Coinbase Global (COIN -5.94%), one of the world’s largest cryptocurrency exchanges, has burned a lot of investors since its direct listing last April. It started trading at $381 per share, well above its reference price of $250, but now trades at about $50.
Coinbase’s stock tumbled for three simple reasons. First, the market’s interest in cryptocurrencies waned as rising interest rates drove investors toward more-conservative investments. Second, that same trend caused investors to sell speculative growth stocks like Coinbase. And third, it expects to post a net loss this year, compared to a net profit of $3.6 billion in 2021, as it faces what it calls a “prolonged and stressful scenario.”
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All those headwinds spooked the bulls, but some contrarian investors might be tempted to buy this former high-flying stock at just three times this year’s sales. However, five red flags indicate it’s still too early to turn bullish on Coinbase’s future.
1. Its CEO expects a recession and “another crypto winter”
In a recent blog post, CEO Brian Armstrong said that the U.S. appeared to be “entering a recession after a 10+ year economic boom.” He warned that “recession could lead to another crypto winter” and that its trading revenue had “declined significantly” during previous downturns.
The U.S. hasn’t technically entered a recession yet, but aggressive rate hikes, which are required to pull inflation back from its 40-year high, could easily push the economy over the brink in the second quarter. If that happens, the market’s interest in speculative assets like cryptocurrencies will dry up, and many of the weaker altcoins could simply vanish.
2. Here come the layoffs
Armstrong said Coinbase had survived “four major crypto winters” since its inception 10 years ago, but that it’s “created long term success by carefully managing our spending through every down period.”
Armstrong admits the company overhired as the market’s adoption of crypto products soared last year. As a result, it now plans to lay off 1,100 employees, or 18% of its workforce, to reduce operating expenses.
That might seem like the financially responsible move, but investors should recall that Coinbase already projected a full-year adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) loss of approximately $500 million during its first-quarter earnings report in May.
That already represented a steep decline from its positive adjusted EBITDA of $4.1 billion in 2021. Therefore, this new round of layoffs strongly suggests its business had deteriorated much faster than it originally anticipated.
3. More regulatory headwinds
The Securities and Exchange Commission (SEC) has also been closely monitoring the cryptocurrency market. Last September, the SEC forced Coinbase to cancel Lend, a planned feature that would have allowed its users to lend out their USD coins (stablecoins tethered to the U.S. dollar) for passive interest income.
In late May, the implosion of TerraUSD and its sister token LUNA prompted U.S. lawmakers to propose a new regulatory framework — dubbed the Responsible Financial Innovation Act (RFIA) — which would enable the Commodity Futures Trading Commission to oversee all digital tokens as commodities. That change might make it easier to regulate cryptocurrency exchanges.
A more tightly regulated cryptocurrency market might be safer for investors, but it could also prevent the aggressive speculators (who had driven a lot of Coinbase’s earlier growth) from coming back.
4. Potential advertising violations
Coinbase generated a lot of buzz in February with its $14 million Super Bowl ad, which featured a single QR code bouncing around a screen. However, its advertising strategies were recently scrutinized in a report by the cryptocurrency news site Crypto Head that analyzed ads that were banned in the U.K. by the Advertising Standards Authority.
The report claims that Coinbase violated the advertising code a dozen times with “misleading” ads that either suggested “untrue” things or left out information that was “crucial in order for the viewer to form a balanced opinion.”
Coinbase was hit by several class action lawsuits this year regarding its promotion and sales of riskier cryptocurrencies. These recent allegations regarding its ads might add fresh fuel to that fire and force it to reevaluate its marketing and user-acquisition strategies.
5. Coinbase might keep your crypto if it declares bankruptcy
Last but not least, Coinbase added an ominous comment in its 10-Q filing in May. It said that in the event of a bankruptcy, the “crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings and such customers could be treated as our general unsecured creditors.” In other words, Coinbase could seize its customers’ holdings if it ever declared bankruptcy, and its customers would end up holding unsecured debt — which isn’t guaranteed to be paid off — instead of being able to freely transfer their assets to another cryptocurrency exchange.
Coinbase said it merely made that statement to comply with a new SEC requirement and that it wasn’t actually in danger of bankruptcy. But that chilling warning simply gives investors one final reason to avoid both the Coinbase platform and its beaten-down stock.