Coinbase Direct Listing: What Investors Should Expect

In January, the cryptocurrency exchange Coinbase officially announced plans to become a public company. It abandoned the traditional IPO in favour of a direct listing of shares (DPO). Coinbase’s listing will take place on April 14 on the Nasdaq stock exchange.

Some describe the IPO wave in the crypto market as a harbinger of the end of the bull rally, but Coinbase’s direct listing is, by any measure, a milestone for the industry.

The story of Coinbase began in 2012 when Brian Armstrong, the developer of the Airbnb startup published a Reddit post describing a prototype cloud Bitcoin wallet. Fred Ehrsam — a trader at Goldman Sachs, who traded cryptocurrency in his spare time — came across the post.

Incredible. Brian Armstrong’s HackerNews post looking for a cofounder for Coinbase.

“Because Bitcoin worked out so well. Have fun with that, dude.”

“I don’t think you’ve properly thought this through.”

“I’m gonna call it right now: bad idea.”https://t.co/qMKb7kuJkN pic.twitter.com/wJLAXA8Ijy

— Austen Allred (@Austen) April 15, 2021

A conversation ensued between the two, during which it emerged that the project had already been completed and that it had joined Y Combinator. After a face-to-face meeting, Armstrong invited Ehrsam to join him as a co-owner of the company.

Five years later, Coinbase became the first unicorn of the cryptocurrency industry, and the latest known valuation of the company stood at $8 billion (in October 2018).

In 2021, its stock-market debut could be the biggest listing by a U.S. technology company since Facebook’s IPO and the first major DPO on Nasdaq.

Coinbase Ecosystem

Coinbase is a platform for buying, selling, transferring and storing digital assets, whose mission is to create an open financial system. The company develops several business lines.

The Coinbase.com platform and wallet are designed for buying, selling and storing cryptocurrencies.

For individual traders, the company offers the advanced-exchange Coinbase Pro; for institutional clients — Coinbase Prime. Both products provide protection for funds.

The exchange business is Coinbase’s main business, but it also has other commercial products. The Coinbase Commerce division supplies online retailers with software that enables them to accept cryptocurrency payments.

For secure custody of digital assets for institutional investors, the company offers a custodial service, regulated by the New York State Department of Financial Services (NYDFS). Coinbase Custody supports more than 100 assets, representing more than 90% of the total cryptocurrency market capitalisation. As of December 31, 2020, assets of $90 billion were under its management. More than 50% of these assets were accounted for by Coinbase Custody.

In the summer of 2019, Coinbase Custody acquired the institutional arm of another custody service — Xapo. The deal was valued at $55 million.

In partnership with blockchain company Circle, the exchange founded the Centre consortium. The organisation is the issuer of USD Coin (USDC), a dollar-pegged stablecoin, and is developing its ecosystem. In late March 2021, the payments company Visa launched a pilot programme to integrate payments in USDC into its network.

Together with Visa, the exchange also issues debit cards that enable spending of digital assets for goods and services.

Coinbase has a venture arm that invests in crypto and blockchain startups at early stages. According to Crunchbase, Coinbase Ventures’ portfolio include 68 startups, including BlockFi and Compound. The arm has acted as lead investor in four funding rounds and has exited from two startups — Curv and Elph Network. According to Messari, Coinbase Ventures’ portfolio contains 22 crypto assets.

In January, Coinbase acquired the infrastructure provider for the digital asset market, Bison Trails. The deal will allow the exchange to enter the IaaS market (infrastructure as a service). Bison Trails continued to operate as an independent company.

Most of Coinbase’s revenue comes from commissions charged on buying and selling Bitcoin and other assets. Coinbase Pro and Coinbase Prime operate on standard maker-taker fee structures.

For processing payments via Coinbase Commerce the company does not charge a fee; however, if a customer wants to convert digital currency into fiat, they will have to pay for it.

The Coinbase Custody service charges a fee for storing cryptocurrencies and a one-off implementation fee.

Coinbase Financials

The Coinbase filing contains information on the state of the business and risk factors that could affect its development and the upcoming listing.

2020 was a good year for the exchange: in 12 months the company earned more than $1.1 billion, up 136% from 2019’s $483 million revenue. Coinbase net income in 2020 was $322 million.

Revenue growth was closely linked to higher trading volumes — the figure rose by 142% from 2019 to 2020. Virtually all revenue (96%) came from commissions, the amount correlating with activity in the digital asset market.

• The main drivers of Coinbase’s revenue growth in 2020 were institutional trades:
• In Q1 2020, institutional trading volume rose sixfold compared with the same period in 2019;
• In 2020, this figure rose from $18 billion in Q1 to $57 billion in Q4;
• During the same period, retail trading volume grew from $12 billion to $32 billion.

Forty-one percent of trading volume came from Bitcoin. Ethereum was the second-most-traded cryptocurrency, accounting for 15%.

Investments in ‘technology and development’ are one of Coinbase’s largest expense items, accounting for 21% of total revenue. Only ‘general and administrative’ expenses are higher, at 22% of revenue.

As of the end of 2020, Coinbase had 43 million verified retail customers and 7,000 institutional participants on its exchange services. The monthly active users were estimated at 2.8 million.

A week before the listing, Coinbase published estimated financial results for the first three months of 2021:

• Revenue for the period is estimated at $1.8 billion, net income at $730–$800 million, adjusted EBITDA at $1.1 billion;
• Quarterly trading volume is $335 billion;
• Assets under management amount to $223 billion — about 11.3% of the total market capitalisation, including $122 billion of institutional-client assets;
• The number of verified users rose to 56 million, with monthly active users at 6.1 million.

The company expects that in the best-case scenario for 2021 the average number of clients making at least one monthly transaction will be 7 million. In the worst-case scenario — 4 million.

Coinbase also said that by the end of 2021 its cumulative spend on technology and development, and on general and administrative needs, could reach $1.3-$1.6 billion. This reflects the company’s ongoing scale-up. The exchange also plans to increase marketing spend — potentially 12% to 15% of net income.

Top Beneficiaries of the Listing

Coinbase split its shares into Class A and Class B, which confer identical rights apart from voting and conversion. Each Class A common share carries one vote. A Class B common share carries 20 votes and can be converted into Class A at any time. Thus holders of outstanding Class B shares collectively own 99.2% of the voting rights.

As of the date of the filing, the largest institutional shareholders of Coinbase were Andreessen Horowitz (14.1% of voting rights), Union Square Ventures (8.1%), and Ribbit Capital (7%). The cap table also includes venture firms Paradigm, Tiger Global, and Viserion Investment.

The largest private holders are its founders Brian Armstrong and Fred Ehrsam, and the exchange’s chief commercial officer, Surojit Chatterjee. The founders own 21.6% and 8.9% of the voting rights respectively, Chatterjee owns less than 1%.

In August 2020, Armstrong was granted 9.3 million stock options at a price of $23.49. If after listing the share price is close to their VWAP on the secondary market, he could stand to gain more than $2.9 billion.

The New Netscape

Some expect Coinbase to repeat the Netscape Communications story, whose IPO is widely regarded as the launch point of the dot-com era.

Armstrong’s company will become the first publicly traded cryptocurrency exchange, and this event will undoubtedly shape the industry.

The Coinbase listing filing shows that the company has a sustainable business model that is already profitable. The exchange has a large base of verified users, which is crucial for regulators.

Coinbase has always said that one of the key tenets of its growth strategy is cooperation with regulators. For example, the exchange avoids listing confidential assets such as Monero.

As stock-market listing entails strict disclosure requirements, in its bid to please regulators Coinbase will take a big step forward. The very fact that the SEC approved the exchange’s filing indicates that the Commission no longer views the business in this space as grey or toxic.

The appearance of Coinbase shares on the public market will provide investors with another instrument for indirect exposure to digital assets. Since the bulk of exchange revenue comes from fees, its shares are likely to be highly correlated with trading volumes in the crypto market.

Investors have already shown considerable interest in Coinbase — a quick look at private market trading activity confirms this. For example, on Nasdaq Private Market in February, quotes rose to $375 per share. But one should not overlook the accompanying risks.

What Could Go Wrong?

In short — a lot could go wrong. Coinbase’s long-term success hinges largely on whether the company can achieve its mission — to reshape the global financial system. This goal comes with a long list of risk factors, the most significant of which include resistance from the cohort of monetary regulators, erosion of public trust in cryptocurrencies, and possible losses due to volatility in digital asset prices.

In the letter accompanying the Coinbase filing, Armstrong writes about financial standards that “no company or country can manipulate.” Yet many countries, especially the United States, whose dollar holds reserve currency status, are not keen to relinquish control over monetary policy. Therefore, in the near term, cryptocurrencies may face tighter regulation — a view echoed by Coinbase itself.

The exchange’s revenue sources depend on the state of the cryptocurrency market, more precisely on trader activity and trading volume. Prolonged periods of lull, or so-called “crypto winters”, could significantly affect Coinbase’s position.

The company also identifies competition from the DeFi sector and the disclosure of Satoshi Nakamoto’s identity as risk factors. Coinbase did not specify how possible identification of the Bitcoin creator would affect it, but noted that its business could suffer if the exchange cannot withstand competition from decentralised and non-custodial platforms.

In addition, traditional factors influence Coinbase’s business. For example, since part of its revenue comes from interest on fiat funds deposited by clients in custodial banks, low interest rates negatively affect the business.

Coinbase notes that developments in mining-related technology, and consolidation of capacity in a small portion of large pools, could “reduce blockchain security and the appeal of cryptocurrencies.” This could lead to the public losing trust in the digital-asset class.

Undoubtedly, Coinbase has proven its ability to generate money. The exchange has a large user base that can still grow, as one of the growth strategy’s key tenets is international expansion. It also collaborates with the leading payments-card player, and its services are used by companies such as Tesla, MicroStrategy and One River.

However, in the longer run, Coinbase’s success is tightly linked to the success of the cryptocurrency industry. The exchange emphasises that the future development and growth of this market depend on many factors that are difficult to predict or quantify.

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