Last time we looked at MicroStrategy, as one of the most vocal and dominant corporate buyers of bitcoin. Today let’s look at Coinbase, one of the most dominant crypto exchanges in the US and the world. The company IPO’ed at $250/share in April 2021 (technically through direct listing). The stock soon spiked up to above $340, before settling back down to the low-$200s range as of writing. This gives the company a valuation of ~$60bn. The earnings of the company tie closely to cryptocurrencies’ wild price swing so can be hard to value. But let’s do our best and dive in.
Financial Performance
Coinbase has been around since 2012, with a simple idea of legitimizing bitcoin and other cryptocurrencies. In the last bull run in 2017, the company has established itself as one of the most dominate and trusted players in the crypto marketplace. It did ~$170bn of trading volume (based on my own estimate). In 2018 and 2019, trading volume retreated back to $100bn and $80bn, respectively. No surprise there due to crypto price downturn. 2019 EBITDA was a paltry $24mm.
Then 2020 came. Crypto prices were on the rise again. Trading volume doubled to ~$190bn. EBITDA 20x’ed to over $500mm. The upswing continued in 1Q 2021, with most crypto prices breaking all-time highs. In just this one quarter, Coinbase trading volume ballooned to $335bn and EBITDA to ~$1bn. Comparing to 2019 results, 4x trading volume resulted in 40x higher in EBITDA. What an operating leverage! And perfect timing on the IPO. In May 2021 the company further issued $1.4bn convertible notes at minimal interest cost, convertible at almost 60% above today’s stock price.
To value the company, if we can just annualize the 1Q number and call it a day, that would be amazing. However, it ties so closely to crypto price movements. When prices go up, more people tend to make more trades (both buying and selling). And since Coinbase takes a small percentage on each trade, the higher the prices go, the more it makes in absolute dollars even on the same amount of volume. In a price downturn however, it will have a double whammy effect. Timing any market is hard; timing the crypto market is even harder!
Investing in the Commodity or the Commodity Companies
Given the unpredictable nature of crypto price swings, some investors may question whether it is better to make a “safer” bet on crypto companies like Coinbase. Generally I think this line of thinking is a fool’s errand. You simply have to have a view on the underlying. For example, if oil price goes down, earnings of any E&P (exploration and production) company will go down, period. Similarly here, and to one extreme, if you think crypto does not offer much fundamental value, Coinbase will not have much value either. Personally I am positive on crypto. I think there is real value-add, besides just the speculative forces and the pump-and-dumps. With that squared away, let’s take a look at the biggest threat to the company, i.e. its competition.
Competition
Coinbase has established itself as one of the most recognized and trusted brands for the masses (both retail and institutions) to get into and stay in the crypto space. As of 2020 year end, the company had 11% of total market capitalization of all crypto assets stored and / or custodied on its platform. Interestingly, only ~5% of users on Coinbase are monthly transacting users (though the number bumped up to ~10% in 1Q 2021). This leads me to believe most people employ very simple strategy of buying, holding and occasional selling, versus active trading and / or other complex strategies. Coinbase provides one-stop-shop solution that meets demands of the overwhelming majority and advanced capabilities if they so choose to.
Other regulated centralized exchanges like Kraken and Gemini provide similar products and services with similar pricings. Brand recognition, economies of scale and ease of use will continue to work in favor of Coinbase. Recently, financial technology companies have also entered into the foray, e.g. Square, PayPal and Robinhood, but generally do not offer as comprehensive of a solution in the crypto ecosystem.
Across the globe, Binance is probably one of the most formidable competitors to Coinbase. It was founded in 2017 and became the largest crypto exchange in the world in 2018 (read more on Wikipedia here). It offers by far the largest set of crypto trading functionalities by operating somewhat under the radar of regulations around the world. Coinbase has chosen a more cautious approach in terms of security, regulatory compliance and licensure. It might have sacrificed a bit on speed to roll out new products and services but will likely be rewarded through customer trust, brand recognition and regulatory support. In a way, Coinbase has built a regulatory moat for longevity of the company. In May, it was reported that CEO Brian Armstrong met with Fed Chairman Jay Powell and other politicians. I applaud him and the company for the efforts.
Decentralized Exchanges, Finance Applications
Lastly, there has been a lot of chatter about how decentralized exchanges (DEXs) and finance applications (DeFis) are going to take over the world. I think they are all very interesting applications but the threat is overblown. For one, decentralized exchanges don’t take fiat currency in exchange for or out of crypto assets (as it requires significant regulatory hurdle). The biggest target addressable market is still the retail individuals and institutions that have NOT yet gotten into the crypto space. For this market segment, Coinbase is poised to capture large share.
Second, again I believe most people (institutions included) employ fairly simple strategy and may actually prefer having a middleman to take care of nuances as related to cryptocurrencies. The decentralized platforms are still very nascent technology. News of these platforms being hacked or money being lost on them occur from time to time. And they are more or less unregulated. Just today, there was a report about an alleged pump and dump scheme on a token listed only on Uniswap (one of the biggest DEXs).
In the long run, I do see many positives to decentralized applications, e.g. better privacy, elimination of middle layers, ultimate customer control of their own assets. But for now I think it’s going to be a co-existing environment. Decentralized applications will take share, while centralized entities remain the dominant force. One thing for sure, however, is that there will be pricing pressure over time. Not much different than brokerage firms finally cutting trading commissions to zero in recent years, but it took decades.
Summary
I do expect the company’s EBITDA to come down from 1Q 2021 level. Given my positive stance on the crypto market, I can see EBITDA normalizes at $2-3bn over next year or two. Current valuation implies a 20-30x EBITDA. Over the medium term, I think the growth in crypto market will far outpace the competitive pressures. A high growth multiple is warranted. Coinbase is expanding into full stack crypto technology offerings from payments, staking, yield earning, borrowing and lending to crypto native cloud infrastructure for businesses. They amount to a very small percentage of revenue today. But will be important to fortify its position in the future. Comparing to other tech companies, I think it is reasonably valued. Furthermore, if crypto were to go much higher, Coinbase is going to be a multi-bagger over time. In any case, this will be a solid company for years and decades to come.
