Described as the "watershed" moment in crypto, Coinbase's IPO this week is regarded as the tipping point of mass acceptance. As the largest crypto platform in the US prepares for their anticipated direct listing, this post condenses my takeaways from their 300 page S-1 filing.
It was interesting writing this post as it helped me familiarise with key business metrics, but more importantly gain perspectives in interpreting the crypto landscape, a segment of greater significance in our new financial ecosystem.
If you only had 30 seconds, these are the 6 things you should know:
COIN is still dependent on a singular revenue stream - 96% of revenue came from trading fees
Institutional adoption - we are amidst the tipping point where institutional investors overtake retail investors in terms of assets on platform & trading volume
Highly dependent on 2 assets - BTC & ETH accounts for 80% of asset on platform and 56% of trading volume
Volatility risk - No holding period for existing COIN shareholders
COIN will be focusing on other crypto use-cases - Outlined in their product roadmap to prioritise staking, borrowing/loaning, and saving products
Regulation risk - Uncertainty with SEC's definition of cryptocurrency
This post was formatted for easy reading by:
outlining in point forms
highlighting key points in red
adding supplemented commentary and research in italics
To begin, the contents have been categorised into 8 sections:
Users - Retail, institutions and partners
Finances - Revenue & trading volume figures
Macro trends in crypto
Business risks - Considerations flagged by Coinbase
Inherent crypto risks
Interesting crypto facts
Coinbase's upcoming focus
Summary - To buy or not to buy?
1. Users - Key stats on retail, institutional and partner ecosystem
43M verified retail users, of which 2.8M are monthly transacting users (In comparison: Binance has 13M users with 1M - 1.5M monthly active, as of July 2019. Etoro has 20M registered users, as of Mar 2021, while Robinhood has 13M as of 2020)
90% of retail investors were acquired organically or through word-of-mouth (Marketing contributed for 6.4% of operating expense in 2020, and 4% in 2019 )
21% of users who invested also engaged with at least one non-investing product per quarter (These includes more sophisticated products like Distribute, Stake, Save, Spend, and Borrow & Lend products)
2020 was big! As seen in the screenshot, new users grew 34% while monthly transacting users grew 180%, signalling that existing users also became more active! Moreover, of the current $90B assets on platform, 82% came in 2020 alone!
(Top-line user stats in the last 2 years)
Currently supports 7000 institutional clients, which grew from 1000 institutions in Dec 2017, to 4200 in Dec 2019. In turn, institution assets on platform grew from $6.5B in 2019, to $44.8B in 2020.
Supports 115k ecosystem partners including developers, merchants, asset issuers, and financial institutions
2. Finances - Key stats on revenue & trading volume
As of Dec 2020, Coinbase has $90B assets on platform
Generated a total of $3.4B revenue, of which 96% came solely from transaction fees. (Compared to other references - Charles Schwab's generates 4 revenue streams: 12% from trading revenue, 40% from asset management fees, 40% from lending, and 7% from other services. Interactive brokers generates 3 revenue stream: 37% from commissions, 56% from interest income, and 6% from others)
Generated $1.3B revenue in 2020, and $533M in 2019. Which meant half of lifetime revenue came in just the last 2 years. (This was almost 2x of Robinhood's 2020 revenue of $673M)
Median quarterly trading volume increasing from $17B to $21B to $38B in 2018, 2019 and 2020, respectively
76% of revenue was derived from US, while the other 24% was from Europe (no other country accounted for >10% of revenue)
Increasing involvement of institutional trading. Screenshot below shows the growing proportion of trading volume by institutions. As of 2020, institutions accounted for 49% of asset on platform and 61% of trading volume.
(Proportion of retail & institutional trading volume, across crypto asset volatility )
3. Macro trends in crypto
Coinbase integrates with 15 blockchain protocols, and offers >90 crypto assets for trading or custody. As an industry, there are >50 distinct blockchain protocols supporting >7500 crypto assets.
As of Dec 2020, Coinbase represented 11% of the total market cap of crypto assets. This grew from 8.3% and 4.5% of Dec 2019 and Dec 2018 respectively.
A heavy concentration of only 2 crypto assets. As seen below, 80% of assets on platform were comprised of BTC & ETH.
(Proportion of assets on Coinbase in the last 2 years)
Increasing popularity of other crypto assets like DeFi, which increased from 18% to 44% in 1 year, even outgrowing the increasing popularity of BTC & ETH.
(Trading volume of asset types on Coinbase)
We are still in the early stages of adoption, as the overall market cap of crypto assets were $782B as of Dec 31 2020 (As of writing in April, it has climbed to $2.2T. A common comparison is the market cap of gold at $11T)
4. Business risk flagged by Coinbase's in their S-1
Impending fluctuations due to the volatile nature of crypto since revenue is dependent on crypto prices and volume of transactions. (Case in point, Coinbase reported net income of $322.3M in 2020, but incurred a net loss of $30.4 million in 2019)
Highly dependent on BTC & ETH as it constitutes majority of net revenue, with the trading pairs accounting for 56% of total trading volume.
Subjected to extensive and highly evolving regulatory landscape. Especially on the uncertainty of crypto asset's status as a "security", if unable to properly characterise, may be subjected to regulatory scrutiny or fines.
Loss or destruction of private keys to access crypto assets may be irreversible, if they suffer hacks or dataloss.
None of the stockholders are party to any contractual lock-up agreement or other contractual restrictions on transfer. Thus, sale or distribution of class A common shares, or the perception, might cause market price to decline. (As compared to the usual underwritten initial public offering, it is customary for most stockholders to enter into a 180-day contractual lock-up arrangement)
If short term interest rates remain low or start to decline further, revenue from interest earned from funds deposited will decrease.
Abrupt/erratic market movement: leads to extreme pressure on platform infrastructure. In 2020, Coinbase experienced 30 outages, average of 64.6 minutes, which led to increased service expense, customer loss, and reputational damage.
3rd party platforms like App Store & Play store. Apple App Store’s restrictions have disrupted the proposed launch of many Coinbase features including the Earn services and access to decentralized applications. In November 2013, the iOS app was temporarily removed by Apple from the Apple App Store. In December 2019, they were similarly instructed by both Google and Apple to remove certain features relating to decentralized applications from our apps to comply with both companies’ policies.
5. Inherent risk related to BTC & ETH flagged by Coinbase
Reduction of mining reward of Bitcoin and the launch of Ethereum 2.0
Possible 51% attack on BTC or ETH network
Ability of BTC & ETH to resolve scaling challenges
Identification of Satoshi Nakamoto (This would be unfathomable)
Development in mathematics or quantum computing that could result in the cryptography being used by BTC/ETH becoming insecure or ineffective
Consolidation of mining power in a small number of large mining farms, could reduce security and lead to increased liquid supply of crypto, reducing crypto's price
Hard forks (Explained: Forks are the existence of two parallel versions of the Bitcoin, Ethereum or other blockchain protocol network, running simultaneously, but with each split network’s crypto asset lacking interchangeability. Past forks have caused fragmentation among platforms, confusion with consumers, and security concerns like the double-spend issue in July 2016. More about hard forks in the references)
If SEC defines crypto assets as a security, platforms have to incur additional compliance cost, and they might have to suspend trading till regulatory approvals have settled. (More about it in the references)
6. Interesting crypto facts:
There has been four major crypto asset price cycles since 2010, each cycle 2-4 years, with the trough higher than the prior peak.
(Macro trends of BTC price)
In the past, crypto market have not appeared to correlate with broader US equity markets. But held true till feb 2020, when US stock & crypto market experienced significant downturn due to covid. Through Dec 21 2020, these markets appeared more correlated than before. (This could impact its perception of providing diversification)
Number of monthly transacting users correlates with the price of BTC/ETH.
7. Coinbase's upcoming focus
Focus future efforts on building ecosystem partner products, while maintaining their cash-cow investment products. (This is already hinted in their product roadmap below, pushed by the need for diversification since 96% of revenue was derived solely from trading revenue)
(Product roadmap over the last 8 years)
Cross sell users to push them to non-investing products (especially since existing users who invest and engage in non-investment products saw net revenue per retail user increase by 90%)
8. Summary - Where do we go from here?
Combing through all these information, the section below would be top-of-mind when deciding my next steps. Section 4 & 5 (risk flagged out by Coinbase) serves as my macro indicators when navigating investments in COIN and the crypto ecosystem.
Key considerations:
Impending regulation - There is still significant uncertainty whether crypto assets should be defined as "securities". In the long run, regulation would be welcomed as it enables wider adoption, but expect short term volatility as it brings about tax and cost implications for investors and exchanges like Coinbase. And this might come sooner than we think, probably in the next 1 to 2 years. A strong indicator for me is the recent SEC nomination of Gary Gensler, a MIT professor teaching "Blockchain and Money", and boasts an illustrious background in finance. I don't think anyone else is more poised to provide clarity than him. (His MIT lectures on YouTube are golden). #Bull
Lack of diversification - Coinbase's current revenue is highly correlated with crypto prices & trading volume, and concentrated in only BTC & ETH. With 96% of revenue derived from trading fees, there is an urgent need for diversification. Case in point as they reported net income of $322.3M in 2020, but incurred a net loss of $30.4 million in 2019. #Bear
No lockup period for COIN's shareholders - They have free rein to cash out and "dump" the risk on public investors. Using Nasdaq's reference price of $250 and current market price of $350 as a baseline, it wouldn't be surprising if early investors who entered between $5 - $25 in earlier rounds are already capturing value to minimally 10X their investments. Especially with the current hype of crypto, and BTC & ETH achieving new ATH. #Bear
Competition - Being best in class to ensure scale and security. As seen above, trading volume is correlated to asset volatility. Crypto investments are highly time-sensitive, which places great importance on the platform's ability to handle big swings in traffic. In their S-1, Coinbase reported a total downtime of 32 hours (30 outages x average 64.6 mins), which risks user confidence and even regulatory fines. However, it has so far not reported any security breaches, unlike competitors like Binance, Upbit and Bitfinex to name few (More hacks here). #Bull
Key opportunities:
Large addressable market - Coinbase is currently focused on US, which drives 75% of revenue, and yet to venture globally. With their new status as a public company, this gives them a short term advantage to onboard the mass market. This is coupled with a growing size of the pie as perception and branding of crypto improves. #Bull
Institutional adoption - The number of institutional clients on Coinbase increased from 4200 to 7000 between 2019 and 2020. As of 2020, institutions already accounted for 49% of asset on platform and 61% of trading volume. With companies like MicroStrategy, Tesla, Paypal, Square leading the way for institutional adoption, its only a matter of time before others follow suit. #Bull
New wave of use-cases like DeFi & NFTs - The use of crypto assets to participate in decentralised finance applications like P2P borrowing and lending is gaining traction. The total value allocated towards DeFi globally grew from $1B to >$15B from 2019 to 2020. The popularity of NFTs is also raging, with what appears to be the start of a hockey stick curve at a current market cap of $20B. This could be bitcoin 5 years ago. #Neutral
Coinbase's IPO is a pivotal moment for crypto, not only for its brand and marketing value, but the credibility it establishes. If you're bullish about COIN, do read this analysis as it cautions that it could be greatly overvalued. Nonetheless, Coinbase's IPO allows investors to gain exposure to crypto, without actually owning any crypto, although they might be highly correlated.
References:
CZ interview about Binance's user stats on YouTube (25th minute)
Robinhood user stats on Techcrunch
More about hard forks:
"Both Bitcoin and Ethereum protocols have been subject to “forks” that resulted in the creation of new networks, including Bitcoin Cash ABC, Bitcoin Cash SV, Bitcoin Diamond, Bitcoin Gold, Ethereum Classic, and others. Some of these forks have caused fragmentation among platforms as to the correct naming convention for forked crypto assets. Due to the lack of a central registry or rulemaking body, no single entity has the ability to dictate the nomenclature of forked crypto assets, causing disagreements and a lack of uniformity among platforms on the nomenclature of forked crypto assets, and which results in further confusion to customers as to the nature of assets they hold on platforms."
"Furthermore, hard forks can lead to new security concerns. For instance, when the Ethereum and Ethereum Classic networks split in July 2016, replay attacks, in which transactions from one network were rebroadcast on the other network to achieve “double-spending”, plagued platforms that traded Ethereum through at least October 2016, resulting in significant losses to some crypto asset platforms"
"If minors of supported crypto asset demand high transacting fees: "For instance, in 2017, Bitcoin miner fees increased from approximately $0.35 per transaction in January 2017 to over $50 per transaction in December 2017. Even though Bitcoin’s miner fees have since decreased, if the block rewards for miners on any blockchain network are not sufficiently high to incentivize miners, miners may demand higher transaction fees, or collude to reject low transaction fees and force users to pay higher fees"
More about SEC's regulation:
"If the SEC, foreign regulatory authority, or a court were to determine that a supported crypto asset currently offered, sold, or traded on our platform is a security, we would not be able to offer such crypto asset for trading until we are able to do so in a compliant manner, such as through an ATS approved to trade crypto asset that constitute securities."
"Although we have applied to operate an ATS in the United States that would allow us to trade crypto assets that are deemed “securities” under U.S. federal securities laws, we have not yet received regulatory approval to, and do not currently, operate an ATS for trading of crypto assets deemed to be securities."
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