Coinbase is the company that’s the most asymmetric I have covered on this site yet.
The blockchain could be a key technology in the future and Coinbase is a clear leader for both retail customers and institutions. I hope this post expresses how I am bullish on the blockchain making everyday tasks more cost-efficient, and transparent, and providing a better platform for innovation than our existing technologies.
If you haven’t explored the blockchain world for yourself, I encourage you to read this with an open mind.
Key Stats
Coinbase by the numbers:
Company: Coinbase Global
Ticker: COIN
Market Cap: $14.6 billion
Revenue (ttm): $2.8 billion
Gross Margin: 84%
Operating Margin: -76%
Net Income (ttm): $2.27 billion
Diluted Shares Outstanding and Y/Y Growth: 225.1 million (-6.9%)
Earnings per share: -$10.20
FCF (ttm): -$361.1 million
Date Founded: May 2012
Founders: Brian Armstrong and Fred Ehrsam
Coinbase Leadership:
Co-Founder and CEO Brian Armstrong: Started the company to simplify digital financial transactions, specifically using Bitcoin.
CFO Alesia Haas: Joined in 2018 as CFO and previously held high-level positions at Sculptor Capital Management and OneWest Bank.
The origin story
For some companies, the origin is key to the investment thesis. I think that’s the case for Coinbase.
Brian Armstrong was an engineer at Airbnb when the company was scaling globally and saw that it would take weeks to get funds from one country to another. He thought that was crazy. We needed digital money for a digital world and it just so happened the Bitcoin whitepaper had been published in 2008 to solve some of these problems. Making Bitcoin easier to use was Coinbase’s first mission.
This idea of making the blockchain easier to use is enfused in everything Coinbase does and it’s the frame with which I look at the stock.
The Strategy and Vision
I will start with what the blockchain is. This image from PwC explains the core technology well. The key players are the user requesting a transaction, validators of the blockchain, and the underlying token that pays for validation (this could be a U.S. dollar toke like USDC).
On the surface, the blockchain could be used for almost anything that goes into a database or spreadsheet today. Bank transactions, stock sales, and loyalty programs are just a few logical use cases, although it’s very early in the technology’s development.
The biggest problem for the blockchain is the first use case that caught on was financial in nature. Cryptocurrencies like Bitcoin exploded in value in the last decade and caught fire in 2021. They were easy to launch, easy to manipulate, and easy to create frauds. Unfortunately, that’s what most people associate Coinbase and the crypt industry with — and that’s a valid criticism.
But if Coinbase is going to 10x or 100x it won’t be because “HODL”, “🚀“, or “number go up”. It will be because the blockchain is fundamentally better technology for digital assets in a digital world.
Terms to know
Before we go too far, let’s set a common language to use with a few terms. These are terms common in crypto to get us on the same page. Some of these terms could be abstracted away in the future (hopefully).
Contract: A computer program on the blockchain. Contracts can create tokens, modify an asset, set lending rules, or do almost anything you can think of a computer program doing.
Transaction: An agreement between a wallet owner and another blockchain participant like a contract or other wallet owner.
NFT: Non-fungible token, or a token where each specific token is unique. This has meant tokens with pictures associated with them, but it’s simply a unique blockchain asset.
What’s great about the blockchain is these features can run 24/7 and anyone can interact with them. For example, you can take a loan out on a digital asset and anyone in the world can lend you money. If you default, the lender can automatically seize the asset.
Use cases for the blockchain are still being developed, but here are a few use cases that make sense over the established status quo. In each of these use cases, notice that Coinbase’s role is on the infrastructure level, enabling digital asset ownership, trading, and technology.
Payments
Financial transactions today are operating with 1980s technology and speed. An ACH transfer from one bank to another takes one to three business days, credit cards take 2-3 days to clear and cost 2.5%-3.0% in fees, and wire transfers are fast but cost $20 or more. Many of these fees are invisible to consumers, but ask any business owner how much they pay in credit card fees every year and you’ll get an earful.
Meanwhile, you can transfer a quarter to someone else on the Solana blockchain for 1/100th of a penny.
Transaction sending $0.25 to another wallet. Taken May 30, 2023.
Moving to blockchain financial transactions can significantly lower costs for merchants. For example, Coinbase partners with Shopify to accept digital payments on its platform and charges a 1% fee, about one-third the cost of accepting credit cards.
Digital assets/loyalty programs
A growing use case for the blockchain is digital assets and loyalty programs. Instead of transactions and levels achieved living on a corporate database somewhere, the information can live on the blockchain.
Starbucks is entering these waters with Starbucks Odyssey, which gives users the ability to collect digital stamps that can lead to rewards.
As Stamps are collected, members' Points will increase, unlocking access to unique rewards and experiences that could range from a virtual espresso martini making class, to unique merchandise and artist collaborations, to invitations to exclusive events at Starbucks Reserve Roasteries or even the opportunity to join a trip to Starbucks Hacienda Alsacia coffee farm in Costa Rica.
A platform I follow called Anybodies is launching a loyalty program on Solana that can provide rewards and discounts. In a few clicks, developers can build loyalty programs with discounts and digital benefits, which Toys R Us is already testing.
In time, blockchain rewards programs could open up a new way to interact with your most loyal guests. Instead of an email offer, an NFT can simply be sent to your wallet, and remember these are on the blockchain, not a corporate server, so they’re more transparent than the alternative.
To facilitate these innovations, Coinbase offers a “wallet as a service”, or WaaS, a product that eliminates the need to develop custom blockchain wallets in apps.
Assets and verifying changes
The way we track changes to the assets we own today is downright archaic. I have a glove compartment of receipts in my car in case anyone wants to see when I got oil changes, tires, or new windshield wipers. This could all be done on the blockchain. Below is a simple example of a car represented by an NFT that is painted blue. You can see that the car (and NFT) owner would interact with a contract, the dealer doing the service would confirm the work with a smart contract signature, and the NFT would be updated.
The established solution today is Carfax, but that’s a costly corporate system that only captures a fraction of the work done on a car. I would love to see transparency like this on the blockchain.
Similar benefits could be brought to the provenance of art and even home histories. Today, we rely on a realtor telling us the history of a house, but what if we had the entire history publicly available on the blockchain? Not only would it be great to know a home’s maintenance history, there would be no more title searches and borrowing could be simplified and open to anyone. That could even upend lending if anyone could borrow money to anyone for an asset like a home. In fact, a home sold last year for $175,000 on OpenSea.
The blockchain could even answer an emerging problem of the validity of work now that artificial intelligence is going to flood our digital lives with content. How do you know whether an article is real, a piece of art is really from an artist, or a piece of music is authentic? NFTs could be an answer.
Coinbase’s role here is the wallet infrastructure, exchange location for assets, and development layer for developers.
Stocks, bonds, and other financial instruments
If you’re subscribed here you probably own a few stocks or other financial instruments. Did you know why it takes two days to settle a transaction?
The quote below is from a rule reducing settlement time from 5 days to 3 days in 2004. In 2017, the settlement would go to T+2, where it stands today.
As technology improves, new products emerge, and trading volumes grow, it is increasingly obvious that the outdated T+3 settlement cycle is no longer serving the best interests of the American people, the SEC remains committed to ensuring that U.S. securities regulation is reflective of modern times, and in shortening the settlement cycle by one day we aim to increase efficiency and reduce risk for market participants.
In a world where digital communication happens in an instant, why does it take two days to settle a stock sale? Because that’s the way we’ve always done it!
Just because a faster, cheaper, more transparent technology exists doesn’t mean we’ll start using it, but the blockchain could make stock or bond trading and settlement easier. Sources have told me big financial institutions are already keeping track of assets on internal blockchains and maybe this is a reason Blackrock has chosen Coinbase for its trading services?
And more…
I’ve covered some areas where I think there are logical use cases for the blockchain. But areas like medicine, exclusive communities, identity, and far more could find traction. Part of the asymmetric opportunity here is we don’t know what use cases will win a decade from now.
Coinbase’s MPC Wallet and WaaS
One of the reasons Coinbase is the place to bring all of these benefits together is its ability to abstract away crypto, NFTs, and wallets from users’ interactions. In fact, if you have the Coinbase app, you already have a digital wallet in the app through what’s known as an MPC wallet. Coinbase has a part of the security keys for the wallet and you have part, but you’ll never be locked out if you lose your portion.
Put simply, users could “Login with Coinbase” instead of logging in with Google or Facebook to get access to their digital identity.
You can see some of the institutional offerings below and this looks more like the products a bank or cloud company offer.
We don’t know what Coinbase will develop over time, but the wallet as a service product was one announcement that I saw as the right vision for the future of the blockchain.
USDC
Coinbase owns 50% of the joint venture that operates the USDC token, a stablecoin that operates on multiple blockchains.
The token is backed by real dollars and that money is invested in low-risk assets, like treasuries. The interest paid by those assets then make their way to Coinbase after paying operating expenses and this year, the company could generate $800 million in revenue from the USDC token at a nearly 100% gross margin.
There are still many, many problems to be answered
I state all of the optimistic views above while acknowledging that problems with blockchain technology still exist. It’s far too easy for scammers to steal digital assets, some blockchains are still far too slow and costly, and user interactions need to improve dramatically to gain wider adoption.
If these problems aren’t solved, Coinbase will be a niche product at best. But if blockchain technology is integrated into the areas I highlighted above it could reduce friction and be incredibly disruptive to financial transactions and digital assets.
The Coinbase strategy in a nutshell
Coinbase’s role is to be the infrastructure layer, acting like AWS, a big bank, and Google for all of the blockchain.
In their own words
I have explained how I see Coinbase and the blockchain, but I thought some quotes from Coinbase’s management would hopefully clarify the business and vision. From CEO, Brian Armstrong:
I think it's always helpful to zoom out and remind everyone why Coinbase exists with our mission and vision. And our mission at Coinbase is to increase economic freedom in the world. We think crypto is the most important technology out there to do that. So many people today, they're still thinking about crypto as an asset class that people like to trade, and that certainly is part of it. But it's actually a technology that can be used to update many different aspects of the financial system. And we think that's really important because 80% of Americans believe the financial system doesn't work for them. They see issues with it. They see that it's too slow. It's too expensive. There isn't equal access for everyone and that's not really surprising. A lot of the traditional financial system is running on outdated code with laws that, in some cases, are 100 years old. So crypto can help improve this. It can help make payments fast and cheap and global like sending an e-mail. It can improve settlement times, it can reduce fees. It can even tokenize different asset classes to make markets more efficient and help with non-financial use cases like decentralized identity or voting and new types of ways for artists to monetize their content. So if you think of crypto as technology to update the financial system, it's also kind of the next generation of the Internet, if you will, what people are calling Web3. And Coinbase has a very important role to play here where people's primary financial account in the crypto economy, making it trusted and easy to use, and we're going to hopefully help bring the power of this technology to eventually 1 billion or more people someday.
And CFO, Alesia Haas:
The first pillar of our strategy is that crypto is an asset, and that is the products and services that you've seen us build to date, which is how do you buy crypto, how do you store it safely, how do you trade it and that gives rise to the products that look like a trading platform or an exchange, the ability to custody an asset, the ability to act like a broker and find ways to engage. What we're rapidly moving to and hoping emerges very soon is the Phase 2. So we have crypto now as an asset, we can buy it, we can hold it, we can do all these things. Now we're going to move to crypto as updating the financial system. When we think of crypto technologies, technology that can make financial services better. So Phase 2 is then really about utility, updating existing financial products. So things like this are thinking about, for example, we launched Base, which is a Layer 2 solution. Think about like Ethereum as a protocol, but the challenges with Ethereum today are the gas fee spike like last couple of weeks with PEPE, the meme coin, like meme coin we saw crazy gas prices.
That's not good for like confirming transactions when all of a sudden, your prices do very well. So Layer 2 solutions are looking to drive down the cost of transactions getting confirmed and increase the speed. And so our goal with Base is a Layer 2 solution that's sitting on top of Ethereum is really the ambition of getting to 1-second $0.01. So if you think about then one payment rail that can universally instantly settle any peer-to-peer -- B2B, B2C, intercompany transaction in a USD stablecoin for $0.01 1-second, that is really interesting for use cases around global remittances for an example, where with current global remittances, especially in long tail currencies, you're stitching together so many different banks and intermediaries, correspondent banks to actually settle a payment. And this has been an open access protocol that anybody can plug into globally. So I think that this is the next generation. So how do we think about crypto making financial services products better.
Third pillar is then crypto as the new Web3. And this is like how do we then think about crypto with decentralized identity. How do we think about creators and content makers communicating directly with their fan base. So you're seeing early examples of this with NFT. Starbucks has an NFT program where they're giving NFTs to their customers. This obviously is a huge loyalty program. You've got a 29 million member loyalty program. Or today, it's like any other loyalty program, you're probably all members of. You get 10 copies, you get 1 free or whatnot. This is now -- I get an NFT, I get exclusive rights to certain events, I can participate in unique ways. And so they can communicate with their members. And then they can also, those NFTs can be traded. They have value. So maybe you decide like you're no longer going to drink Starbucks and that thing had value because you were like a die-hard member but now you can monetize that involvement. So really just interesting -- and these are early. These are -- people are dabbling like think about this as like the first wave of the Internet where yes, pets.com existing, you could buy pet food, it failed. We all now buy a lot of things on Amazon that we weren't ready to do in 1999, but these are early kind of indications. And what we see in these waves of technology is you get these early start-ups, you learn something, then the next version comes out a little bit better and a little bit better. So we think of Pillar 3 is like the pinnings of the new Web3 is we're starting to see this benefit of like sending value online. We send data online all the time, but now it's sending value and what does that unlock?.
They lay out an optimistic vision for the blockchain and Coinbase’s role in it.
Financials
I’m going to look at Coinbase’s financials into three areas.
What’s coming in the door (revenue) and how sustainable is it?
What’s going out the door on an ongoing basis (operating expenses)?
How much runway is there (cash on hand)?
Revenue has been all over the map and given the drop in crypto prices over the last year it’s no surprise that transaction revenue has dropped nearly 70%. But I want you to look at two numbers in the table below.
Interest income jumped from $10.5 million a year ago to $240.8 million in the first quarter of 2023. This is because of rising interest rates, which have led to higher income on the $5.3 billion in cash on the balance sheet as well as the assets underlying the USDC token.
Blockchain rewards have stayed stable and was $73.7 million last quarter, helped by staking. Adjusted for crypto prices, which have dropped over the last year, blockchain rewards have about doubled.
As investors, we want to see subscriptions be a larger percentage of revenue and the reliance on trading fade into the background. That’s happening, albeit slowly, and with a lot of strain on the business.
As revenue dropped, Brian Armstrong and Coinbase reacted quickly to cut costs. You can see that operating expenses are down 48% in just a year after major headcount reductions.
Coinbase’s cash has also fallen by just $172 million in the past three months despite investing $32 million in M&A and paying down short-term borrowings by $21 million. This is enough cash to last nearly a decade at the current run rate.
Revenue is down, there’s no doubt about that, but it’s growing in the areas Coinbase is investing in and thinks are more stable long-term (subscriptions). And operating expenses are coming down rapidly giving the company plenty of runway to survive and thrive if blockchain technology indeed becomes a bigger part of our future.
Coinbase Ventures
Another asset for Coinbase is the Coinbase Ventures investments, which include stakes in Magic Eden, Uniswap, Dune Analytics, Opensea, and over 250 other companies.
These investments increase the asymmetric upside if blockchain technology indeed takes off.
How to 10x From Here
Coinbase is a bet on the future of blockchain technology and Brian Armstrong’s ability to steer the company to the right path. Coinbase has a market-leading position in the U.S. and is quickly expanding around the world. As a reliable, publicly traded company it has also been able to attract institutional partners, which is a great sign for long-term development.
To 10x from here, the company would need to reach a market cap of about $150 billion. That may seem like a lot, but remember that Coinbase is trying to disrupt payments, banking, and identity with blockchain technology. Three companies leading in those markets are all worth more than $150 billion.
Visa: $490 billion market cap
JPMorgan Chase: $400 billion market cap
Alphabet: $1.4 trillion market cap
The blockchain is just over a decade old, so projecting exactly what Coinbase looks like 10 years from now is impossible. But I think the idea that we’ll own more digital assets and digital transactions will change with the help of the blockchain is likely. If that happens, Coinbase can easily beat its peak performance of $7.8 billion in revenue and $3.6 billion in net income. I think the stock could 10x or more if that happens.
I have found Brian Armstrong to be one of the most clear eyed and fast acting leaders in technology today. He could go down as an icon a few decades from now. Even the possibility of that happening is worth a small position in an asymmetric portfolio.
How to 0x From Here
If the blockchain is just a fad and no one is using it a decade from now, Coinbase will be out of business. It’s as simple as that.
What to Watch
Here are the trends and financial metrics I’m watching to see how Coinbase’s business is faring:
Subscription revenue growth
Operating expenses
Interest revenue (on cash and USDC)
Innovation on the blockchain (organic or from new startups)
Crypto prices as a proxy for activity
Cash level and burn
Slowly but surely, I think blockchain technology will be more and more valuable to our digital world. But it won’t be a straight line up and investors buying now are hopefully getting in on the ground floor of a rising tide.
Disclaimer: Travis Hoium owns shares of Coinbase. Asymmetric Investing provides analysis and DOES NOT provide individual financial advice. All content is for informational purposes only. Asymmetric Investing is not a registered investment, legal, or tax advisor or a broker/dealer. Trading any asset involves risk and could result in significant capital losses. Please, do your own research before acquiring stocks.
