Coinbase: Despite Temporary Crypto Surge, There's More Risk Than Reward Here

Summary Cryptocurrencies, including Bitcoin, have surged over 60% year to date, with Coinbase shares also rising ~55%. The company is enjoying a temporary surge from elevated Q1 volatility, stemming in large part from the January release of spot Bitcoin ETFs. Over the long run, Coinbase faces stiff competition from Binance as well as brokerages like Robinhood, and its revenue exposure to altcoins may also cause it to trip. With the stock already trading at ~10x projected FY25 revenue, it's best to steer clear here. Stocks aren't the only asset class that have soared this year: cryptocurrencies are also experiencing a huge surge, with anchor currency Bitcoin (BTC) up more than 60% year to date. The rise isn't attributed simply to increased investor appetite for risk-taking, however; it's also due to U.S. regulators' approval of the first-ever spot Bitcoin ETFs in January, which saw nearly $5 billion in inflows on the first day of trading . Partaking in the upswing as well is Coinbase ( COIN ), one of the world's best-known cryptocurrency exchanges and crypto wallets. Year to date, shares of Coinbase have also leaped ~55%, nearly mirroring the performance of Bitcoin. Data by YCharts To be transparent: I have embraced cryptocurrencies as a diversification tool, and allot a single-digit percentage of my portfolio to large, stable coins including Bitcoin. I'm not, however, as sanguine about Coinbase's prospects in 2024 and beyond. For investors who are relatively newer to the space: Coinbase was an early mover in the crypto space, opening its doors in 2012 (three years after the launch of Bitcoin). While it is the only pure-play crypto exchange, it's also far from the largest; as rival Binance supports nearly double the variety of coins versus Coinbase and has nearly 10x the trading volume (according to CoinMarketCap ). Broadly speaking, while Coinbase is known to be more beginner-friendly, Binance is better-known among diehard crypto enthusiasts and offers more advanced trading functions. Broadly speaking, I see a number of major risks for Coinbase moving forward: The Q1 trading surge may be temporary. Volumes were elevated in Q1 as volatility peaked with renewed interest in Bitcoin following the launch of spot ETFs in January. Competition. ETFs themselves may prove to be a competitive driver versus Coinbase, as more inflows flow in through "regular" stock market exchanges and take trading volume away from coins themselves. Most of Coinbase's trading revenue is derived from smaller altcoins. I'm of the belief that the crypto market will eventually converge to a few top coins, on which Coinbase makes a lower spread. Against all of these risks, Coinbase is also quite expensive, even if we judge the stock's current valuation against the peak results it generated in Q1. All in all, I'm pegging Coinbase at a sell rating: steer clear and invest elsewhere. Q1 trading volume may be a fluke We'll acknowledge one thing: Coinbase saw phenomenal results in Q1. Coinbase Q1 revenue trends (Coinbase Q1 shareholder letter) Total revenue grew more than 2x y/y to $1.59 billion, driven by a near-tripling of transactional revenue (Coinbase generates roughly two-thirds of its revenue from trading spreads, while the remainder comes from subscriptions and non-trading fees). This wasn't all a bitcoin ETF story, however. The company notes as well that performance was driven by ~30% growth in the market cap of USDC, the largest "stablecoin" that is tethered to the U.S. dollar. The company also grew subscription and services revenue by 41% y/y to $510.9 million, which it attributed in part to growing membership of Coinbase One, the company's consumer subscription plan that starts at a $29.99/month (offering zero trading fees and higher staking rewards, or interest rates, on USDC held in Coinbase accounts). Coinbase One subscribers surpassed 400k in the first quarter. The company also believes that it's helping crypto move beyond just a speculation asset and into a utility. It notes that its new platform Base helps to improve transaction speed and lower costs. Per CEO Brian Armstrong's remarks on the Q1 earnings call highlighting boosted developer activity on Base: Next, let's move on to utility. First, I'd like to spotlight our Layer 2 solution Base. As a reminder, Layer 2 solutions help blockchains scale, similar to when the internet moved from dial-up to broadband. And we believe this scaling will drive many new use cases in the crypto economy. Base has helped dramatically reduce transaction fees and confirmation times, getting us closer to our goal of having the average crypto transaction take less than one second and cost less than $0.01 anywhere in the world. Developer activity on Base increased eight-fold in Q1. In the last 30 days, Base has processed over two times as many transactions as the entire Ethereum network on Layer 1. Base is now the number-one Layer 2 solution by the number of transactions processed, a huge accomplishment. We've made Base faster and cheaper to use with fee reduction by about 80% through protocol upgrades, and our fees are now often below $0.01." In spite of the organic strength that Coinbase can claim in Q1, we do have to worry about the risk of trading performance - still responsible for the lion's share of the company's revenue - if crypto assets fall. In my view, Q1 saw heightened trading activity from the ETF launch, and crypto has been falling from recent peaks over the past month as ETFs have also seen outflows . Competition from many angles To me, Coinbase has very little moat for preserving either its trading volume or its user base. First, consider ETFs themselves. The entire reason that bitcoin ETFs saw such aggressive inflows when they launched earlier this year was that ETFs make it easier for everyday investors to participate in bitcoin's upside, bypassing crypto wallets and exchanges altogether (which still have an aura of lacking safety, despite years of smooth operations). In my view, bitcoin ETFs - and the potential ETFs of other coins that follow - have the potential to draw trading volume out of exchanges like Coinbase and into "regular" brokerages. We should also consider the fact that standard brokerages are also gaining a leg up on Coinbase. Robinhood ( HOOD ), in particular, reported 232% y/y growth in direct crypto trading revenue in Q1. And we note that with Robinhood's ability to support both direct crypto trading as well as ETFs, it may be the biggest beneficiary of this year's renewed interest in crypto. And among more hardened traders, Coinbase has always faced competition from a much larger exchange, Binance. Coinbase may end up getting stuck in the middle as a platform that isn't as "vanilla" as Robinhood, but isn't sophisticated enough to support professional traders like Binance. Concentration risk in altcoins Altcoins, or essentially smaller-cap cryptocurrencies, have so far been a very speculative realm. Because of higher spreads on these assets, Coinbase generates the majority of its trading revenue on altcoins. Coinbase Q1 trading share (Coinbase Q1 shareholder letter) In Q1, 55% of the company's transactional revenue was generated from non-Bitcoin, non-Ethereum trades. 43% of trading volume, meanwhile, excludes these assets plus USDT. Many investors, including myself, are of the viewpoint that cryptocurrencies will eventually converge into a smaller pool of "winners" rather than continually support hundreds of speculative altcoins. In a longer-term future in which altcoin speculation recedes, spreads earned by exchanges like Coinbase may also correspondingly falter. Valuation, upside risks, and key takeaways We also shouldn't ignore the fact that Coinbase is incredibly expensive after this year's run-up. At current share prices near $245, Coinbase trades at a market cap of $60.0 billion; and after netting off the $7.1 billion of cash and $4.2 billion of debt on Coinbase's most recent balance sheet, the company's resulting enterprise value is $57.1 billion. Meanwhile, for next fiscal year FY25, Wall Street analysts have a consensus revenue target of $5.96 billion for the company, or a -2% y/y decline (essentially betting that this year's heightened trading activity will recur and be sustained). Against that estimate, Coinbase trades at 9.6x EV/FY25 revenue. We note as well that in Q1, Coinbase generated $1.0 billion in adjusted EBITDA. Even if we assume Q1 trading volumes are sustained, and we annualize the company's EBITDA to $4.0 billion, the stock would trade at 14.3x EV/adjusted EBITDA. Either way: there's already a lot of strength priced into Coinbase's stock. To me, there is one significant upside risk to consider, and that's institutional participation in cryptocurrencies. In Q1, institutional revenue made up only 8% of the company's overall revenue (but 82% of trading volume). Coinbase continues to develop its institutional trading platform, Coinbase Prime, which saw record inflows and active clients in Q1 driven by the boosted proliferation of USDC. Prime now offers a more complete suite of custody, trading, financing, and staking services (versus just custody, or wallet, services during the last crypto bull run). A greater feature set and further de-stigmatization of crypto assets may eventually pull more institutional funds into the fold. Still, I view Coinbase as having far more risk than opportunity especially at current share prices. Steer clear here and invest elsewhere.