After The FTX Mayhem, Coinbase Is Looking Better And Better

After The FTX Mayhem, Coinbase Is Looking Better And Better
Jonathan Hobbs

about 1 year ago5 mins

  • Crypto exchanges have been cast in a bad light since the FTX debacle. But perhaps this might play into Coinbase’s hands in the long run: its strategy is to be the most compliant exchange around.

  • Unlike the competition, Coinbase is a publicly listed US company, with ultra-strict reporting requirements to keep it in check.

  • Coinbase will need the crypto market to bounce back if it’s going to rake in the big bucks again. Until then, its cash and other income streams will have to tide it over.

Crypto exchanges have been cast in a bad light since the FTX debacle. But perhaps this might play into Coinbase’s hands in the long run: its strategy is to be the most compliant exchange around.

Unlike the competition, Coinbase is a publicly listed US company, with ultra-strict reporting requirements to keep it in check.

Coinbase will need the crypto market to bounce back if it’s going to rake in the big bucks again. Until then, its cash and other income streams will have to tide it over.

With FTX being swept away in a solvency hurricane, buying shares in a crypto exchange is probably the last thing on anyone’s mind. But Cathie Wood’s Ark Innovation Fund scooped up $21.4 million of Coinbase (COIN) stock on November 8th – right in the eye of the storm. So let’s find out whether she’s onto something here, and whether you might want to follow her lead by picking up some Coinbase stocks yourself.

How is Coinbase doing moneywise?

Coinbase’s third-quarter results came out on November 3rd. As I wrote the next day, the firms’ net quarterly revenue was down yet again. The digital asset exchange generated just $576.4 million overall – a drop of about 28% from the quarter before. But the report wasn’t all bad: Coinbase grew its other income streams, scaled back costs, and still has a wad of cash to see it through the chills of crypto winter.

Digging into the net revenue numbers more, you’ll see a pattern from the start of 2021: Coinbase’s trading revenue (red line) and overall revenue (white line) have both been trending down, but its revenue from everything other than trading (green line) has been trending up.

Breakdown of Coinbase’s net revenue (revenue less direct expenses related to obtaining that revenue) per quarter. Data from Coinbase Q3 2022 shareholder letter.
Breakdown of Coinbase’s net revenue (revenue less direct expenses related to obtaining that revenue) per quarter. Data from Coinbase Q3 2022 shareholder letter.

To be fair, it's been a down market, so you’d expect trading revenue to drop off – a lot of people have preferred to hold their coins than trade them. And the longer the bear market lasts, the worse things will be for Coinbase on that front. In the meantime, it’s got to pull in more bread from blockchain rewards, custodial fees, and interest income.

Coinbase net revenue (revenue less direct expenses related to obtaining that revenue). Source: Coinbase Q3 2022 shareholder letter.
Coinbase net revenue (revenue less direct expenses related to obtaining that revenue). Source: Coinbase Q3 2022 shareholder letter.

As for what Coinbase is spending, it cut back quite a bit last quarter. It lowered its overall operating costs by 22%, reduced employee headcount by 5%, and just about halved its sales and marketing budget. Mind you, it's still spending about the same on tech and development – and that seems justified for a growing company with lofty ambitions.

Coinbase operating expenses. Source: Coinbase Q3 2022 shareholder letter.
Coinbase operating expenses. Source: Coinbase Q3 2022 shareholder letter.

Bottom line: Coinbase made a $544.6 million loss last quarter, which means it's still spending more than it's taking in. But on the bright side, it’s not as bad as the $1.09 billion loss it made the quarter before, so there is at least some improvement.

What’s the future look like for Coinbase?

Coinbase has three things that could set it up for growth in the long run.

1. Coinbase is a US-listed company.

With all the shenanigans at FTX, (and Celsius Network and Voyager before it) you’d expect investors to be wary of Coinbase too. But unlike that shady bunch, Coinbase is a publicly traded US company – it has strict reporting requirements that none of those three would have passed. Coinbase’s public financial statements – quarter after quarter – have to show it holds customer assets one for one.

Coinbase has said many times: its strategy is to be the most secure and compliant digital asset exchange – and that makes a lot of sense from a business angle. Crypto is a growing asset class, but it's still viewed with raised eyebrows by many traditional investors. So if Coinbase can be the most compliant and trusted exchange, it'll be first the first place those investors look when they eventually come around to crypto.

2. Coinbase has been making friends in high places.

Back in August, Coinbase partnered with BlackRock (the world’s biggest asset manager) to make it easy for institutional investors to buy, store, and trade digital assets in their portfolios. BlackRock has a product called Aladdin, which is already used by over 200 institutions (including BlackRock itself) as a portfolio management system for traditional assets. Coinbase is busy working with BlackRock to plug Coinbase Prime – its institutional platform – into Aladdin, and expects to have that up and running in the first half of next year.

And just a month ago, Coinbase partnered with Google Cloud, so customers will be able to pay for their services with crypto using the Coinbase Commerce payment system. Google will also use Coinbase Prime for digital asset storage and reporting.

3. Coinbase is trading at good value, but the stock is volatile.

According to Bloomberg, the stock has a forward-looking enterprise-value-to-sales ratio of 2.57 – making it about 25% cheaper than the overall Nasdaq by that metric. The ratio takes the firm’s enterprise value (EV) – in other words, the company's total value – and divides that number by what analysts forecast its sales will be in 2023. Keep in mind, analyst estimates can often be wrong, but the ratio is still used by investors to gauge whether a stock is a bargain.

And as for its volatility, Coinbase has a “beta” of 2.5 versus the Nasdaq (with a beta of 1). In other words, it’s assumed to be 150% more volatile than the index itself. That’s great when the Nasdaq is going up, as Coinbase tends to go up even more. Of course, it can work the other way around when the Nasdaq falls.

So what’s the opportunity here?

Back in May, I wrote an Insight about Coinbase. My thesis was (and still is) that the firm is playing the long game with regulation and compliance. Sure, that might slow it down when launching innovative products, and it might have to spend more time and money to stay squeaky clean, but that could all pay off big later on.

Given what’s just happened with FTX, you can bet your bottom bitcoin that regulators are going to be cracking down on crypto exchanges now more than ever. So if anything, FTX’s fall from grace could be a good thing for Coinbase: it’s got one fewer competitor now, and its compliance focus could give it the upper hand over the ones that remain.

Still, Coinbase will need the crypto market to come roaring back to life if it’s ever going to pull in the big bucks again. Until then, its cash and other income streams will just have to tide it over. As for the crypto market itself, I think you might find what Pantera Capital CEO Dan Morehead has to say about it quite interesting. I’ve written about that over here.

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Disclaimer: These articles are provided for information purposes only. Occasionally, an opinion about whether to buy or sell a specific investment may be provided. The content is not intended to be a personal recommendation to buy or sell any financial instrument or product, or to adopt any investment strategy as it is not provided based on an assessment of your investing knowledge and experience, your financial situation or your investment objectives. The value of your investments, and the income derived from them, may go down as well as up. You may not get back all the money that you invest. The investments referred to in this article may not be suitable for all investors, and if in doubt, an investor should seek advice from a qualified investment advisor.

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