- March 26, 2021
Coinbase filed for IPO, revealing a robust 2020
Coinbase, the largest crypto exchange in the US, has filed for IPO via direct listing with a market consensus of valuation at US$50-100bn. Starting from a centralized crypto exchange in 2012, Coinbase has expanded itself to the broader cryptoeconomy including the recently booming decentralized finance (DeFi) and now supports 50 cryptocurrencies. In 2020, Coinbase reported a total revenue of US$1.28bn, up 139% YoY, and turned into profit with a headline net income of US$322mn; excluding stock-based compensation, adjusted net income reached US$392mn. The US remains Coinbase’s largest market, contributing 76% of revenue. The company’s trading volume grew by 142% to US$192bn, and assets on platform quadrupled to US$90.3bn, representing 11.1% of total crypto market capitalization as of Dec 31, 2020. Its verified users reached 43 million, and monthly transacting users surged from 1 million in 2019 to 2.8 million. Institutional users increased from 4,200 in 2019 to 7,000 in 2020. Coinbase only holds a small amount of crypto assets in its treasury and measures the assets at cost, rather than at fair value. Adjusted net operating cash flow (excluding changes in custodial funds due to customers) increased by 493% to US$294mn.
We estimated a much lower fair valuation compared to market consensus. We expect that increasing number of active users and higher average trading volume per institutional client will boost its revenue growth; however, compliance cost and the resulted slower new business development will limit Coinbase’s growth potential compared to some of its peers. Given the high volatility of crypto market and the fierce competition from centralized crypto exchanges as well as decentralized exchanges globally, we assign a lower P/E to Coinbase compared to Nasdaq, CME and ICE.
The leading crypto exchange in US: overseas business relatively small
Coinbase still occupies the leading position in the US crypto market, ranking 1st among all crypto exchanges by cryptocurrency received on-chain from 2H19 to 1H20, according to Chainalysis. Coinbase generated 76% of revenue from US market and 24% from Europe in 2020. However, the overall North American market only accounted for 15% of crypto values sent and received in the world, and the proportion was 17% for North and Western Europe.
Strict compliance helps Coinbase attract institutional clients, but limits its innovation and profitability
With strict regulatory compliance, especially to the US federal rules, Coinbase became the one pick for institutions interested in crypto investments. Coinbase’s institutional clients include financial institutions such as One River and Grayscale, as well as tech companies such as Tesla and MicroStrategy. Institutional trading volume constituted 62% of total trading volume in 2020, up from 57% in 2019, and nearly half of Coinbase’s assets on platform were from institutions. However, institutional transaction revenue only took up 5% of transaction revenue due to a lower fee rate.
Coinbase benefited from 4Q20 bitcoin enthusiasm from institutional money. The entry of institutional investors pushed the skyrocketing of bitcoin prices, and led to the surge in Coinbase’s trading volume: Coinbase’s growth rate exceeded all other centralized exchanges (CEX) with an average quarterly growth of 52%, and its market share expanded from 0.4% in 1Q20 to 1.6% in 4Q20.
However, regulations limit Coinbase’s participance in crypto derivatives and overseas expansion. Subject to the CFTC enforcement actions, Coinbase could not offer derivative products, which limited its innovation and product diversification. In 2020, 85.8% of Coinbase revenue was transaction fee. The crypto derivatives market surpassed the spot market in both trading volume and growth rate in 2020, and derivatives trading volumes in some top exchanges such as Binance and Huobi became absolute dominance.
Coinbase Ventures: One of the most active crypto investors worldwide to build a crypto ecosystem
Coinbase Ventures has made over 100 investments since its launch in 2018, and accelerated its crypto investments in 2020, with 44 minority equity or token investments completed. Web3, centralized finance (CeFi) and custody are the top 3 categories in terms of capital allocation, totaling 60% in all investments, while DeFi accounted for 11% of the capital allocation.
Revenue model: Revenue growth mainly powered by retail customers
Coinbase operates like a traditional stock exchange and acts as an agent in facilitating crypto transactions between customers, and charge a transaction fee for each transaction. Retail customers’ transaction fee was around 1.42% in 2020, higher than institutional customers’ fee of around 0.05%. Retail transaction revenue accounted for 95% of total transaction revenue and 81% of total revenue. Subscription and services fees are 0.023% of trading volume in 2020. When unanticipated system disruptions occur, Coinbase would fulfill transactions with own crypto assets, and crypto asset sales revenue represented 10% of total revenue in 2020. The transaction expense was around 0.01% of trading volume from 2019 to 2020. Excluding stock-based compensation expense, in 2020, Coinbase had an adjusted net margin of 30.7% and its adjusted ROA and ROE were 9.5% and 53.7%, respectively, surpassing major global exchanges.
The rise of DeFi means both challenges and opportunities to Coinbase
DeFi, or decentralized finance, has become the hottest vertical in the crypto world. Online searches for “DeFi” have increased exponentially over the last year across the world, as shown by Google Trends. As of Dec 31, 2020, there was over US$15bn equivalent value worldwide allocated towards DeFi applications and protocols.
Centralized exchanges including Coinbase is facing growing competition from DeFi exchanges (DEX). Decentralized spot trading volume increased from about 0.01% of trading volume on centralized exchanges at the beginning of 2020 to 3% in September and remained above 1% in December 2020, according to Tokeninsight. The currently largest DEX Uniswap V2’s trading volume has exceeded US$1.7tn in less than 1 year since its launch in May 2020.
Coinbase is actively embracing DeFi. Coinbase invested in Uniswap in 2020. Besides, Coinbase also invested in DeFi protocols and exchanges including Compound, Paradex, Synthetix, dYdX, etc. Coinbase Wallet allows users to connect to DeFi applications and self-custody crypto assets, and its WalletLink API helps DeFi developers to accept crypto payments.
The fierce competition in crypto space and volatile crypto prices bring high uncertainty
The spot trading market is under fierce competition, with the top 10 exchanges accounting for only 16% of total trading volume. Binance, Huobi and OKEx maintained their leading position in 2020, with a market share of 4.6%, 2.4% and 2.1%, respectively. Coinbase’s trading volume accounted for 0.9% of overall market in 2020, ranking 8thin all CEX.
The high volatility of crypto prices may bring downside risk to Coinbase’s profitability. As of 15 Mar 2021, the 60-Day BTC/USD volatility was 4.99%. Bitcoin is the largest asset class in Coinbase clients’ portfolio. 70% of assets on platform are bitcoin, and 44% of revenue came from bitcoin. To reduce fair value-related risk, Coinbase does not maintain large crypto holdings. The company conducts periodic checks every day and convert crypto assets received for transaction fees into fiat currency upon reaching US$100, and the conversion amount will be no more than US$5,000.
Different from most of companies, Coinbase’s IPO will not involve proceeds raising, but aim at offering liquidity for the existing investors. It has no contractual lock-up agreements or restrictions on its stockholders.
