Coinbase: Wall Street’s Gateway Drug

IMPORTANT: This note discusses the cryptocurrency exchange/service provider Coinbase and its upcoming direct listing, and while we are fascinated by it, the usual rules apply and disclaimers need to be made. This note should NOT be construed as financial advice or a recommendation to purchase any securities. Do your own research - public filings are available on the SEC’s website and other public media channels. And for completeness, we do not own any position in Coinbase ahead of its direct listing.

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Frequent readers of our newsletters know that we are keen watchers of the happenings in the cryptocurrency space, as well as in the world of global macro and equities. But what is coming up next week is at the intersection of everything that we’re interested in. Stocks, crypto and macro.

Coinbase is going public via a direct listing, at what is expected to be a whopping US$100bn valuation. Fans and sceptics abound on either side of the fence but the important reality is that according to their S-1 filing with the SEC, this is a highly profitable company that generated US$1.2bn of revenues last year, leading to US$322.3m of profit in 2020.

In the first quarter of 2021 alone, Coinbase printed US$1.8bn of quarterly revenues, with Net Income of approximately $730-800m on their preliminary numbers released here.

Perhaps these few months are an anomaly. The cynics call it a one-off, “just a flash in the pan”. Yet ask any CEO if they’d like to have a “one-off” US$730-800m net income quarter and we’d bet few would say no. The fact is that this is a business with the ability to generate net income of this quantum – that’s no coincidence.

This strategically-timed release of their first quarter preliminary results just days ahead of their direct listing can be said to be the anchor for justifying the valuation they are seeking of US$100bn. The intricacies around what the “right” valuation is can be discussed for the months and years to come, but the key point is this: Coinbase’s listing is the best validation that crypto could ask for.

We think that this is an epochal moment for Crypto. Coinbase demonstrates that there is widespread adoption (56m verified users, of which 6.1m transact monthly), that crypto is a profitable, cash-generative business that makes REAL money, and most importantly that crypto is here to stay, formalised and increasingly integrated into the economy in a way that overcomes all of the reservations that early (and ongoing) skeptics have.

Coinbase’s role in this is critical. Because of everything we’ve discussed before which characterises today’s equity markets, Coinbase will bring institutional money into crypto one way or another.

It’s the mouth getting put where the money is. And now we’re all in the game.

All aboard

To start with, US$100bn as an initial market cap isn’t small. At that market cap, Coinbase would be within the top 100 largest market cap companies in the world. In the US, it would be just behind the likes of Citigroup and Honeywell (also at c. US$100bn market cap each), and ahead of popular names like Starbucks.

More importantly, it gets into the top 30 largest companies in the NASDAQ, around where the likes of AMD and Intuit are ranked.

And perhaps most importantly, Coinbase is coming in at a valuation about 40% higher than the US$77bn valuation held by ICE, the owner of the New York Stock Exchange, at a point where adoption in its core asset class is accelerating and growth is structurally rising. For a cryptocurrency exchange to list and trump its “traditional finance” counterpart – not least one of the largest in the world – is a statement in itself.

The key here is that at that size, no index-benchmarked investment manager can avoid owning Coinbase, regardless of their prior views. If it’s big, it must be owned in a fund. Especially so when there aren’t any “poor allocations” to blame – it’s a direct listing. The addressable market for Coinbase stock is broad and immense: financials, technology and growth.

The reflexivity game has the potential to kick in on so many different levels here. The first obvious channel is in terms of price and valuation: if Coinbase is included into major benchmark indices, the passive flow that follows these benchmarks may inevitably contribute to even higher valuations over time.

But more so than the financial implications are the implications on reflexivity in narrative. Getting Coinbase into the hands of every major investment manager on the planet is key to forcing them to have skin in the game. Once cash has been allocated (willingly or by virtue of benchmarking) to this emerging sector, the narrative changes: this is no longer a fringe play, but a mainstream, broadly used consumer financial service.

And that means a lot: the social network value of the largest managers in the world putting capital behind Coinbase confers legitimacy not only to Coinbase as a company, but by consequence to the entire crypto space.

No longer is this the domain of terrorists, hackers or drug dealers. Crypto had first gone to Wall Street – but it was “just a punt”. Now it’s going into 401(k) plans and personal accounts all over the world, directly or indirectly.

To top it off, Coinbase has chosen to set its business up in the most compliant way possible – arguably at the cost of growth (yes, it could be MUCH bigger if it weren’t the good student in the classroom – look at Binance, which never ceases to push the envelope). Just look at the number of people complaining about how cumbersome Coinbase is, thanks to the many layers of KYC/AML protocols in place. Yet even with all of that, Coinbase manages to build itself into the massively successful business it is today.

The good kid in class has proven that being good is not mutually exclusive to being wildly successful. This is its graduation ceremony.

Everyone goes the crypto way

As anyone who has stayed awake to listen to graduation speeches go, however, we know what advice is often given at graduation: this is not the end of the journey, but just the beginning.

The mainstreaming of crypto has only just begun. Arguably, there was no better advertisement for the viability of crypto than a rising price, but as was aptly put by Nic Carter last year:

Snarky jokes aside, he has a point: had this been a flash in a pan occurrence, re-emergence would have been impossible. The amount of capital required to reflate a “bubble” to its prior highs AND take it to almost triple that prior high, at current US$1.96tn of total crypto market cap, is prohibitive – it’s hard to pump and dump in that kind of size.

In contrast, it is more likely that the much broader adoption and awareness of the capabilities of cryptocurrencies and its many applications – from DeFi to NFTs to deploying hardware infrastructure – has been the reason for its resurgence to new highs. Hardcore cynics can speculate and propose claims of rampant market manipulation being the reason for crypto’s resurgence – but Occam’s Razor would suggest that maybe the simplest explanation is the correct one.

That people actually find value in what crypto offers and are willing to pay up to access that value.

If that is true, then we are truly at a seminal moment in history.

As we often seek to emphasise, crypto is a technological development (starting from the first Bitcoin blockchain) which has given birth to a plethora of new approaches to business. This is not just an improvement or a redesign of old technology and infrastructure – that’s “fintech”. This is more than just a fancy user interface and a chat bot which answers questions.

Crypto fundamentally re-imagines how business can be done by removing the single pain point in all business dealings: the need for trust.

By allowing transactions to happen between parties that do not need to fundamentally trust (or even know) each other, securing the integrity of the transactions in question through technology and code, middlemen are removed – and with them, their costs (and margins) and any other human limitations that come with middlemen, including office hours, permission, consent or toilet breaks.

The first applications of this technology were financial: trading 24/7 on decentralised exchanges (like Uniswap) that didn’t require “dealers” to exercise discretion over proposed transactions; minting synthetic token-equivalents of real-world assets like USD, Gold and even stocks on Synthetix; or coordinating savings and lending between depositors and borrowers without a bank on Aave.

All of these applications took the middlemen away and allowed both sides of the transaction to interact in the surety that no one was going to run away with anything without fulfilling their end of the contract. Digital assets secured by code.

This reimagination of business has only just begun to seep out of the financial realm. We wrote a couple of weeks ago about how Helium Inc, an IoT network provider, has used token economics to bootstrap the world’s largest contiguous wireless network for IoT devices (for now). We saw 24k hotspots back then, the number is now closer to 26k according to the Helium Explorer.

Add into the mix the recent craze with Non-Fungible Tokens (NFTs) which have applications beyond Art, having the potential to represent unique, non-fungible assets of any form (think individual properties, collectibles, contracts etc – anything that can’t be perfectly substituted one for another), and the possibilities are endless.

Alongside the “means” of doing business also comes a different ethos all together: an unprecedented degree of transparency in EVERY single transaction that happens on the network. Just like Helium has a live map of all of its hotspots, and Ethereum has a publicly auditable log of every transaction done on the network on Etherscan, most public blockchains provide their users with transparency on fees, transactions and activity like no privately-owned entity could (or would) ever provide.

Ironically, it is that transparency and ability to access data for free that topples the need for a central “trusted” counterparty to provide services of “trust”. It’s the classic battle of the “suits” against the “common man” – even when it comes to messaging, gone are the slick, glossy covers of prospectuses and powerpoint presentations dished around by investment banking analysts; enter whitepapers, memes, gifs and crypto-twitter.

This fundamental change in the ecosystem could make or break long-entrenched business models: clearinghouses, stock exchanges, banks, insurers, real estate agents, lawyers, notaries… the list goes on. Perhaps stocks will soon trade 24/7 – why not? Life would be easier without gaps in trading overnight. And fund transfers will take a matter of minutes to clear instead of the “1-3 working days” we’re currently facing. Doing a token listing? No bankers needed – in fact, you might not even need a registered company structure.

Even the likes of Visa and Paypal now accept cryptocurrencies as a medium of payment – perhaps necessary for them to stay relevant, given payment processors too are institutions of “trust”, assuring merchants that payment will be received eventually after funds are cleared by banks in… “1-3 working days”.

The tides of change have been coming for a while now, but we believe that we are at an inflection point. Who knows what the human mind can create in the future, armed with a brand now revolutionary technology?

In or out?

All of that said, we are arguably still in the early years of the life of this nascent asset class. It’s not everyday a new asset class comes along, and the skepticism around it is understandable. But to technologically enable the creation of a new class of assets that co-opts customers into users, sharing specific slices of economic outcomes (not just profits) and incentivising cooperative behaviour on the part of “customers” by aligning their interests with that of a broader network is a new level of innovation altogether.

Just as the Dutch East India Company’s “IPO” in 1602 ushered in a new era of public participation in private companies, allowing corporations to access and share their profits with new providers of capital, crypto is in our opinion ushering in the next iteration of incentive alignment. Anyone can participate – regardless of location, accessible to anyone, with no access-controlling intermediaries other than a web browser and a wallet plug-in.

13 years after Satoshi Nakamoto’s Bitcoin Whitepaper hit the internet, Coinbase’s IPO marks crypto’s graduation from the ephemeral to the tangible.

Fortunately, it’s only the beginning. The question is whether you’re in or out?

Edward PlayfairApril 9, 2021