Under the Spotlight Wall St: Coinbase Global Inc (COIN)

The crypto industry revelled as Coinbase ($COIN) debuted on Wall Street in 2021. Three years later, the company is taking the fight to regulators, building its own Layer 2 blockchain and trying to pivot away from a business model dependent on trading fees. 

Coinbase does well when crypto does well. Its shares gained 155% over the last year, as traders said goodbye to crypto winter. A new bull market brought a fresh all-time high for Bitcoin. 

But it’s far from smooth sailing at the crypto exchange. Although the firm has come to be known as one of the most trusted platforms in the digital asset space, legal challenges and fierce competition could impact profit margins even when it's good times for crypto.

Bitcoin big leagues

Coinbase’s origin story is what you might expect from a crypto company starting out in the early days of the industry. Former Airbnb ($ABNB) engineer Brian Armstrong met cofounder Fred Ehrsam on Reddit ($RDDT) in 2012, and the two went on to launch Coinbase from a two-bedroom apartment shared with another company. At the time, US$6 could buy you a whole Bitcoin.

We’ve come a long way since Bitcoin’s single-digit value days, when it was perceived as magic internet money to fund transactions on the dark web. It has evolved into a legitimate asset class, with a place in the portfolios of institutional investors. Major asset managers like BlackRock, Fidelity and VanEck count themselves among the 11 spot Bitcoin ETF issuers, with the collective assets under management of these funds now exceeding US$60b. 

Coinbase is the custodian of choice for eight of those ETFs, which indicates how it’s making the most of Bitcoin’s new status. It’s the largest crypto exchange in the U.S., with a daily trading volume of US$2b from its 200+ crypto trading pairs on offer. Coinbase’s US$100b direct listing on the Nasdaq in 2021 was dubbed a ‘watershed moment’ for crypto, but the revenue trajectory that followed didn’t exactly justify its valuation.

A volume game

In 2021, Coinbase brought in US$7.89b in revenue, marking a 513% increase from the year prior. But its revenue declined 59% in 2022 to US$3.19b, and a further 2.69% in 2023 to US$3.10b. This year, the first quarter alone has brought in US$1.6b in revenue, marking a 111% increase YoY.

This inconsistency checks out considering transaction fees represent 67% of Coinbase’s revenue. The sharp drawdown in crypto prices over the last two years naturally translated into lower trading activity, prompting Coinbase to build other avenues of income generation. In 2023, the company made US$1.4b in subscriptions and services, up from US$792.57m in 2022. 

A crucial part of this revenue source stems from Coinbase’s partnership with the USDC stablecoin issuer Circle. The companies share interest income generated from USDC, earning Coinbase US$197m in stablecoin revenue last quarter.

Coinbase vs SEC

One major point of concern for Coinbase is continuing operations in an uncertain regulatory environment. The U.S. Securities and Exchange Commission (SEC) is suing Coinbase for allegedly operating as an unlicensed securities broker. Separately, Coinbase is suing the SEC and the Federal Deposit Insurance Corporation (FDIC) for not complying with the Freedom of Information Act. The exchange had also sued the securities regulator in 2023 in an attempt to force a yes or no answer to a rulemaking petition for the crypto industry.

Despite the hefty legal bills, Coinbase will likely continue to advocate for ‘a clear legal framework for the crypto industry’ – understandable, as product innovation can only go as far as the rules permit. 

Base case scenario

Coinbase may have started out as a centralised crypto exchange, but it has found unlikely competition from a growing number of blockchain-based decentralised protocols that function as exchanges, borrowing markets and lending markets. With approximately US$100b in value locked, the booming decentralised finance (DeFi) sector shows no signs of slowing down.

Driving most of this growth are Layer 2 (L2) blockchains (think of this as a network built on top of another network) that allow for cheaper and faster transactions. In August 2023, Coinbase launched its own L2 blockchain called ‘Base’ on Ethereum, and it's already amassed US$1.7b in value. 

If there’s one thing that Wall Street might not be pricing in, it's the revenue that Coinbase stands to earn from Base. Coinbase batches transactions and posts them to Ethereum in its role as Base’s sole sequencer, earning ‘sequencer fees’ for doing so. In Q1, Coinbase earned $15.5 million just from this, and all of it went straight to the firm’s bottom line.

That’s why Bitwise Asset Management describes this particular line item as ‘the game changer in Coinbase’s earnings report that has some people thinking Amazon ($AMZN).’

This does not constitute financial advice nor a recommendation to invest in the securities listed. The information presented is intended to be of a factual nature only. Past performance is not a reliable indicator of future performance. As always, do your own research and consider seeking financial, legal and taxation advice before investing.