Morning Thoughts Ahead of Coinbase Listing
The current frenzy around the Coinbase listing is reminiscent of two trends in the financial industry:
Firstly, the gold miners trade as a proxy investment to gold. A few decades back, certain equity investors couldn’t invest in gold for a lack of a commodity and/or derivative mandate and were instead investing in gold miners. Many retail and institutional investors eying the Coinbase listing are doing the same: they have neither the knowledge nor the infrastructure to invest in Bitcoin and crypto and are using Coinbase as a proxy investment in the sector.
Secondly, euphoric valuations. in terms of euphoric valuations, Coinbase is right up there with Tesla whose market cap is larger than the top 9 auto manufacturers combined and was trading at an overinflated PE of 1000+ in 2020. Based on valuations in European private markets, Coinbase was trading at a $150bn valuation this morning (higher than the LSEG, ICE and CME market cap combined), and at close to 116 price to sales ratio based on 2020 revenues. A very bullish calculation looking at their Q1 2021 revenues brings it down to the 21–36 range. Other exchanges trade between 3 (Nasdaq) to 15 (CME).
This is further proof that the framework of traditional valuations is broken and the current euphoria, driven in part by helicopter money, is nothing but unsustainable.
There are two major risks that Coinbase faces, one relating to fees and the other relating to regulations:
Fees: Coinbase has disclosed that it charges customers a flat fee of around 0.5% on the dollar value of each trade. On average this translates to $300 per Bitcoin. In comparison, traditional exchanges charge on average 0.01%. This translates into margins 50 times higher than traditional marketplaces. It’s likely that competitors such as Kraken, Binance, Gemini and Bitfinex will seek to drive these fees down in order to secure higher market share.
The real forward risk for these exchanges comes for the DEXes (Decentralised exchanges) that charge a mere 0.03% (which is actually paid to their participants). While decentralised finance is still in its infancy, this is a real long term risk facing all the centralised market places and holds the potential to erode trading fees and revenues in the long term.
Regulations: Regulation also came up as a risk highlighted in Coinbase’s S1 filing, and justly so. Currently Coinbase operates under a Money Service Businesses license, meaning its “trading” activities are left totally unsupervised. For example, Coinbase takes principal positions to facilitate liquidity to their clients and acts as a prime broker by offering credit-based products and post-trade credit. No other regulated exchange is allowed to offer these services for obvious conflict of interest reasons. Once the regulator requires Coinbase to apply for an exchange or alternative trading system license, it’s likely that a good chunk of profits will be eroded.
There is no doubt that Coinbase listing is a positive for the crypto industry as a whole and today’s listing will set the tone for the rest of us. I doubt it won’t be successful, however, don’t let the current short- term euphoria blind you to long-term shortcomings.
Disclaimer: I hold coinbase shares.
