Coinbase: the future of currency

Overview

Coinbase is the largest cryptocurrency exchange in the U.S., and its mission is to create an open financial system. Since being founded in 2012, over $456bn of cryptocurrency has been transacted on the platform.

Coinbase ($COIN) went public in April at an $80bn valuation, and the price soon jumped pushing its valuation to $100bn. Its listing on NYSE proved to be an incredible moment for the Crypto community. While the listing served as validation for Coinbase’s business model and the increasing demand for Cryptocurrency. Coinbase’ CEO Brian Armstrong said ‘It feels like a shift in legitimacy not just for Coinbase but for the whole industry. Crypto has a shot at being a major force in the world’. In the past few weeks, we’ve seen Bitcoin skyrocket (and crash) and also alt coins like DOGE rally to new highs, and we thought it would be great to use this article to inform our readers on the basic mechanics of Cryptocurrencies.

To understand the current value of Coinbase and its future prospects its first important to understand Cryptocurrency.

A brief intro to Crypto

What is a currency?

A currency is a medium of exchange for goods and services, i.e. I can give you something in exchange for something you can give me. Before money was invented people used to barter, in the modern world currency is the primary medium of exchange. Currency in the form of money is usually issued by a government. Previously money issued by central banks was backed by a commodity, usually gold or in the UK’s case sterling silver — now most currencies aren’t backed by anything, these are called ‘fiat currencies’.

What is a cryptocurrency?

In short Cryptocurrency is digital currency that is secured by cryptography which makes them impossible to duplicate. Cryptocurrencies are powered by blockchain technology, which in brief is a way of recording transactions by passing information through a chain in an immutable manner. Blockchain contains a record of all transactions that have been made. Bitcoin is regarded as the first cryptocurrency in circulation.

Okay so what’s bitcoin?

After the financial crisis of 2007, a person called Satoshi Nakamoto (a pseudonym, his identity is still unknown) wrote a paper titled ‘Bitcoin: A Peer-to-Peer Electronic Cash System’. In summary, Satoshi wanted to create a ‘trust-less’ system by removing central banks from the equation. The first block was mined in January 2009 and since the price of bitcoin has grown from less than $0.01 in 2020 to $63,000 earlier this week, it rallied in the lead up to the Coinbase listing.

Why should I consider owning one?

The reason Bitcoin is so powerful as a store of value is because of it’s scarcity. There are a fixed number of Bitcoin that can be mined, 21 million to be precise and this was set out in Satoshi’s paper.

Unlike the pound, the dollar, we can’t just print more. Today many individuals and institutions are realising the value of bitcoin and how important it is to allocate part of their portfolio to Cryptocurrency. Tesla announced that they invested $1.5bn in Bitcoin in January supported the legitimacy of the currency — Tesla has made a $1bn return in 10 weeks from this investment.

History

Brian Armstrong graduated with a dual Bachelor’s degree in economics and computer science from Rice University in 2005. During his time at university, he started a business that matched tutors to students and upon graduation, he spent a year in Argentina while working on his business. Moving to Argentina for a year plays a big part in this story, at the time Argentina had just had a huge economic crisis and was still handling the effects of hyperinflation. In short, hyperinflation is when the price of goods increases very quickly. Say you roughly spend £100 each month on groceries, a 50% monthly inflation rate means that next month your groceries are £150 and by the end of the year your groceries are £8700. Fun fact: Argentina’s (annual) inflation rate is currently 54% — for most countries, inflation is normally kept around 2%. One of the main causes of hyperinflation is when a government prints money to pay for its spending (keep this in mind while I explain the next part).

In 2011, Brian Armstrong was working at Airbnb as a software engineer. During his time there he saw how difficult it was for Airbnb to move money to over 190 countries around the world as each country had their own systems, fees and regulations. That year, Brian came across the Bitcoin white paper published by Satoshi Nakamoto and realised how powerful a decentralised currency could be.

The key takes from this paper are that Bitcoin is:

• Decentralised — there are no barriers to moving the currency around — this solves Airbnb’s payments issue
• Immutable — it can’t be copied or ‘printed’ therefore hyperinflation is far less likely to happen if Bitcoin is the adopted currency

Brian wanted to make crypto easy to use, to be able to buy, sell and transact in crypto like any other currency. He built the first prototype in 2011 when Bitcoin was $6. The start-up community was not very interested in Crypto at that time so Brian had to go out of his way to find someone to build the project with. He wanted to apply to Y-Combinator but he needed a co-founder, so he posted the following on the popular forum Hacker News on Reddit:

‘Apply with me to YC in the next 3 days and change the world’

Fred Ehrsam responded and the two went on to join YC’s 2012 cohort. For people who don’t know much about Y-Combinator, they are an accelerator program that has built some of the largest start-ups in the last decade e.g. Airbnb, DoorDash, Stripe, Dropbox, Reddit and Twitch.

Two years after leaving YC, Coinbase grew to a company with over 1000 employees, however, the price of Bitcoin was at times a determining factor in the companies growth. In 2017 after the Bitcoin price reached an all-time high price of $20,000 it then dropped by 30% in a single day and by 2018 it had dropped to $3,100 — over a third of the Coinbase employees left including Fred Ehrsam the Co-founder.

In the same year, Coinbase was valued at over $1bn, after raising $200m from various investors and becoming the most downloaded app on the iPhone in the US.

During the rally leading up to the 2017 crash many new coins tried to list on Coinbase, however, they developed a vetting process to protect their users against ‘pump & dump schemes’ — where people list a coin just to scam others. Coinbase exclusively listed legitimate and safe coins in its pursuit of creating an ‘open financial system’. Throughout 2018 a string of well-timed acquisitions allowed Coinbase to enter near markets, e.g. they acquired GDAX to appeal to professional traders and that product has now been rebranded to Coinbase Pro.

Coinbase also launched ‘Coinbase Ventures’ that invests in new token projects that support their long term mission mainly Decentralised Finance (DeFi) technology. The company believes the investment arm could actually grow larger than the Coinbase platform as the DeFi space has grown to over $40bn in the last 10 years.

In 2021 Coinbase filed to list on the Nasdaq, in the filing the company had to disclose vast amounts of information including financials and strategy but don’t worry you don’t have to read it I’ll summarise the key statistics below:

1. $456bn — the amount of crypto that has been traded on Coinbase throughout its lifetime
2. 43m — the number of verified Coinbase users (as of Dec 2020)
3. $90bn vs $782bn — asset value on Coinbase vs the Crypto Market Capitalisation
4. 70% — the concentration of BTC on Coinbase
5. $32bn vs $57bn — institutional vs retail trading volume in 2020
6. $1.1bn vs $482m — 2020 revenue vs 2019 revenue

Point 6 really emphasises how much Coinbase has been able to grow and monetise its platform, lets take a deeper look into how they make money.

Revenue & Drivers

Coinbase has a fairly simple revenue model, they charge transaction fees when you make a trade through their platform. The average feed for customers is about 1–2% of the trading volume and 90% of the company’s revenue is made this way. The other 10% of revenue comes from Coinbase selling its own crypto assets to customers. Revenue is primarily driven by the trading volume which can be increased in two ways:

• Increasing the number of users on the platform
• Increasing the value of the assets traded

The second driver is inherently linked to the price of Bitcoin, so if Bitcoin suddenly crashes it’s likely trading volume will too.

Cost & Drivers

There are 4 main operating expenses that Coinbase has to account for:

• Transaction expense — this is the cost incurred to process crypto, this includes verification fees and fees to process transactions on the blockchain network — for every $1 in crypto traded this is $0.0007 in fees
• Technology and development — maintaining the platform, hosting and infrastructure costs as well as Technology staff — this accounts for a third of all operating expenses
• Sales and marketing — ads and all marketing costs incurred, they have an affiliate marketing program that you can sign up to
• General and administrative — arguably the most boring line on any companies financial statement but this basically means salaries for all the departments not involved in technology and development, also facilities and equipment

Unit Economics

Coinbase has a fantastically simple business model, for every dollar transacted through their platform they make c.$0.02 and spend $0.0007 — that’s a 97% profit margin. After subtracting all the other previously mentioned operating expenses they still have an EBITDA margin of 32%.

HTMM Opinion

I need to start by stating this is not financial advice but I think Coinbase is going to continue to grow in the coming years. Their business model is so simple and they have achieved their aim of making crypto easy to buy and sell. The key to Coinbases’ success has been limiting the coins they trade, their vetting process is so integral to gaining consumer trust and hence increasing interest in Crypto. Bitcoin continues to rally (and dip) and more retail and institutional investors are increasing their exposure to Crypto and as the market is getting flooded with new capital people are looking to alternative coins. If you’ve ever tried to buy a coin that’s not listed on Coinbase or (their main competitor) Binance, you’ll understand how difficult the process is. You have to make a wallet, find the address, buy a coin to exchange with and then keep track of the exchange rate in your head — it’s so painful and a lot of these alt coins (popularly called ‘sh*tcoins’ on Twitter) are very very volatile. You see people become millionaires overnight after putting in $10k and then also see people lose millions as well. Coinbase has been smart to not expose itself to this gambling like element of Crypto trading by listing a smaller selection of coins.

I think another key factor to Coinbases ultimate success will be its investment arm. Blockchain technology has the ability to disrupt any and every service we use. For example, you may have seen the rise in NFTs and their use in ownership verification of arts. A digital art piece called ‘Everydays: the first 5000 days’ was sold by Beeple in March 2021 for $69.3m, Art galleries caught on and by mid-April Sotheby’s had helped sell $17m worth of NFT art as well. Coinbase is investing in coders who are building blockchain technologies that can disrupt industries and are doing a great job at that too. Coinbase Ventures invested in ‘Compound Finance’ a protocol that lets you lend and borrow crypto assets with no middle man, which disrupts the business of merchant banks, compound is now worth over $3.5bn.

However, regulation may stunt the growth of Cryptocurrency adoption. Central banks around the world and banning crypto with the latest being Nigeria, digital currency poses a real threat to the traditional banking system and a Governments ability to control its currency. It likely we will see more countries move towards banning Crypto or at least imposing taxes on Crypto gains as we see more and more 18-year-olds become overnight millionaires. Coinbase being listed was almost like Crypto receiving a verification badge on Twitter, it makes it far more difficult for at least western countries to try and move against the motion.

Hot Take

To the Moon! It’s my birthday soon, send me BTC, ETH or BNB to my wallet!

— by £m€m