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Revenue at Coinbase tends to fall when prices of cryptocurrencies drop.
Tiffany Hagler-Geard/Bloomberg
There are several bearish cases against
Coinbase
stock, but one of the most important ones may not stand up to scrutiny.
The cryptocurrency exchange is heavily dependent on Bitcoin and Ethereum trading, skeptics say, and both have been known to decline 60% or more in bear markets. That is a problem because management has said trading volume and revenues tend to decline when prices fall. At the same time, the company will be subject to changing regulations that could make it harder to operate, and might ban or limit various activities it is already involved in.
But the concern that has gained the most traction is that Coinbase (ticker: COIN) is a company dependent on retail transactions, an area in financial services that has historically led to diminishing returns. Coinbase now charges fees to people who want to trade cryptocurrencies, and rivals will likely try to undercut it on price. The company generated 96% of its 2020 revenue from transactions, largely from fees charged to retail investors.
The brokerage industry offers an example of what can happen. The major brokers had to cut their commissions to zero in 2019 as a result of a pressure from Robinhood and a longstanding rate war.
“The race-to-zero phenomenon that took place in late 2019 with stock trading fees will likely make its way to the crypto trading space,” wrote David Trainer, CEO of the research firm New Constructs. “We expect Coinbase competitors to cut their trading fees to zero in an effort to increase market share.”
This isn’t a new worry. In fact, venture-capital firms considering investing in the stock in 2017 brought it up then.
“This was a question we and others asked four years ago, and it hasn’t really changed very much,” said Tom Loverro, a partner at venture-capital firm IVP, which led a funding round for Coinbase in 2017. “I think fees in the industry have come down for institutions. And maybe they come down a little for consumers. But I think the narrative of pricing pressure is mostly based on an analog to stocks, which doesn’t apply here, because it’s a different bundle of services you’re buying.”
Loverro points out that Coinbase does more than facilitate trades. It offers high-quality custody of an asset that is difficult to secure, among other services. “You have to kind of think about it as a bundle of services that comes with the Coinbase trusted brand.”
Lisa Ellis, an analyst at MoffettNathanson, also thinks that the company has competitive advantages that should keep fees robust. “Coinbase runs custom nodes on 15 blockchains to create liquidity across 108 crypto assets,” she said. “And they’re licensed in 30 countries. Schwab isn’t doing that.”
Most of the big brokers lack the specialized expertise that Coinbase has.
Ellis also points out that investors have raised similar concerns about other financial technology companies. “With both PayPal (PYPL) and Square (SQ), the biggest controversy on those stocks was actually fee compression, exactly like Coinbase,” she said. “In those cases, here we are five years later, and they have not. Their fees have been dead solid the whole time because they’re actually adding a lot more value than people originally believed, and there’s a huge runway in the market.”
Both Loverro and Ellis also expect Coinbase to diversify in the years ahead. Ellis is particularly excited about Coinbase’s recent acquisition of Bison Trails, an enterprise blockchain start-up that she thinks will help Coinbase become a key hub for software developers looking to build applications. It puts them “on a path to becoming the Microsoft Azure of blockchain,” Ellis said.
She sees the stock hitting $600 in a year. It was down 1.7% on Thursday to $322.75.
Write to Avi Salzman at avi.salzman@barrons.com