The Truth about Coinbase
“We’re in the picks and shovel business, Tim.”
That’s what my old boss used to tell me at any given opportunity.
Have a meeting about Brexit planning, picks and shovels. Discuss risk, picks and shovels. Holiday request, picks and shovels…
*I spent my annual holiday that summer selling, you guessed it, picks and shovels to miners in Paracatu City, Brazil.
He’d inevitably go on to explain that it was the men who sold the pans, picks and shovels who were the smart money during the gold rush of the 1800s. Not the gold miners.
A very tired and much regurgitated quote which I think all CEOs learn on their first day at CEO school of hot air and blagging.
His point being, it didn’t matter if the market was up or down, we were here just to facilitate a smooth-running trade platform for clients. Like estate agents, our upside is the velocity of transactions, not the underlying price of the assets itself.
Thanks for that pearl of wisdom, Mr H.
“However, I can’t help but feel that the notion of Coinbase’s success being so highly dependent on further crypto price increases might be slightly off the mark.”
But his over-utilised analogy does somewhat remind me of a very present situation. That being the explosion of Cryptocurrencies and it’s shining star, Bitcoin.
And now it’s my turn to take a leaf out of the CEO book of hot air and tired quotes and bless you with; “Price is what you pay, value is what you get”. Said by an upstart trader I found on Tik Tok who goes by the name Warren Buffett.
You see, if Bitcoin were to vanish overnight – it wouldn’t be missed. Fortunes would be lost, most certainly, but our day-to-day living wouldn’t materially change. Remove cryptocurrency, blockchain and Bitcoin and the oldest bank in the world, Banca Monte dei Paschi di Siena (founded 1472), will still be there to hold your surplus wealth and change up holiday money.
The same can’t be said for agricultural farming, banking or pharmaceutical companies. Or take just one of the S&P 500 behemoths such as Amazon, which employs 1.3 million people directly and accounts for nearly $1m of revenue for every minute of every day of the year. Remove one of these, and you’ll quickly realise the difference between price and value.
So when Warren Buffet says, ‘cryptocurrency has no value’ (said in 2019) don’t for a moment think he’s denying that the price of said crypto can’t go up exponentially. It would be ignorant to think otherwise. But I can’t disagree with him on that old adage of ‘price is what you pay, value is what you get’.
But it’s an asset which means once you buy it, you’re left holding the baby until someone else bids it up further. Not too dissimilar to a pyramid scheme – sorry Crypto fan boys, it’s just my opinion.
And in all fairness, you could argue this isn’t too different from gold. And many other asset classes, I’m sure.
But times are changing and the crypto space has become a serious market mainstay with a flourishing fintech industry now creating jobs and dare I say it, value?
So I can call it magic beans all I want, ultimately, it doesn’t matter what my opinion is. As long as the price keeps increasing like my lockdown waistline, then it’s good times for all.
And with that, the existence of Coinbase becomes essential.
Essential is one way of describing Coinbase. I’d say highly-sought-after would be more accurate given it jumped 71% from its reference price to the opening trade day high.
Let’s first understand how Coinbase make money. Quite simply, they charge the user fees for buying/selling cryptocurrencies. Same as any traditional broker does really.
To try to get a handle on awarding Coinbase a relative valuation, market analysts at investment banks will look at their growth and attempt to categorise them into an industry profile like tech, brokerage or even banking. And to be honest, they’re a bit all of the above.
I think it best to not try and type cast Coinbase for now, but just look at the revenue, users and growth of both those numbers to date to give us a bit of a handle.
First Quarter Numbers
Q1 revenue of $1.8bn. Up nine times from the same quarter in 2020.
Net income estimated between $730m - $800m. A 21-24X increase from the previous year.
56m registered users. Up 13m from Q4 2020.
From the above-mentioned mind-boggling numbers, the one that immediately jumps out at me is net income. Unlike most ‘tech’ debutants, Coinbase is actually making a profit. A very serious profit.
This isn’t a vanity fair based upon just user growth whilst haemorrhaging investor capital, quite the contrary.
Given such a blockbuster start, you can start to understand why the bidding of Coinbase shares elevated them to a $85bn market cap by the close of business on its first day of being a publicly traded company.
A high number indeed, but is it justified?
I was tempted to expand this section and shed light on some kind on a discounted cash flow model or forward Price to Earnings, but given the subject matter is Crypto related, it feels a touch pointless.
Realistically, Coinbase’s share price is only ever one sub-Reddit thread away from doubling or trebling.
Given it’s still such a new NASDAQ entry, there’s been much commentary but not a great deal in the way of firm price targets from the usual suspects. However, research firm MoffettNathanson has been the first to stick their opinion on the chopping block with a $600 price target.
Another Coinbase bull, Cathie Woods of ARK Invest, has quickly accumulated a cool 1m shares.
Concerns
Despite such impressive Q1 numbers, I was very surprised to learn that Coinbase collected 0.57% of every transaction in fees. That’s a lot. It comes as no shock then to see such healthy net income so early on.
And that worries me because it’s possibly setting false expectation as to what’s the come. When in fact, given how much the crypto market is heating up, I can envisage significant downside in their fees model. The likes of Kraken, Binance and Gemini will be sure to even the playing field and put pressure on their, currently, lofty fee schedule.
Not to mention that there isn’t exactly a very high barrier to entry. I don’t like to spend too much time fearing the unknown, but it wouldn’t take much for a new market player to come along with a new crypto platform with an interesting twist. Money + app and you’re at the table.
We can all sit in awe of their dazzling Q1 numbers, but they’ve got a helluva job on their hands to keep investors impressed. And although I think it’s a case of when, rather than if, they lower fees, they could easily counteract this if they’re able to maintain new user growth.
Narrative anomaly
“Can Coinbase stock work if Bitcoin is falling?”
“Unlikely. If Bitcoin falls, then Coinbase’s results will go with it and go down”
This exchange was between CNBC’s Sara Eisen and D.A. Davidson’s Gil Luria.
Much has been said in business media regarding the correlation between Bitcoin’s price and the Coinbase’s share price, mostly with concerns surrounding any possible fall in the price of Crypto prices.
Companies such as Coinbase wouldn’t be where they are now if it hadn’t been for Bitcoin’s meteoric rise and their tremendous user growth should very much be credited to Bitcoin’s performance over the last 12 months.
However, I can’t help but feel that the notion of Coinbase’s success being so highly dependent on further crypto price increases might be slightly off the mark.
Coinbase make money from transactional fees, and interestingly they take their fees in good ol’ US dollars rather than the respective crypto of which the user is trading. The more transactions there are, the more money they make. That includes both buying and selling.
The more volatile the asset, the more it’s traded.
Their business model is refreshingly uncomplex and one which is easy to understand. Having been a stockbroker for 10 years, I can tell you that market corrections equal more transactions. And Coinbase is very much in the transaction business.
Providing it’s not a long-sustained bear market, any short-term pricing swings in the crypto space I would see as a positive for Coinbase.
Conclusion
A friend asked me in 2012 if he should be buying this new Bitcoin thing to which I nonchalantly dismissed it in three words, “It’s a fad”. Either this fad is breaking new records of what can be considered a fad or I’m very much in the wrong which I’m not ashamed to admit.
Clearly, I’m not a Crypto convert and stuck in my ways. But this shouldn’t matter in the case of Coinbase. Their business model is very much aligned with that of Mitto Markets (on a micro scale). Crypto is here to stay it seems and every time I blink, its popularity seems to have gone up another notch.
I’m certainly weary of their eye watering valuation but as they say, *reaches for tired old sayings from the CEO book of generic blab*, a rising tide lifts all ships. And Coinbase is primed to ride the humongous crypto wave!
Or as Brian Armstrong, Coinbase CEO put it on a recent CNBC interview, “We’re selling picks and shovels”.
Maybe Mr. H did have a point after all…
If you’ve enjoyed this article and want to start your investing journey, feel free to reach out to me personally on t.sunderland@mittomarkets.com or call +44 (0)208 159 8985
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