Investing In Coinbase - The Bank of the Future?
Updated: Dec 17, 2021
Coinbase - A Pioneer In Crypto Investing
Cryptocurrency has been a divisive topic since Bitcoin began its rise to prominence in 2009. Back then, it was just something Larry in IT would talk about while he connected little red strings to pictures of digital currency logos on a cork board. Now, however, cryptocurrency is seen as a legitimate investment, batting down gold and other commodities as it rises up the ranks. The DeFi (decentralized finance) movement that cryptocurrency represents is being steadily embraced by everyone from tech nerds to business icons like Mark Cuban. Speaking of Cuban, his Dallas Mavericks NBA
franchise was one of the first organizations to announce Dogecoin as legal tender in their stadium for tickets and merchandise. Cryptocurrency has gained steam among the populous, and Coinbase is the train engine leading the way.
Market Capitalization: $48.57 billion
Q1 2021 Revenue: $1.80 billion (up 844% year over year)
Q1 Net Income: $771 million (up 2,312% year over year)
2020 Revenue: $1.27 billion (first year of data)
How Did They Get Started?
Founded in 2012 by former AirBnB engineer Brian Armstrong, Coinbase is a result of Y-Combinator's startup accelerator, and accelerate they did. After gaining several
business partners, Coinbase launched the ability to connect to a bank and buy or sell Bitcoin directly in the exchange. This is when the company took off. Venture capital firms like Andreesen Horowitz and Ribbit Capital (the largest backer of stock trading app Robinhood) jumped aboard, providing the capital required for Coinbase to execute several acquisitions, including the integration of Bitcoin storage directly in the service. As funding continued ramping up, so too did the capabilities of the platform. In 2016, Coinbase began accepting Ethereum transactions, with Litecoin added one year later. This continued through 2020, continually adding cryptocurrencies and expanding their operations, becoming the third top cryptocurrency exchange in terms of transaction volume. In 2021, the company went public via a direct listing on the Nasdaq.
What's The Business?
If you haven't figured that out by now, I can't help you. They're in the cryptocurrency game, babyyyyy. Coinbase actually offers a few core services:
Coinbase is your standard application. On both desktop and mobile app, you can buy and sell from a big list (but not all) of cryptocurrencies, including Bitcoin, Ethereum, Litecoin, USD Coin and others. However, you're paying HEAVY fees when you make transactions through this process.
The way to reduce these fees? Coinbase Pro! Think of the relationship between the two products like TD Ameritrade's "Think or Swim." You have the standard TDA stock exchange, and then you have the Think or Swim tool for "pro traders." That's exactly what this is. Pro offers a wider range of cryptocurrency tokens, executes faster trades and lowers fees because theoretically, you're making up for the fee loss in volume. Finally, they have Ventures, which is a venture capital firm specifically to assist those startups in the cryptocurrency and blockchain space.
So Will I Invest?
Coinbase is an odd one, because it's almost a political ideology vote if you decide to invest. It's no secret that their business model is cryptocurrency. That's it. They charge fees and have a VC firm in-house, but let's be real: where Bitcoin goes, Coinbase goes. So you have to decide: do you think Bitcoin is a fad, or a legitimate asset? If it's the former, then this company likely is not for you. And you're in good company. Nasim Taleb, author of investing tome "Black Swan" calls Bitcoin "a gimmick." He sees the whole space as too volatile to serve as an actual currency and not a safe haven for combating inflation.
And he might be correct; we have no idea. But let's, for the purposes of this research, assume he isn't.
Let's assume that Bitcoin, due to the inherent scarcity of the asset, becomes akin to gold. It serves as a store of value that, while volatile now, could be more stable later on when 10% price swings don't serve as the average. Let's also assume that other coins, like Ethereum and Litecoin, actually become legitimate forms of payment due to the constant upgrades being made in the next few months and years that include both reliability and transaction speed. If all of this comes to pass, Coinbase will be seen as a bank. That's what it truly is, and it's the first of its kind.
While other payment solutions companies like Square and Paypal are beginning to dip their toes into the crypto pool with buying and selling via the Cash App and Venmo, respectively, Coinbase was natively built to be able to handle vast amounts of transactions in the crypto-space, and store the coins in a wallet on-platform, just like a checking account. They're also partnering with Visa to create the first cryptocurrency debit card, drawing straight out of your Coinbase wallet. Finally, they've created a type of "digital-first" savings account with their USD Coin product which is pegged to the US Dollar so it's stable, and offers a 4% annual APY on the cash you hold in there.
Coinbase is so obviously becoming a bank, it's hard to see past that. And I love that business model. Banks are recurring revenue monsters, and the ability to derive net-interest income from institutional holdings is an unbelievable power to wield. Brian Armstrong could be forming into the 21st century Jamie Dimon, but there are some business risks to look out for here.
What I'm Watching Out For
2021 is a very strange year for a company to go public. When you file your S-1 documentation, you typically look at your finances for this year, and how it stacks up to the year prior. Obviously in this case, the year prior was the year of the pandemic when we were shut in our homes. So what do we see when we look at Coinbase in 2020 and 2021? Insane volatility. Cryptocurrency had its big moment in late 2020 and early 2021, especially around Dogecoin, which many will point out as a detraction from Coinbase. How could they replicate that amount of fee volume again? Well, fellow investor, look a little closer: Coinbase didn't have Dogecoin until June 2021, essentially when Elon Musk stopped tweeting about it and the mania had subsided slightly. Their fee volume really does come from transactions in the major cryptocurrencies.
Now let's look at the current valuation. At time of writing, Coinbase slipped nearly 5% in intraday trading, following most of the tech sector downwards. You hear that? Tech sector. This company is currently viewed as a tech company. Never was that more true than its direct listing, where rumors circulated through the financial media that Coinbase was staring down the barrel of a $100 billion valuation on its first day of trading. Those rumors turned out to be true, almost on the dot. Coinbase finished its first day of trading at a $99 billion market capitalization, but has since slipped back to about $48 billion. Why? Remember earlier when I said "where Bitcoin goes, Coinbase goes?" I wasn't lying. Bitcoin slipped 35% in May and a further 6% in June, and Coinbase dropped right along with it. But back to valuation.
Coinbases's current price-to-earnings ratio (P/E) is 89, with a forward price-to-earnings ratio of 38.79. Essentially, Wall Street consensus is picturing huge growth for this company, and is treating it like a low-overhead, high margin tech business. Let's compare those numbers to the largest American bank, JPMorgan Chase.
JPMorgan currently sits at a P/E of 10.31 and a Forward P/E of 13. For context, JPMorgan is a revenue monster, but has high overhead since it's a bank. This is the disconnect I'm talking about. As Coinbase begins to shift into bank territory, it's going to look INCREDIBLY expensive.
The Bottom Line
This is my first company deep dive where I'm genuinely torn on my opinion of the company. I truly believe Coinbase is an innovative, important, first-of-its-kind company with a great recurring revenue business model. I also noticed that famed investor Cathie Wood's ARK Invest fund picked up nearly $7 million worth of the company this week during its share price dip, and I respect the hell out of ARK's recent track record.
What I'm having an issue with is the valuation. It's very expensive at the moment, even for a tech company let alone a banking-style company. It will have to sustain long periods of increased fee volume to be able to justify the valuation, and that's something they have no control over because that will be inherent to the crypto-world's volatility. Their listing date was also a little bit fishy to me. They went with a direct listing after one of the highest periods of crypto volatility in years. Was it to make their financials look better? That's only speculation on my part.
In the end, this is a company I use and I like from a consumer perspective. I think Brian Armstrong is an intelligent founder, and the VC's that backed him are similarly innovative. While I think the business risks are many, this is a company I'll be keeping an eye on before jumping into with my cash. If you're a patient investor with an extremely long time horizon, I think investing in Coinbase could be a big, big winner.
The information contained within the following article should not be taken as investment advice, and is for information and entertainment purposes only. Please do your own research and do not buy or sell securities based solely on the information in this article.