cryptocurrency exchange Coinbase is set to publicly debut on the Nasdaq exchange on April 14 under the ticker $COIN — drawing much interest as the first and most well-known company in the crypto space to go public.

Many crypto fans see this as a watershed moment for the industry — a signal from the traditional financial world that it has accepted crypto as a legitimate technology.

Earliest last week, Coinbase posted its Q1 2021 numbers ahead of its public listing:

  • Trading Volume of $335 billion
  • Total Revenue of approximately $1.8 billion
  • Net Income of approximately $730 million to $800 million

Each of these metrics vastly surpassed Coinbase’s numbers for the entire year of 2020 — when the company brought in $1.2 billion revenue with a profit of $332 million on $193 billion of volume.

So not only is Coinbase growing at an absurd rate, they’re also doing it while still managing to be profitable.

Critics of Coinbase see its projected $100B+ valuation as another example of wanton speculation — untethered from the intrinsic value of the company.

Regardless of one’s views on crypto, many will be watching the ticker this Wednesday with deep interest and anticipation.

And in honor of Coinbase’s (and the crypto industry’s) public debut, I’ll be writing a bear case — as well as a bull case for the exchange.

Bear Case #1: Frothy Valuation Based On Historic Bull Market

Let’s say $COIN does debut at a $100B market cap.

With a 2020 annual revenue of $1.2B, Coinbase would be valued at 83x EV-to-revenue multiple — which is a pretty unattractive investment to say the least.

If we were to factor in a 2021 annualized revenue of $7.2B (four times Q1 2021 — not the best assumption but bear with me), Coinbase has a far more tenable 14x multiple.

Although it would be very hard to make that assumption, given that Q1 2021 was a crypto bull run that rivaled Fall/Winter 2017 — before its historic and well-documented crash.

And Coinbase’s S-1 has stated that its business largely depends on the sustained interest of retail traders — traders who are known to be more involved during a bull market rather than a bear one.

“You can expect volatility in our financials, given the price cycles of the cryptocurrency industry.” — Brian Armstrong, Coinbase CEO

Source: Coinbase S-1

New Constructs, a cryptocurrency investment research firm, is notably very bearish on Coinbase — stating that its valuation should be 80% lower than its projected to list at.

In a research report, New Constructs states that Coinbase would need to have a 50% CAGR for almost the next decade in order to justify its valuation from a discounted cash flows perspective. For reference, Nasdaq’s largest 10-year CAGR was only 21%.

Coinbase “has little-to-no-chance of meeting the future profit expectations that are baked into its ridiculously high expected valuation of $100 billion.” — New Constructs

Bear Case #2A: Heightened Competition from CEXes

CEX is shorthand crypto jargon for a “centralized exchange”, meaning an exchange that is a private company that custodies users’ funds in order to buy and sell crypto — companies like Coinbase, Binance, Gemini, etc.

In 2020, Coinbase earned 85% of its revenue from trading fees — with the vast majority being from retail investors.

For every trade, the company earns roughly 57 bps, but retail investors pay much higher than institutional clients, paying roughly 1.42% per trade.

In contrast, competitors like Binance and Kraken offer fees in the 10–25 bp range.

Coinbase is known for being one of the most expensive crypto exchanges in the industry.

They’ve been able to charge handsomely for their services, but they have invested in a great UX and a solid brand of security and trust.

However, those are moats that can easily be chipped away by competitors — while still offering a lower fee than Coinbase.

Just like how Robinhood broke into the brokerage space with commission-free trading, prompting stalwarts like TD Ameritrade and Fidelity to follow suit, crypto exchanges can offer zero or near-zero trading fees as a market share play — stealing users from Coinbase.

“The crypto markets are very young and we expect many more companies to compete for the profits Coinbase enjoys today. As the cryptocurrency market matures, we expect Coinbase’s transaction margins to drop precipitously.” — New Constructs

Bear Case #2B: Competition from TradFi

TradFi is another crypto shorthand for “traditional finance”, i.e., traditional institutions that are looking to issue their own crypto products — like PayPal and Visa for example.

If Coinbase’s biggest value proposition in the industry is a trusted brand, they will have to justify their services to the mainstream investor vs. well established financial brands like PayPal and Robinhood — and eventually even consumer banks like Chase.

Moreover, traditional brokerages like Fidelity and TradeStation are actively looking to offer and expand their cryptocurrency services for their clients.

For users who are interested in an easy one-stop investing experience, they may opt to stay with their equities broker — instead of opening an account at Coinbase.

If traditional brokerages begin offering the ability to trade cryptocurrencies, they will most certainly cut down on the unnaturally [high fees] in the immature cryptocurrency market.” — New Constructs

From the institutional investment side, Coinbase is seeing plenty of competitions from the likes of FalconX, Genesis, and BitGo.

Asset management giant Stone Ridge spun up NYDIG to expose institutional clients like MassMutual to Bitcoin. The firm hopes to have $25B AUM by EOY.

Bear Case #2C: Competition from DEX

DEX is short for a “decentralized exchange”, these are exchanges that are not private companies — but rather, they are open-source code that allows for peer-to-peer exchange of assets in a trustless, permissionless manner.

Examples of DEXes include Uniswap, Sushiswap, Bakeryswap and Pancakeswap (yes I know, they’re all food or animal names lol).

Given that cryptocurrency is founded on the Web3 principles of open, trustless, and decentralized, DEXes have been attracted avid attention from crypto-native investors — the so-called DeFi degens.

DEX proponents claim that this peer-to-peer exchange protocol will disintermediate CEXes like Coinbase — as traders no longer have to deal with middle-men and trusted counterparties.

DEXes have become so popular that Uniswap briefly surpassed the monthly trading volume of Coinbase.

At the height of “DeFi Summer” in September 2020, DEX volumes was nearly 20% share compared with CEXes (it currently sits at ~7%).

Source: CoinTelegraph

The most surprising part?

Uniswap did so with only 20 full time workers — compared to Coinbase’s 1200+ employees — showcasing the high operating leverage of the protocol.

Bear Case #3: A Potential Hack

Again, given that Coinbase’s brand is predicated on trust, this trust could be easily wiped out by a large, damaging hack.

The crypto industry is known for its hacks, especially in regards to exchanges, stemming back to the infamous Mt Gox hack in 2014 that resulted in nearly half a billion dollars worth of Bitcoin being taken and Mt Gox declaring insolvency.

More recently, lender Cred and social token community Roll got hacked as well.

So it stands within reason that even Coinbase could be hacked as well.

Source: Coinbase.com

As always, please DM me on LinkedIn or Twitter if you have any questions or want to discuss any of these topics in detail. I love talking to folks about crypto and about life broadly :)

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