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Everything you need to know about the Coinbase direct listing

Everything you need to know about the Coinbase direct listing

Coinbase, the cryptocurrency exchange, filed its S-1 on Feb. 25 to go public via a direct listing on the Nasdaq exchange. The company made its debut on April 14. Shares traded at over $424 within a few minutes of opening, representing a nearly 70% increase from the $250 reference price set on April 13. Coinbase achieved a market capitalization of around $100 billion through its IPO, making it (as of writing) more valuable than General Motors, CVS Health, U.S. Bancorp and Xiaomi. But a broad-based retreat in tech stocks pulled Coinbase shares along with it. Shares closed at $328.28 — still a hefty 31% rise from the reference price, leaving the company worth $85 billion.

On April 6, Coinbase released stellar Q1 2021 estimated earnings results. The filing reveals an estimated net income for the quarter between $730 million and $800 million. Even at the low end of the range, Coinbase will have earned more than double the net income in Q1 2021 than it earned in the entirety of 2020.

Depending on who you ask, however, the Coinbase listing could be the latest symptom of a major financial bubble or a significant milestone in the restructuring of the global financial system. Coinbase's mission is to "create an open financial system to the world." It believes the prevailing system of global finance, with the U.S. dollar serving as the global reserve currency, is outdated and inefficient. This mission pits the interests of Coinbase squarely against many of the world's most powerful nations, making regulation a grave and — if cryptos continue gaining momentum — probable risk.

What does Coinbase do?

If you want to buy Bitcoin or Ether or other crypto, you can begin the costly, labor-intensive and extremely technical process of mining. Or you can turn to a crypto exchange like Coinbase, which allows retail buyers and sellers to meet in the middle.

Coinbase also believes today's financial system relies on too many intermediaries (banks, brokers, clearinghouses, payment processors, exchanges, etc.), and that relying on this web limits access, efficiency and costs for users. The internet transformed the way we communicate and live, and Coinbase believes that the financial system has hardly been affected in the same way. By enabling anyone with an internet connection — and a bank account, with funds to invest — to easily invest in crypto assets, Coinbase aims to "democratize" access to the crypto economy.

The company isn't vastly unlike other cryptocurrency exchanges, which have come and gone since crypto trading hit the zeitgeist in 2017. General finance apps have jumped into crypto as of late, including Robinhood and Square, and crypto-specific competitors include Gemini, Kraken and Binance. Coinbase has stuck around largely because of its efficiency, but also by keeping users' personal data secure. "From the early days, we decided to focus on compliance, reaching out to regulators proactively to be an educational resource," CEO Brian Armstrong writes in the S-1. "We invested heavily in cybersecurity, built novel key storage mechanisms, and obtained a cybercrime insurance policy."

The company's exchange service is its main offering, but it also has a few other lines of business. Coinbase commerce provides online retailers with software that lets them accept crypto payments (like PayPal, but for crypto). Coinbase Card is in the early stages, giving users a physical Visa debit card and accompanying app. Coinbase even offers a cryptocurrency it helped back called USD Coin, which is built on Ethereum and tied to the U.S. dollar, so the price remains stable.

At the end of 2020, the company had 2.8 million monthly active users and 43 million verified users (about 6.5% of users are active monthly).

Coinbase's financials

Coinbase had a stellar 2020. It recorded $1.1 billion in revenue for the year, up 136% from $483 million in revenue in 2019. This increase in revenue tracks closely with the 142% increase in trading volume between 2019 and 2020.

Coinbase derives almost all of its net revenue (96% in 2020) from transaction fees, which have been correlated with fluctuations in the value of cryptocurrencies. The rise in institutional trading volume has been a major source in revenue growth for Coinbase over the course of 2020. For instance, in Q1 2020, institutional trading volume rose to 6x the volume of Q1 2019. And even over the course of the year, institutional trading volume went from $18 billion in Q1 2020 to $57 billion in Q4 2020. Retail trading volume went from $12 billion to $32 billion in that same timeframe.

Bitcoin accounted for approximately 41% of trading volume on Coinbase in 2020, followed by Ether (15%) and other crypto assets (44%).

Coinbase posted net income of $322 million in 2020, which is pretty incredible for a company that says it's choosing "to prioritize growth because we believe that global scale is central to achieving our mission and the potential of our business model." The biggest expenses in 2020 were "general and administrative," which represented 22% of total revenue, and "technology and development," which represented 21% of total revenue. In 2019, Coinbase reported a net loss of $31 million.

What could go wrong? 

The short answer: a lot.

Coinbase is driven by a techno-utopian/libertarian mission, and its long-term success is predicated on overhauling global power structures. This comes with a long list of risk factors, but some of the most significant include: regulation by a cohort of nations to protect the central banking system, loss of public confidence in cryptocurrencies and revenue loss that would come with greater stability in cryptocurrency prices.

"If the world ran on a common set of standards, that could not be manipulated by any company or country, the world would be a more fair and free place, and human progress would accelerate," Armstrong wrote in the S-1's introduction.

There's a lot to unpack here, but let's start with the bit about financial standards that "could not be manipulated by any company or country." This vision would mean the U.S. dollar loses its status as the dominant global reserve currency, a system established at Bretton Woods following World War II. It would render The Federal Reserve — with its fiscal toolkit intended to provide economic stability — obsolete. With cryptocurrencies such as Bitcoin, there are a finite number of tokens, so quantitative easing isn't possible.

It isn't in the interest of many nations, particularly the U.S., to give up central banking control due to cryptocurrencies becoming the global reserve currency.

  • Coinbase writes that new regulations and laws "may adversely impact the development of the crypto economy as a whole and our legal and regulatory status in particular by changing how we operate our business, how our products and services are regulated, and what products or services we and our competitors can offer, requiring changes to our compliance and risk mitigation measures, imposing new licensing requirements, or imposing a total ban on certain crypto asset transactions, as has occurred in certain jurisdictions in the past."
  • It also details how loss of institutional support could impact its business: "We may face difficulty establishing or maintaining banking relationships due to our banking partners' policies and some prior bank partners have terminated their relationship with Coinbase or have limited access to bank services. … In addition, financial institutions in the United States and globally may, as a result of the myriad of regulations or the risks of crypto assets generally, decide to not provide account, custody, or other financial services to us or the cryptoeconomy generally."

This regulatory uncertainty hinders institutional adoption of cryptocurrencies.

  • For instance, in January, Ray Dalio of Bridgewater Associates wrote: "For now, though, we do not see it as a viable storehold of wealth for large institutional investors, thanks mainly to a high degree of volatility, regulatory uncertainty, and operational constraints. Rather, we see it as more like buying an option on potential 'digital gold' — it has a wide cone of outcomes, with one path leading to it becoming a true institutionally accepted alternative storehold of wealth."

Now let's tackle the first part of Armstrong's statement about a world that runs "on a common set of standards." For Coinbase to succeed, it needs cryptocurrencies to remain valuable and worth transacting.

  • "The development of new technologies for mining, such as improved application-specific integrated circuits (commonly referred to as ASICs), or changes in industry patterns, such as the consolidation of mining power in a small number of large mining farms, could reduce the security of blockchain networks, lead to increased liquid supply of crypto assets, and reduce a crypto's price and attractiveness," Coinbase writes.
  • Another potential risk factor comes with "security issues, bugs, and software errors" of crypto assets that "could adversely affect its price, security, liquidity, and adoption."

Finally, there's a contradiction within Coinbase's current business model that bears mentioning: Coinbase derives most of its revenue from transaction fees, which are highly correlated with fluctuations in the value of cryptos. The contradiction lies in the fact that cryptocurrency price volatility is seen as one of the primary barriers in something like Bitcoin realizing its potential as an exchange currency rather than an asset class.

Coinbase believes this isn't actually an issue, since the dynamics will change over the long term. The company writes:

  • "Over the long term, we expect further diversification of market participants, to add support for more crypto assets, and for crypto asset use cases to expand. We believe these factors will contribute to diversification in the composition of our Trading Volume and reduce the correlation to both Bitcoin price and Crypto Asset Volatility, subsequently leading to lower volatility in transaction revenues. Further, we expect that diversifying our sources of revenue towards subscription and services revenue will contribute to less fluctuation in our results from operations."

Who gets rich?

Coinbase has divided its shares into Class A and Class B, with Class B receiving 20 votes per share and Class A receiving only one. Class B shareholders are also allowed to convert their shares to Class A at any time.

This setup makes it difficult to say precisely which entities will own Coinbase when it makes its trading debut. As of Jan. 31, 2021, some of Coinbase's largest institutional shareholders included Andreessen Horowitz, Tiger Global, Ribbit Capital, Union Square Ventures and Paradigm. Some of the largest individual shareholders included Frederick Ernest Ehrsam III (the co-founder of Coinbase), Armstrong and CPO Surojit Chatterjee.

What people are saying

  • "The @coinbase Direct Listing will either confirm direct listings as a reasonable on-ramp for companies or kill it all together by making retail the true bag holders. If institutional investors use this period to manipulate the stock from a $54B valuation on Jan29 to $100B now... And then sell to retail at $100B or greater, it will be the ultimate form of stock manipulation. If the stock snaps back at a much lower valuation, each private txn preceding the DL seems manipulative. Good luck to all the players...I'm sitting out. The process stinks." —Chamath Palihapitiya on Twitter.
  • "Given the Crypto Cycle, I expect Coinbase IPO to be very successful and price to pump hard. A NYSE 'exchange' security trading >$100B should help drive up Crypto Exchange tokens. I can see a bull market narrative where something like UNISWAP is compared to Coinbase in cap." — Bob Loukas on Twitter.

Updated: This article was updated April 1 to include the date of Coinbase's IPO, on April 6 to include the Q1 2021 earnings estimates and on April 14 to include data from the trading debut.