The company’s operating leverage is huge. But leverage works in both directions.
Coinbase Global shares, at $333, are off from their peak but might yet attain a long upward trajectory. What will drive them? There are four elements.
A merchant that gets a percentage makes more money when the merchandise price goes up. Bitcoin is up six-fold from a year ago. That’s the main reason Coinbase Global is insanely profitable right now, with first-quarter net estimated to be near $750 million.
If virtual currency prices double over the next year, Coinbase profits will more than double. It would be doing the same work as it’s doing now, with more or less the same employees, for twice as much money.
Operating leverage works both ways. Cut the prices of bitcoin, ethereum and the lesser coins in half and Coinbase profits would fall by more than half.
Price gains bring out speculators. There are people who trade coins all day long, indeed many with robots that run up tens of thousands of trade tickets a year. All this puts coin in the Coinbase till.
Last year Coinbase’s trading volume averaged $48 billion per quarter. In the first quarter of 2021 it saw $335 billion. Some of that dollar gain is due to price changes (see above), but not all.
Here’s why the direction of price changes matters: In a year when crypto is up, traders can delude themselves. They can attribute their profits to trading skill, when in fact they collectively would have done better just buying and holding.
These delusions are crucial to Coinbase’s success. While the company does some institutional work (such as custody for institutions), it got 96% of its net revenue last year from transactions.
Might the delusions end some day? They did for the day traders who briefly got rich 22 years ago during the craze for internet stocks.
Offsetting, to some degree, the risk that speculators will go away is that the investing masses are coming in. Bitcoin is becoming ever more accessible to savers across the planet via funds, custody accounts and other vehicles; some of that will drive activity on exchanges like Coinbase.
Amateurs pay stiff commissions and bid/ask spreads on the main Coinbase platform: roughly 2% to buy or sell. There’s also a Coinbase Pro for the savvier players, with much lower fees. This year Coinbase’s revenue is averaging just over 0.5% of the transaction amount. Small players and big ones can both get better deals elsewhere.
Working in Coinbase’s favor: lingering memories of the Mt. Gox hack seven years ago. Coinbase spends lavishly on security, and has a mostly blemish-free history. Its services are worth a premium over the offering from some discounter with sketchy offshore affiliations. The risk to Coinbase is that some august institution like J.P. Morgan Chase or Fidelity Investments dives into coin trading, reducing the premium Coinbase can charge for its reputation.
Working, for now, in favor of the middleman: price volatility. Speculators trying to triple their money aren’t very attentive to whether a markup is 0.5% or 0.25%.
A reasonable expectation is that over time Coinbase will confront declining percentage fees but might make up for that in volume gains.
Why is it that twice as many workers are in financial services as are on farms? It’s because money is complicated. Much effort is expended on stocks, bonds, checks, wires, mortgages, credit cards, retirement accounts, tax collections and tax avoidance.
Brian Armstrong, founder and chief executive of Coinbase, has some very expansive notions about how the blockchain will transform commerce. Some of this is fantasy. Some of it might turn into new revenue streams. He certainly has enough money pouring in over the transom to finance the research.
Charles Schwab & Co. used to make its money from brokerage commissions. Competition has recently sent the going commission rate to zero. Yet Schwab is prospering. In a financially complex world it has a lot to offer. In ten years Coinbase might be in lines of business not so dependent on gamblers who think they can get a triple.
Do these four drivers of Coinbase’s fortunes call for a bullish or a bearish view? It’s a toss-up. A year from now the stock could easily be at $600, or just as easily at $160.