Tokyo FinTech
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Tokyo FinTech

Old man yells at Coinbase

At the beginning of the US trading day on Tuesday, right after everybody returned to work following the long Memorial Day weekend, we experienced just another crypto mini-crash. Within minutes, both Bitcoin and Ethereum retreated around 20%. Like clockwork, Coinbase was down. Reports of cancelled orders, inaccessibility of the platform, and inability to execute withdrawals prevailed.

So the “easiest place to buy and sell crypto” only works during normal market activity. Any spike, typically a drawdown of 10% in Bitcoin, brings the Coinbase infrastructure to its knees. We are excited that Coinbase has hired a new CMO from Facebook at the end of August, but maybe the engineering team is in a more urgent need of a boost?

If you have been in the crypto markets for a little while, then you will be more than familiar with the notion of such drawdawns. There is no surprise. They do occur regularly. You can plan for it. The crypto world likes to advocate HODLing, and if you do, you would not care about Coinbase being down during those challenging market periods. If your preference is to protect your capital, however, Coinbase teaches you very effectively one of the basic lessons of trading — use stop loss orders.

To turn this into a constructive dialog rather than an old man yelling at the clouds, allow me to cover three different perspectives. At the end of the day, Coinbase and its investors are market-driven, and it is a matter of incentives to make them deploy their capital in areas that actually benefit their customers (which might trigger a Robinhood-like debate about who the Coinbase customers in fact are, which goes beyond this article). Just to be entirely straight about it: any marketing blurb about “democratizing finance” is total bullocks if you lock your traders out of your platform during times of highest volatility.

Hence we will cover:

  • Individual remedies
  • Regulatory remedies
  • Technology

I would have loved to add some historical perspective on how we managed capacity across the trade processing flow in capital markets during the pre-cloud days, but I fear this might stretch the reader’s patience. If you would like to hear about it, to learn how much simpler and cost-effective it has become today, then please leave a comment and I will be happy to elaborate in another article.

Individual remedies

You just have to take a look at the Twitter-sphere to acknowledge that these outages affect more than a few users. Every time a “mini-crash” happens, the picture is the same, and it has been going on for years. What do they say about doing the same thing over and over again, and expecting different results?

The American legal system has an effective remedy to aggregate the complaints of plaintiffs who on their own might not be able to take on a $50bn market capitalization behemoth like Coinbase. It is called a class action lawsuit. And it is much more effective now that Coinbase is a publicly listed company.

In fact, such class action has been filed in the Northern District of California on July 22, 2021, and firms like Dillendorf are looking to represent investors who lost money trading COIN after the highs following the IPO.

The complaint specifically calls out mis-representation as to the stability of the platform.

According to the complaint, the IPO offering materials were false and misleading because they did not disclose that (1) Coinbase actually needed a significant injection of cash to operate, and (2) its platform was increasingly susceptible to service disruptions.

According to Coinbase’s IPO prospectus, it is its “trusted and easy-to-use products” and “robust backend technology platform to support the global, real-time, and 24/7/365 demands of crypto asset markets,” (i.e., its “unique approach”) that “draws users, institutions, and ecosystem partners to [its] platform.”

Shortly after the market opened on May 19, 2021, as the value of cryptocurrencies radically plummeted, Coinbase revealed technical problems experienced by users on its platform, including “delays…due to network congestion” effecting “those who want to get their money out.” Such service-level technical problems are disastrous for a Company which bills itself as “the easiest place to buy and sell crypto,” and which relies on transaction fees to generate nearly all of its revenues

The complaint argues that these technical problems had a direct and material effect on Coinbase’s stock price, and seeking redress. Hence it is not quite like making the users of the platform whole, but it could potentially be a powerful means to redirect the attention of Coinbase management to the areas that matter to their users.

Regulatory remedies

Press coverage this week focused on the Well’s Notice the SEC issued against Coinbase concerning the launch of its “Lend” program. While these two threads are not necessarily connected, they offer another opportunity to exert pressure on Coinbase to do the right thing.

Whatever we might say about the various regulators, in particular in the US with their somewhat overlapping authorities, at the end of the day they tend to be fairly reasonable, not withstanding the occasional multi-million or billion dollar fine. They tend to work with the business lines or functions of the organization that are of concern, and leave the remainder to go about their business as usual. It typically takes a while for the regulator to completely lose patience.

But when they do so, the most effective measure is a “cease & desist” order that requires remediation of specific points before the organization as a whole can enter into new business lines (either organically or through acquisitions). It implies that management focus would be too distracted by the shiny new toy to seriously work on the required remediation. The most recent example is the cease & desist order against Citibank issued in 2020. Arguably, this was the culmination of years of neglect in fixing deficiencies. You are free to view the Citibank CEO transition as not entirely accidental.

The SEC is famously more lenient than the Federal Reserve or the OCC, however, what would the effect be of not allowing Coinbase to start any new business (e.g., “Lend” or international expansion) without sorting out their infrastructure issues first? That seems like a pretty good incentive to me. Obviously, the discussion around the “Lend” program goes further, and has at its heart the question whether those transactions should be governed under US securities law.

Technology

On the technology side, let us take a look at the trading software itself, and its scalability, including infrastructure, which are ostensibly linked. This is a black-box view, without any knowledge as to what is going on inside Coinbase. Call it speculation if you want, we will try to extrapolate common causes from the symptoms we are witnessing.

First, Coinbase has been in business since 2012. That’s close to a decade for those counting. It is entirely possible that Coinbase has almost as much legacy code as your common securities broker, and that the current architecture simply does not scale any further. With this, we give Coinbase management the benefit of the doubt, essentially saying that they are fully aware of the problem and want to fix it, but cannot. So you either re-build or buy.

If you start up an exchange today, you would go buy a matching engine and associated infrastructure from any number of vendors. For example, our friends at Archax, the London-based security token exchange, have chosen the Aquis matching engine and surveillance tools for their platform.

Second, if we assume that the Coinbase infrastructure is scalable from a software architecture perspective, or has been re-factored/re-built to be fit-for-purpose, then the infrastructure (compute, storage, networks) need to able to scale up and down rapidly, given the nature of the crypto markets.

Following Amazon Web Services’ (AWS) Well-Architected Framework, and its five pillars (Operational Excellence, Security, Reliability, Performance Efficiency, and Cost Optimization), you might be surprised to read as one of the design principles:

Stop guessing capacity

That’s right. One should design the systems such that they scale automatically, and one does not have to run a capacity program to monitor and adjust capacity manually, like we old hands used to do. This is clearly not what is happening at Coinbase.

“Stop guessing capacity: A common cause of failure in on-premises workloads is resource saturation, when the demands placed on a workload exceed the capacity of that workload. In the cloud, you can monitor demand and workload utilization, and automate the addition or removal of resources to maintain the optimal level to satisfy demand without over- or under-provisioning. There are still limits, but some quotas can be controlled and others can be managed.”

Come on, let’s get this done, Coinbase!

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Norbert Gehrke

Norbert Gehrke

2.3K Followers

Passionate about strategy & innovation across Asia. At home in Japan. Connector of people & ideas.