- A Few Thoughts About Coinbase
Just now·4 min read
(No position in the stock with no plans to initiate one)
I was impressed but not surprised with how profitable they currently are (2020 gross profits of over $1 billion and net income of $322 million). Given the surging interest in owning and trading crypto over the past year, it should not be surprising that Coinbase had an incredible 2020 from a financial perspective.
Because its primary revenue driver is commissions (every time you buy or sell crypto, Coinbase takes a cut of the total transaction), the more trades there are the more money they make.
And because they take a cut of the total transaction amount, the higher that bitcoin prices go, the more money Coinbase makes. This second point is a smaller positive than it first seems due to the ability to buy fractional coins. Thus, average transaction sizes might not get larger as prices rise —at times they may even get smaller as increasingly casual investors catch on to the hype.
No Need To Market
As the current market leader in facilitating crypto trades and investing, Coinbase has virtually no need to market itself. That’s why sales and marketing expenses were just 4% of revenue in 2020. Bitcoin itself and all the news and hype around it serves as a giant, can’t-miss neon advertisement for Coinbase.
I’m still thinking over how much of a competitive advantage its first-mover advantage grants Coinbase. At this point, it’s probably a formidable one — the crypto market in terms of trading is still a nascent one and a bit of a wild west. There’s a real risk of getting hacked and losing your coins or just losing it via user error. Coinbase’s rep as the market leader and the most trusted brand in crypto is a real edge for now. It’s telling that they spend more than five times more on tech than marketing — being the gold standard in terms of security is critical to their business and brand.
Moreover, people are generally lazy when it comes to pulling out their money from one brokerage to another. A company would have to really screw up before customers pull out in significant numbers. This means that their customer and asset base is likely pretty sticky.
Race Against Time
Coinbase is in a race against time — commissions will inevitably decline in the crypto space, especially for the most popular coins like Bitcoin and Ethereum. The easiest way for a rival broker to win share from Coinbase is via cost competition. Sure its brand and scale insulate it somewhat, but the competition will be formidable.
Square and to a lesser extant Robinhood bring both pristine brands and years of operating experience (albeit not crypto specific). Traditional brokers even more so — not many can resist the siren call of commissions as high as 50bps.
Inevitably commissions will fall as the popular cryptos (which account for most of the trading) become more liquid and accepted. Crypto ETFs will drive this decline as well as they will give casual investors a more convenient way to access crypto.
So before that happens, Coinbase needs to take the money it is minting right now and translate that into new services and profit streams that are more durable and harder to replicate. It’s starting to do that with custodial fees (users Coinbase to protect their crypto) and staking (Coinbase uses users’ coins to help validate transactions and gets paid for it, the payment is split with users). The nice thing about both of these is that they scale well. The cost to custody and protect $1 billion in Bitcoin is not that different than the cost to protect $100 billion in Bitcoin — it’s not like you need a bigger vault, just a large fixed investment in security tech. So as they custody more and more crypto the additional revenue should be pure margin. And the more crypto that Coinbase users accumulate, the higher its staking revenue — according to Coinbase: “The size of a stake is directly proportional to the chances of that node being chosen to forge the next block.”
The downside is that these are crypto driven advantages and not Coinbase specific advantages. Any firm with the financial heft and tech know-how could earn custodial fees (Coinbase got into the custody business via an acquisition) and any firm with a large amount of a particular crypto can start earning staking fees in that crypto.
It could be that the durable competitive advantages that I prefer for my investments are just not available in this space. Which would mean that the best Coinbase can do is to bet on its ability to out-execute (in terms of tech and security), out-scale, and ultimate outlast its competition. But if I am right, the competition will be fierce and that will be terrible for commissions and profits at least for a time (good for users, bad for Coinbase’s investors). This may be offset somewhat by a rise in transactions fueled by the decline in commissions.
Finally, similar to Robinhood, it is also a (for lack of a better word) hip and trendy brand — it may sound superficial, but investors should not overlook what a hip brand and a slick UX can do for user base growth and retention.
- Date of publication:
- Thu, 04/22/2021 - 19:08
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