Coinbase will release its Q3 2024 results on 30th October. Analysts expect Q3 revenue to grow 86.1% YoY to $1.25 billion and GAAP EPS of $0.38. Management has guided Subscription and Services revenue in the range of $530 million to $600 million, representing YoY growth of 69% at the midpoint.
We entered Coinbase primarily based on technical analysis. Coinbase’s fundamentals are not a reliable indicator of future performance. Instead, asset prices and volatility in crypto are more important than traditional fundamentals.
Technical analysis shows a potential for a pullback, and if so, we will be watching $160 to $170 for our next potential tranche. Given the election is next week, anything can happen and if the setup changes and the stock does not pullback, then Advanced members will be updated in our weekly webinar as to the plan.
Revenue
The company’s revenue growth rate is expected to slow as it laps tough comps more often than a typical growth stock. By virtue of Bitcoin and crypto reaching a new high in March 2024, the company is expected to see negative growth of (-14.3%) the following year in the March quarter of 2025. The current estimates suggest a bottom in Q1 2025. Notably, on a sequential basis, revenue is expected to increase from Q3 2024 to Q2 2025.
Q2 revenue grew by 104.8% YoY to $1.45 billion.
Analysts expect Q3 revenue to grow 86.1% YoY to $1.25 billion and 41.8% YoY to $1.35 billion in Q4.
Analysts expect 2024 revenue to grow 83.1% YoY to $5.69 billion and 2025 revenue to grow 3.3% YoY to $5.88 billion.
Revenue is expected to decline by (-7.2%) YoY to $5.45 billion in 2026. Analysts shy away from predicting too much growth in either direction in the next few years, which is why technical analysis matters quite a bit with Coinbase.
Margins
Margins have widely fluctuated with revenue. The company also implemented an accounting change in Q1 2024, wherein they will report the fair value of their crypto assets. This means that the company will report unrealized profits or losses based on the crypto prices at the end of the quarter.
Q2 operating margin was 23.7% compared to (-10.4%) in the same period last year. Operating expenses increased 26% QoQ to $1.1 billion due to unrealized losses in Q2 compared to gains in Q1 and higher marketing and policy spending.
Technology and administrative expenses are expected to increase in Q3 due to uneven stock-based compensation recognition, while marketing expenses will increase due to increased online marketing spending.
Management stated, “We expect Q3 transaction expenses will be in the mid-teens as a percentage of net revenue. We expect technology & development and general & administrative expenses to increase Q/Q to $700-$750 million, largely driven by the non-linear expense recognition of our stock-based compensation.
Finally, we expect sales and marketing expenses to increase Q/Q to $160-$210 million, primarily driven by higher variable digital marketing.” The company also plans to increase its headcount in the second half of the year to support product and international expansion.
Net income was $36.1 million or 2.5% of revenue (includes $319 million in pre-tax crypto assets losses vast majority of which were unrealized as crypto prices were lower at the end of Q2 compared to Q1) compared to a net loss of (-$97.6 million) or (-13.8%) of revenue last year.
Adjusted EBITDA was $595.55 million or 41.1% of revenue compared to $188.73 million or 26.7% of revenue in the same period last year.
EPS
EPS has been lumpy in the past as discussed in the above paragraph. It is expected to increase sequentially in the next few quarters.
Q2 GAAP EPS was $0.14 compared to (-$0.42) in the same period last year.
Analysts expect Q3 EPS to be $0.38 compared to (-$0.01) in the same period last year. Q4 EPS is expected to be down (-35.6%) YoY to $0.67.
2024 GAAP EPS is expected to grow 1413% YoY to $5.6 and down (-4.6%) YoY to $5.34 in 2025 due to high comps.
2026 EPS is expected to decline by (-36.5%) YoY to $3.39. This will be highly dependent on crypto’s performance, however, and the subsequent trading volume.
Cash Flow and Balance Sheet
The company is generating strong cash flows. Coinbase’s cash flows have seen a remarkable turnaround, from (-51.6%) in 2022 to 27.7% in 2023.
Free cash flow was $484.2 million or 33.4% of revenue compared to $151.1 million or 21.4% of revenue in the same period last year.
Cash was $7.23 billion, and debt of $4.23 billion, compared to $6.7 billion and $4.23 billion in Q1. The company issued $1.3 billion of convertible notes in Q1 and plans to use the net proceeds of $1.1 billion to repay the outstanding debt at or before maturity, depending on market prices. Management also clarified in the earnings call that the other reasons for maintaining large cash balances were to support the ETF launches and for potential investment opportunities, both organic and inorganic.
Alesia Haas, CFO, answered the analyst's question on the cash build-up. “Yes, we're really pleased with the balance sheet strength. We are using cash, as we've mentioned in our prime financing business. A large amount of that cash was used to support the ETF launches in Q1 and Q2 with the Bitcoin ETF and now hopefully be a Ethereum ETF where you can see a lot of day-to-day or week-to-week volatility of those loan balances. We did grow prime financing fees within the quarter. And so you can see while the balance at the end of quarter was down versus of Q2. We saw growth intra-quarter for those balances. So using our cash to support our products is a primary use case for us.”
Key Segments:
Coinbase’s Q2 transaction revenue grew 138.7% YoY and down (-27%) QoQ to $781 million. Crypto asset volatility declined approximately (-13%) compared to the Q1 average, resulting in softer crypto spot market trading in Q2 compared to Q1.
Within Transaction revenue, Consumer is the main driver at $664.8 million, up 130% YoY, compared to Institutional revenue of $63.6 million, up 272% YoY.
Base and payment-related revenue has been reclassified to other transaction revenue. It grew 149% YoY to $52.5 million. Improved efficiency and reduced fees led to the number of base transactions growing 300% sequentially.
Management stated they saw $210 million in transaction volume for July, pointing toward mid-$600 million for transaction revenue. This compares to $110 million in July of last year.
Q2 subscription and services revenue grew by 78.6% YoY to $599 million. This is an all-time high for Coinbase in this segment and helps to diversify from being entirely dependent on transaction revenue. The growth was due to stablecoin revenue and blockchain rewards revenue; it also benefitted from a one-time blockchain validator reward of $8 million. Management guide for Q3 is $530 million to $600 million, representing a YoY growth of 69% at the midpoint.
Stablecoin revenue grew by 58.8% YoY to $240.4 million. This was primarily helped by higher average USDC on-platform balances and higher average USDC market capitalization.
Blockchain rewards revenue grew by 111.3% YoY to $185.1 million. This segment opens an exciting opportunity as interest rates go lower. Staking yields are not determined by FOMC policy; instead, by the participation rate of coins being staked. As demand increases for crypto, yields will increase to entice more coins to be staked. As a non-correlated yield to traditional financial instruments, which are mostly tied to central bank policy, this creates an opportunity for portfolios to diversify incomes in an interesting way, and adoption should increase as rates go lower.
Interest and finance fee income grew by 33.7% YoY to $69.4 million. This segment is tied to interest rates, Coinbase offers loans against the coins being held in-house. This is unlikely to be sustained now that the FED has lowered rates.
Custodial fee revenue grew by 102.9% YoY to $34.5 million.
Other subscriptions and services revenue grew by 153.1% YoY to $69.6 million.
Other Key Points to Watch:
Regulatory Changes
Improving regulatory clarity is another catalyst for the stock in the near term. With the elections around the corner, both candidates show support for crypto. Management was also optimistic about the regulatory clarity during Q2 results.
“In Q2, we made extraordinary progress towards driving regulatory clarity in the US and around the world. Crypto legislation has become a mainstream issue in the US, garnering bipartisan support, and there is real energy within both the House and the Senate to pass meaningful legislation. We continue to support Stand With Crypto – which now has over 1.3 million advocates – and will continue to invest in policy initiatives throughout the 2024 election cycle to help elect pro-crypto candidates. The approval and launch of the ETH ETFs was another huge step forward for regulatory clarity as it confirmed what we have been saying for years: ETH is not a security. Outside the US, we saw USDC become the first stablecoin to achieve compliance with the European Union's landmark Markets in Crypto-Assets (MiCA) regulatory framework.”
Institutional Adoption
For institutions, there is a product called Coinbase Prime. This full-service prime brokerage platform facilitates trades and custodian services for large institutions. Management has stated that institutions have maybe 1% to 3% of their funds in crypto. This is a low allocation, which has a lot of potential for growth. Management has mentioned that lack of regulatory clarity is the main hindrance for more institutional adoption.
Brian Armstrong, Co-founder and CEO, said in the Q2 earnings call, “90% of institutional investors say regulatory clarity would boost their confidence in investing more in crypto. For these reasons, Coinbase will continue to push for clear rules in the courts, in Congress and in the November elections.”
He further answered in Q&A, “Well, I think you're right that the lack of regulatory clarity is probably the biggest blocker for institutions to put more and more funds into crypto. We have a huge number of them as clients in Coinbase Prime, our institutional product. And when I meet with them, they'll often say, we've got 1% or 2% or 3% of their funds in some portfolio, holding in crypto. And I asked them, what would it take for it to be 10, 20, 30, and they all say regulatory clarity.”
Derivatives
Coinbase has primarily been a spot trading exchange, where crypto traders buy the asset at current market prices. In November of 2023, Coinbase added derivatives trading, which will help the exchange participate in a higher percentage of trading activity. Derivatives trading is roughly 2/3 of all crypto trading compared to spot trading at 1/3.
Management mentioned during the Q2 earnings call that the company’s focus has been on adding users and growing market share. This has included additional contracts and margin trading for crypto futures. The derivatives market is expected to be an important growth market in the future.
Valuation
Coinbase is trading at a P/E ratio of 37.7 and a forward P/E ratio of 38.9. P/S ratio is 12.3 and a forward P/S ratio of 9.3. It is trading above its average P/S ratio of 8.5.
Technical Analysis
By Portfolio Manager Knox Ridley
Like Bitcoin, Coinbase has been in a correction since March of 2024. Based on the lack of a clear trend, and on-going overlap, there are numerous interpretations of the current price action. Below, I present the three most likely, along with what levels need to hold/break to confirm each.
Green – The correction that started in March is a 4th wave that ended in early October. The final 5th wave is tracing a large degree 3 wave uptrend (A,B,C). This means that the path higher will not be a typical, direct move, but an overlapping push higher. If this is playing out, we will see a correction start soon, which will hold over $170 – $160. If this happens, the general target for the next leg higher will be around $280.
Blue – We will see a gap higher on heavy volume that breaks above $235. This means that the 4th wave correction ended in August and we are further along in the final swing higher. We should push toward the $280 region before seeing our first larger correction within this new uptrend.
Red – We break below $170 – $160. This will indicate that we are still in the 4th wave, which will be targeting $128 – $95.
Conclusion
Coinbase’s move into the derivatives market and its role as a trusted custodian for institutional investors in the crypto space, will continue to entice institutions to its platform. The regulatory clarity is another catalyst to watch in the near term. We continue to successfully navigate the crypto volatility by using technical analysis.
Royston Roche, Equity Analyst at the I/O Fund, contributed to this article.
Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.
The I/O Fund recently entered Coinbase primarily based on technicals. Coinbase offers investors a rare glimpse into the fundamentals of a crypto-related company, yet it’s clear to see Coinbase’s fundamentals are not a reliable indicator of future performance. Rather, asset prices and volatility in crypto are more important than traditional fundamentals for Coinbase because the company charges trading fees for each transaction.
Below is a clear picture that Coinbase trades in lock-step with Bitcoin. Due to it being a publicly traded stock, Coinbase can exceed Bitcoin at crypto peaks due to the ease of trading a stock compared to crypto assets.
Coinbase has primarily been a spot trading exchange, to where crypto traders buy the asset at current market prices. In November of 2023, Coinbase added derivatives trading which will help the exchange participate in a higher percentage of trading activity. Derivatives trading is roughly 2/3 of all crypto trading compared to spot trading at 1/3. Sometimes, derivatives trading is as high as 70% or even 75% of crypto trading volume, which means for the first time this year, Coinbase is able to participate in this lucrative space.
Equally as important (if not more so), Coinbase has launched a Layer 2 called Base over the past year, which has been growing in popularity and ranks #6 across both Layer 1 and Layer 2 chains in terms of total value locked (TVL). At one point, Base surpassed Solana in its first year of launching. Base facilitates faster and cheaper transactions, which is the most critical problem for the crypto complex to solve. If Coinbase has truly solved this pain point with Base, and it appears it has, then the company is setting up a nice future for itself by not only diversifying away from asset prices and crypto volatility, but is also opening up a new revenue stream that theoretically could eclipse platform revenue once the blockchain ecosystem is fully mature.
Before we sound the bull horn, Coinbase has an important hurdle to clear. Bitcoin ETFs are impacting Coinbase’s core business model of charging high fees for crypto transactions. It’s clear from the data we pulled below that ETFs are not additive for Coinbase, which is the opposite of what management had promised earlier this year. Instead, Coinbase is participating at a lower percentage when comparing to the last time Bitcoin reached an all-time high.
We look at these key points below. Please note, crypto is highly volatile. The I/O Fund plans to trade Coinbase as a momentum play and this stock is for Advanced Members only. Should Coinbase break key levels, we will close the position with no hesitation. As stated, technicals carry higher importance than fundamentals for crypto, and this is true for Coinbase due to its correlation with Bitcoin. You can find critical notes from Knox on his trading plan below.
Coinbase Overview
Coinbase is best known as a crypto trading platform, which accompanies high volatility and an overabundance of competition. The company charges transaction fees for each trade with fees up to 0.50% up to 4.5%. This is quite high when you consider money managers typically charge on average a 1% recurring fee to manage an entire account. The high fees are further brought into focus when you consider that equities, including ETFs, no longer charge transaction fees.
Coinbase’s success is tied to trading volumes, as higher volumes lead to higher fees for Coinbase. Even though we are seeing Coinbase successfully diversify their revenue, trading volume still accounts for the bulk of their revenue, and likely will for the time being. The arrival of Bitcoin ETFs is impacting Coinbase’s primary source of revenue, as ETFs offer an easy alternative to Coinbase’s fee driven trading platform. The ways in which Coinbase successfully pivots and differentiates its trading platform will be crucial for its ability to grow in the crypto space as the high trading fees will continually become disrupted.
We are seeing Coinbase’s trading platform to evolve to meet these challenges. Advanced Trade, previously called Coinbase Pro, is a platform for more advanced crypto traders that offers staking, decentralized app wallets, the ability to trade crypto derivatives and even a Coinbase credit card.
As discussed, the ability to trade derivatives on Coinbase is new this year. Derivatives are a large portion of daily crypto market activity. According to CoinDesk, derivatives were at 68% of the market in March of 2024, reaching a high of $6.18 trillion of $9.12 trillion in total trading volume. This is when Bitcoin was at all-time highs of $73,000+. Last month, CoinNess reported that derivatives reached a total of $5.22 trillion with $3.68 trillion or 70% being from derivatives trading.
Spot trading (which is your typical crypto trading) accounted for $1.54 trillion of crypto exchange volumes last month, or about 30% of volume. In March, spot trading reached a peak of $2.94 trillion for the highest monthly volume since May of 2021.
Coinbase reported a decline in spot trading volume of 28% QoQ citing volatility in crypto pricing. This quarter will be important for spot trading volume growth and derivatives growth as competitors Crypto.com have been reporting growth MoM on spot trading and up to $1 billion in open interest in derivatives, up 4X since January. Crypto.com has significantly lower trading fees of 0% to 0.075%, so it’s not too surprising it's gaining market share while Coinbase is struggling considering that spot traders will often use whichever platform offers the most competitive trading fees. Binance offers 0.1% fees on spot trading.
Coinbase One is a subscription plan that removes trading fees for $29.99 a month for the first $10,000 traded every month. This can work for investors who dollar cost average every month, yet is unrealistic for most crypto investors. One of the premiere features of Coinbase One is that it offers up to $1 million in insurance under certain terms and conditions.
The offer for no trading fees (or “gasless transactions”) is accomplished through Base, which is a Layer 2 built on the Ethereum network. Base offers 1 cent, 1 second transactions with the company currently seeing $20 billion per week in USDC transactions. By bundling hundreds of smaller transactions and processing them as one large Ethereum transaction with Ethereum as the settlement layer, Base reduces the transaction fee. The OP stack that Base is built on helps to deploy Rollup blockchains. We’ve discussed Rollups before in an Ethereum analysis as a key feature for the merge to Proof of Stake. Rollups allow hundreds of transactions to be rolled into one.
Base is compatible with the Ethereum Virtual Machine (EVM), which is the runtime layer that executes smart contracts on the Ethereum network. By being an EVM-compatible Layer 2 chain, Base offers interoperability with other EVM-compatible applications and the security and decentralization of Ethereum’s Layer 1 while improving on the Ethereum network’s scalability issues. We’ve covered the scalability issues in a previous analysis that discussed high gas fees on the Ethereum network. Due to lowering transaction fees, Base saw 300% QoQ growth in the number of transactions last quarter.
Due to Base resulting in faster transaction times, lower fees and offering compatibility with Ethereum, the Layer 2 chain is open sourced for developers to utilize these features for custom decentralized apps (dapps). The plan is to increase Base’s revenue potential after building a developer ecosystem around Coinbase’s unique ability to develop a Layer 2 that addresses gas fees: “We believe that this growth will then add users to develop products, we'll add developers and apps on Base. And that in turn will drive transaction volume and will drive down sequencer fees, and we will then see revenue as a result of those efforts.”
Coinbase is the sequencer, which manages the collection and publication of user transactions. For now, Coinbase controls the transactions, which will need to change in the future to adhere to blockchain’s ethos of decentralization. Coinbase is clearly profiting from Base with an estimated $52.5 million in the current quarter – exceeding even custodian ETF fees. By combining many transactions into one payment, Base can collect an arbitrage between the transaction fees and the network gas fees. There is also interest income from USDC on Base.
The Coinbase Developer Platform is a much larger initiative to become the backbone for financial-based decentralized apps (dapps). The platform offers APIs such as: building programmable crypto wallets to transfer crypto between two parties, or the ability to send, receive, trade and stake crypto. There are software development kits (SDKs) that help to integrate onchain AI, trading bots or automated payouts.
Bitcoin ETFs Having a Negative Impact on Coinbase
This year, the SEC approved 11 spot Bitcoin ETFs on January 10th, opening the door for more investors to gain exposure to Bitcoin without directly holding it. We stated at the time that the approval and subsequent widespread access for institutions and retail investors would shape up to be one of the most bullish fundamental moments in Bitcoin’s history.
Our paid research site has been anticipating this moment since 2019 when we stated: “One of the biggest hurdles for institutions, however, is not the idea of a world run on digital currencies, but rather the decentralization concept and the need for cryptocurrency storage. Institutional investors need to know the assets are secure, insured, and under the care of a trusted third party, per SEC rules, which requires advisers to keep client funds with a qualified custodian.”
Due to ETFs, the demand for Bitcoin has increased. Spot Bitcoin ETFs have seen a surge in net inflows, surpassing more than $30B AUM in mid-April after amassing $17B in funds in less than two months after a launch in mid-January. Trading volume on the ETFs nearly tripled in March, reaching $111 billion – for an asset class that had launched only two months prior, that’s a significant figure.
By mid-July, BlackRock Bitcoin ETF (IBIT) surpassed Invesco QQQ in year-to-date net flows despite total assets in IBIT being only a fraction of the Qs at $22 billion compared to $287.2 billion. At the time, two Bitcoin ETFs were in the top 10 including Fidelity.
In late August and early September, investors pulled roughly $1.2 billion or 3% of total assets from Bitcoin ETFs in the “worst string of outflows yet.” At eight of the eleven ETFs, this was the most consecutive days of net outflows that ETFs have experienced since the Jan 2024 launch. The 3% shows resiliency and may be leading to higher lows for Bitcoin, given the ETF outflows were not higher.
Since then, Bitcoin ETFs have seen their second consecutive week of inflows while Ethereum ETFs are seeing outflows. Since Ethereum ETFs were listed, Bitcoin has seen $5 billion of inflows while ETH products have seen $500 million of outflows (from Grayscale).
In the first eight months of the year, Bitcoin recorded its highest ever trading volume to-date, exceeding even the crypto bubble of 2021.
The most recent data from Dune shows Bitcoin ETFs having cumulative onchain holdings of $59.2 billion with BlackRock having 38% market share with $22.5 billion.
At the time of the ETFs launching, our team covered Coinbase and Robinhood in an analysis where we examined the impact of spot ETFs. Coinbase’s management team stated at the time:
Q: “Will Coinbase consider reducing transaction fees to make them more competitive with other platforms where ETFs are being traded at significantly lower prices?”
A: “We have no current plans to reduce transaction fees because of ETFs. If you just zoom out a little bit, spot ETF should be a positive catalyst for the entire crypto space. They should add credibility to the market, and we should see increased liquidity and market stability as we've seen with other asset classes such as gold.”have no current plans to reduce transaction fees because of ETFs. If you just zoom out a little bit, spot ETF should be a positive catalyst for the entire crypto space. They should add credibility to the market, and we should see increased liquidity and market stability as we've seen with other asset classes such as gold.”
It was our hypothesis at the time that lower volatility would mean fewer transactions for Coinbase, resulting in ETFs having a net impact on Coinbase.
In the Q4 call, Coinbase’s management team also asserted the ETFs will have a positive impact on the company’s revenue: “This will unlock new pools of capital to flow into the crypto space with Coinbase playing a key role here. We are earning revenue, not just on custody, but also on trading and financing.” It was also stated: “And we've always said that ETFs would be a win-win for Coinbase, and we're starting to see that play out on our platform.”
Being even more direct in the Q4 call held in February, it was stated: “For anybody worried about cannibalization, ETFs have been positive for the industry, which has been additive for Coinbase. We're seeing elevated engagement and net inflows across both retail and institutional Q1 to date” and also “ETFs are a massive way to get more capital to come in. So far, we have not seen any cannibalization. As Alesia said, it's been additive for Coinbase, and we're seeing elevated engagement and net inflows on both retail and institutional Q1 to date.”
However, the data we have pulled shows ETFs are not additive, and are instead, having a negative effect on Coinbase.
Source: I/O Fund
Description: Bitcoin hit all-time highs in Q4 2021 and again in Q1 2024. We can see from the data above that Coinbase is participating at a lower percentage of trading volume.
We would want to see higher institutional volume than the last ATH for the narrative that Coinbase is participating in institutions driving forward Bitcoin’s asset price in Q1 2024. Instead, we see it’s flat while consumer is more than 50% lower than Bitcoin’s last all-time high. The interpretation is that Bitcoin ETFs are not an additive for Coinbase at this time.
Similar to volume, we would want to see growth in institutional revenue help to offset a decline in consumer revenue.
Source: I/O Fund
Description: Transaction revenue from institutions was similar between Bitcoin’s previous all-time high, yet consumer is revealing that Coinbase’s fees are not attractive compared to the $0 trade fees from ETFs (albeit ETFs come with management fees).
The custodial fees of roughly $35 million, are up about $20 million since before the ETFs launched but do not help to absorb the combined $1.256 billion difference in transaction revenue between Bitcoin’s last ATH in Q4 2021 and Bitcoin’s ATH in Q1 of 2024.
The Bitcoin ETFs are cheaper to trade on stock trading platforms at $0 fees. As Bitcoin’s reputation has greatly increased with institutional participation, there may also be a psychological hurdle to trading and owning other cryptos, which in contrast, are high risk and have little to no institutional adoption. This would weigh on Coinbase compared to the last crypto boom as Bitcoin’s rising popularity erodes Coinbase’s value proposition to offer tokens that are hard to find on other exchanges.
Keep in mind, if this was purely a fundamentals play, the decoupling of Coinbase’s transaction revenue with the bellwether’s new all-time high would be concerning. However, Coinbase represents a means of trading crypto as a stock, and thus, even with a much lower revenue correlation to Bitcoin’s asset price, we expect Coinbase will continue to trade in lock-step with the bellwether.
ETF Custodian
Coinbase is the custodian for 10 out of 11 spot ETFs and eight of the nine approved Ethereum ETFs. In addition to being paid custodian fees, Coinbase can monetize ETFs through trading fees on the Prime product for institutions and financing for trade settlements.
We only have a two-quarter glimpse at results, yet the custodian fees are not able to offset the losses in transaction revenue. The custodial fee revenue for Q4 was $19.7 million, and grew 64% QoQ to $32.3 million in Q1. However, in Q2, the QoQ growth was only 6.8% QoQ.
Notably, this week, Blackrock has amended its custody agreement with Coinbase to require 12 hour withdrawals. According to the amendment, Coinbase Custody must now process a withdrawal of digital assets to a public blockchain address within 12 hours of receiving instructions from the Trust. This follows social media rumors that Coinbase was not purchasing Bitcoin with funds from ETFs, and was instead, issuing letters of debt. The pushback on these rumors is that Bitcoin’s price has been depressed due to other causes, and that Coinbase settles transactions on-chain even when some wallet addresses are concealed. The outcome is that there will be more liquidity and faster settlements for ETFs and institutions, and it’s likely Coinbase has to follow similar settlement times for consumers, as well.
Coinbase Financials:
Coinbase has tricky financials since it’s a crypto-related company. It would be tough to rely on fundamentals for an entry as it can change quickly in either direction. The metric that tends to track the best with Coinbase’s price action is asset prices and monthly transaction volume for crypto. However, the crypto market is largely dictated by sentiment, and we’ve found that Coinbase’s price is as an extension of this reality. The best indication of Coinbase’s trend is to track Bitcoin’s trend. They have been moving in lockstep since COIN’s IPO.
Coinbase’s forward estimates are meaningless as the estimates require predicting where crypto will trade in any given quarter. This is impossible for any analyst to do. Rather, for investors in Coinbase, importance should be placed on crypto transaction volumes, volatility indicators and pricing.
The company is also cyclical as it laps tough comps more often than a typical growth stock. By virtue of Bitcoin and crypto reaching a new high in March of 2024, the company is expected to see negative growth of (-12.08%) the following year in the March quarter of 2025.
Again, estimates are meaningless. If crypto is trading at all-time highs in March, then Coinbase will report growth – this company has seen growth of 1,100% in one quarter in 2021. During periods of crypto selloffs, the company has reported up to (-75%) revenue decline. As you can probably guess, this was in 2022.
Where Coinbase has seen a remarkable turnaround is with the cash flows, from (-51.6%) in 2022 to 27.7% in 2023. The company is prudent at keeping cash on its balance sheet with $7.23 billion in cash and $4.23 billion in debt for net cash of $3 billion. This is helpful as a stock, yet also helpful given the counterparty risks crypto exchanges carry; with nearly every competitor being private and not regulated by the SEC, the transparency of having $3 billion in cash and reporting quarterly is likely to attract institutional interest.
Revenue:
This quarter, the company is expected to report revenue of $1.28 billion for growth of 89.7%. Due to lapping tough comps, the growth rate is expected to slow considerably in early 2025 with current estimates expecting a bottom in Q1 2025 with growth of (-12.08%).
Notably, on a QoQ basis, Coinbase will be nominally up in revenue from Q4 2024 to Q2 2025 whereas it’s a tough YoY comp from Bitcoin reaching all-time highs in March of 2024.
Last quarter, Coinbase reported revenue of $1.45 billion for growth of 105%, beating estimates by 6.2%. This declined from the March quarter with growth of 112% and revenue of $1.64 billion.
If you look further out, you see that analysts shy away from predicting too much growth in either direction. This is why technicals matter quite a bit with Coinbase:
Pictured Above: Analyst estimates are essentially flat due to an inability to predict crypto trading volumes.
Key Segments:
Coinbase’s trading volume was $226 billion, up 146% YoY yet down (-28%) QoQ. This compares to $312 billion in the March quarter when Bitcoin was at all-time highs.
Coinbase’s transaction revenue was $781 million in the most recent quarter ending in June, representing growth of 138.7% YoY and a decline of (-27%) QoQ. During Bitcoin’s peak in March, the company reported transaction volume of $1.08 billion. Compare this to 2023’s transaction volumes, which were less than $500 million and often down up to (-50%).
Management stated that there is beginning to be a disconnect between revenue and volume due to wallet fees and derivatives being counted as consumer revenue yet do not contribute to consumer volume.
Within Transaction revenue, Consumer is the main driver at $664.8 million compared to Institutional volume of $63.6 million. The institutional percentage has been growing rapidly from $39 million in H1 2023 to $149 million in H1 2024 for 282% growth. Consumer grew 159% in the same period.
Base revenue has been moved to Other transaction revenue and was at $52.5 million in the current quarter. From H1 2023 to H1 2024, Base and other transaction revenue grew 145%. This means that Base revenue is higher than custodial fees.
Management stated they saw $210 million in transaction volume for July, pointing toward mid-$600 millions for transaction volume. This compares to $110 million for July of last year in the same period.
What we’ve extrapolated above is that Coinbase is not a beneficiary of Bitcoin ETFs as both trading volumes and transaction revenue are significantly lower than Bitcoin’s previous all-time highs but that institutions, derivatives and Base may (over time) help make up for consumer-related spot trading losses.
Subscription and services revenue was $599 million, compared to the guide for $525M to $600M, reporting growth of 78.6% YoY and 17% QoQ. This is an all-time high for Coinbase in this segment and helps to diversify from being dependent entirely on transaction volume. The growth was due to stablecoin revenue and a one-time blockchain validator reward of $8 million.
Within Subscription and Services:
Looking forward, subscription and services are expected to be “within a range of $530 million to $600 million.”
Stablecoin revenue of $240.4 million was up 59% YoY and reached an all-time high. The segment was up 17% QoQ. According to management, they are seeing almost $20 billion per week in USDC transaction volume. USDC is a 1:1 with the dollar and is used for global transfers. Advanced crypto traders and institutions will also settle a high-dollar token swap with USDC rather than token-to-token or transferring into cash to avoid high spreads and high fees.
Blockchain rewards was at $185.1 million, up 111% YoY and up 22.6% QoQ. This segment opens up an interesting opportunity as interest rates go lower. Staking yields are not determined by FOMC policy; instead, by the participation rate of coins being staked. As demand increases for crypto, yields will increase to entice more coins to be staked. As a non-correlated yield to traditional financial instruments, which are mostly tied to central bank policy, this creates an opportunity for portfolios to diversify incomes in an interesting way, and adoption should increase as rates go lower.
Interest and finance fee income of $69.4 million, up 34% YoY. This segment is tied to interest rates, as Coinbase offers loans against the coins being held in house. This is unlikely to sustain now that the FED has lowered rates. Yet, segments such as these can help stave off losses since crypto as an asset class tends to underperform in a high interest rate environment.
Custodial fee revenue was $34.5 million, up 103% YoY.
Other subscription and services revenue of $69.6 million was up 153% YoY.
Margins:
Coinbase does not provide a gross margin on their income statement. The operating margin fluctuates wildly aligned with revenue fluctuations. Last quarter, the operating margin was 23.7% compared to 46.4% in the previous quarter. A year ago, the operating margin was (-10.4%).
The operating expenses increased 26% QoQ to $1.1 billion primarily due to a loss of (-$31 million) on crypto assets held for operations in Q2 compared to a gain of $86 million in Q1 and Technology & development, G&A, sales & marketing expenses increased by $106 million due to higher USDC reward payouts, performance marketing spend, and policy spending.
Net margin last quarter was 2.5% for $36.1 million in profits. This was down considerably from 71.9% in the previous quarter with profits of 1.18 billion. In the year ago quarter, the net margin was (-13.8%) for losses of ($97.6) million.
Stock based compensation was $217 million or 15% of revenue last quarter. This is down considerably from 28% of revenue last year. However, management stated: “We expect technology & development and general & administrative expenses to increase Q/Q to $700-$750 million, largely driven by the non-linear expense recognition of our stock-based compensation.” This would imply a $40 million increase at the midpoint for $257 million in SBC or about 20% of revenue.
Earnings and EBITDA:
GAAP EPS of $0.14 last quarter compared to GAAP EPS estimates of $0.92. This compared to GAAP EPS of $4.40 last quarter and adjusted EPS of ($0.42) in the year ago quarter.
Adjusted EPS of $0.14 last quarter compared to estimates for $0.80 EPS.
Coinbase is expected to report adjusted EPS of $0.43 next quarter and GAAP EPS of $0.48. The expectation is that Coinbase remains GAAP profitable although this will depend on the level of drawdown seen in any future crypto selloffs.
The company reported adjusted EBITDA of $595.5 million for a margin of 41.1% compared to adjusted EBITDA of $1.01 billion last quarter for a margin of 61.9%.
Notably the company was adjusted EBITDA positive even in Q2 and Q3 of 2023 when it reported negative YoY revenue. At that time, adjusted EBITDA was in the range of 26% and 27% for $188.7 million and $178.3 million. When including stock-based compensation, the company would not be adjusted EBITDA positive as SBC was $199.8 million and $218.2 million, respectively, in those two quarters.
Coinbase Additional Notes:
More on Derivatives:
As stated, derivatives are about 70% of the trading market for crypto. A derivative contract is an instrument, such as a futures contract, option or perpetual contract, whose price is based on the underlying crypto currency. Unlike spot trading, where you are buying the asset and mostly participating on the long side, derivative trading allows the owner of the contract to speculate on both up and down price movements, hedge a spot position, or add leverage to a position. This allows an investor to bet on the inevitable downtrends in crypto, and therefore allows institutions, or retail traders, to hedge their positions.
Derivatives are a key element to attract savvy retail and institutional investors. Having a user-friendly platform to trade these instruments is an important piece to Coinbase’s evolution with institutional adoption. In the medium-term, derivatives will help to compensate for the lower consumer spot trading volumes on Coinbase’s platform.
Great. Thank you. Hi, Brian. Hi, Alesia I just want to ask a question about the derivatives platform and we're tracking just quarter-to-date, a continuation of building volumes there. And I know you're not breaking it out in revenues separately yet, but it sounded like it was a positive contributor in the second quarter.
Brian ArmstrongBrian Armstrong
Yes. So I'll start off and then maybe I'll hand over to you, Alesia on some of the margin questions. So just zooming out, derivatives is about 75% of all crypto trading activity by volume. And so it is the majority of trading volume. Now the take rates are lower on it, but it's really a key part of the market overall. And so I'm really glad that we are now in market, both the U.S. with Coinbase financial markets and then internationally with our international exchange as well
For Coinbase International Exchange, we also expanded our asset coverage quite a lot in Q2. We added 25 additional perpetual futures contracts. The volume has been really good today, actually, on Coinbase International Exchange. So you can check out at international.coinbase.com.
And so you can kind of just see Coinbase following this path of we're not always first-to-market, but we do it the do it the right way. We compliant way, the secure, trusted way. And so we're the trusted counterparty that many of these folks have been waiting for to enter the market. And I think that's going to pay off as a really good long-term strategy. Alesia, anything you want to add?
–End Quote
Base Layer 2
As stated above, the offer for no trading fees (or “gasless transactions”) is accomplished through Base, which is a Layer 2 built on the Ethereum network. Base offers 1 cent, 1 second transactions with Coinbase reporting there is $20 billion per week in USDC transactions taking place on the Layer 2. Base offers interoperability with other Ethereum network-compatible applications, offering the security of Ethereum’s Layer 1 while improving Ethereum’s scalability issues (primarily gas fees). Coinbase’s goal is to decentralize Base to make transactions faster while leveraging the security of Ethereum mainnet.
Total value locked (TVL) for Base was at $8 billion as of July 2024, making Base the second largest Layer 2 by TVL after Ethereum’s Dencun upgrade. Crypto has settled a bit since July, yet Base remains the second largest Layer 2 by TVL with $1.965 billion TVL. Base has seen trading volumes of up to $1 billion per day with up to 3 million transactions per day, whereas Coinbase sees about $2 billion in trading volume and Ethereum sees about 1 million to 2 million transactions per day. This means at the onset, Base exceeds Ethereum in number of daily transactions.
Base is further interesting for I/O Fund Members as the Layer 2 offers Data Streams from Chainlink, which is low-latency data that allows developers to build DeFi apps. Base also offers Chainlink VRF, the leading random number generator across Web3 with more than 21 million transaction requests completed and with a latency of about two seconds. We’ve covered Chainlink automation with up to 90% reduction in gas fees, Cross-chain Interoperability Protocol (CCIP) and Price Feeds in the past here. Our original Chainlink thesis is a must-read for anyone new to the I/O Fund, as LINK is an asset our firm has held since launching our research site in 2019.
Over the past few months, Base has been integrated by Stripe and Shopify, which is an important step forward to see onchain versions of Fortune 500 applications. Stripe uses Base for faster and cheaper money transfers by adding USDC to crypto payouts, and fiat-to-crypto for currency conversions. There is also an integration with Coinbase Wallet to allow users to purchase crypto with credit cards and Apple Pay. Stripe originally offered crypto payments in 2014 but ceased doing so in 2018.
The company has stated its focus is to build a developer ecosystem around Base first and foremost: “Our focus, as I mentioned in my opening remarks, is driving developer activity, we're driving those transaction volumes that we commented on. We're doing this by driving down fees, increasing the scalability and creating a powerful developer platform that's enabling anybody to build these onchain products.
We believe that this growth will then add users to develop products, we'll add developers and apps on Base. And that in turn will drive transaction volume and will drive down sequencer fees, and we will then see revenue as a result of those efforts.
Regulations
For institutions, there is a product called Coinbase Prime. This is a full-service prime brokerage platform, which facilitates trades as well as custodian services for large institutions. Management has stated institutions have maybe 1% to 3% of their funds in crypto. This is a low allocation, which has a lot of potential for growth. However, it is being stymied due to the lack of much needed regulations within the crypto space, which has been fraught with fraud.
For example, On November 11th, 2022, FTX, one of the largest crypto exchanges in in the world, filed for bankruptcy. At the time, it was the 18th crypto exchange to file for bankruptcy, and by far the largest, with an estimated $9 billion lost. One of the many fraudulent practices, which wasn’t limited to FTX, was that FTX would not register an internal transaction until a customer wanted their coins out of the exchange. This led to a scenario where 28 million Bitcoins had been bought with only 19.8 million in supply. Therefore, FTX created a crypto-version of a ponzi scheme that suddenly ended.
There have been a total of 20 crypto exchanges that have failed through 2024. The reason for their failures range from hacking events, mismanagement due to faulty business models, to outright fraud. We’ve even seen exchanges attempt a fractional reserves model where loans were offered based on a fraction of the total coins being held on their exchange.
These exchanges are all private businesses, except for Coinbase, so there is no way to see their financials. Furthermore, there are no mandatory audits to prevent fraud or mismanagement. When you factor in that over 50% of all cryptocurrencies have failed, it’s no wonder institutions managing millions to billions have been hesitant to explore this asset class.
As of now, Canada, UK, Switzerland, El Salvador, and China have regulations around crypto currencies. The United States is expected to follow, as the House just passed a meaningful crypto bill that defines regulations. The 200 page bill helps categorize a cryptocurrency and thus determines if should be regulated as a security by the SEC or as a digital commodity by the CFTC, through well-defined oversight. Furthermore, the bill would remove exchanges from comingling coins, as well as removing conflicts of interest, such as trading as an entity while also acting as a broker between buyers and sellers.
Whether it gets passed by the Senate is yet to be seen. With some of the world’s largest financial institutions now involved in the crypto space through Spot ETFs, it’s only a matter of time before much needed regulations will settle the nerves of money managers looking to diversify into this space. When this happens, it should act as a tailwind to Coinbase’s current business model.
Strong Cash on the Balance Sheet
As stated, free cash flow was $484.2 million or 33.4% of revenue compared to $151.1 million or 21.4% of revenue in the same period last year and 25.1% of revenue in Q1.
Cash was $7.23 billion and debt of $4.23 billion compared to $6.7 billion and $4.23 billion in Q1. The company issued $1.3 billion of convertible notes in Q1 and plans to use the net proceeds of $1.1 billion to repay the outstanding debt at or prior to maturity, depending on the market prices. Management also clarified in the earnings call that the other reasons for maintaining large cash balances were to support the ETF launches and for potential investment opportunities.
Here was a question on the earnings call:
Benjamin BudishBenjamin Budish
Hi. Good evening, and thanks for taking the question. I was wondering if you could give us an update on your balance sheet strategy. We noticed the cash build continues to really grow. And it seems like with the — the business generating cash and spending really kind of ramped down from a few years ago, there may not be as much of a need for it. So any update there? And then kind of along the same lines, you've been generating now a lot of your gross profit from interest income. And just curious, if there's any thoughts around the hedging strategy should rates start to come down. What's your kind of philosophy there? Thank you.
Alesia HaasAlesia Haas
Thanks for those questions. Yes, we're really pleased with the balance sheet strength. We are using cash, as we've mentioned in our prime financing business. A large amount of that cash was used to support the ETF launches in Q1 and Q2 with the Bitcoin ETF and now hopefully be a Ethereum ETF where you can see a lot of day-to-day or week-to-week volatility of those loan balances.
We did grow prime financing fees within the quarter. And so you can see while the balance at the end the end of quarter was down versus of Q2. We saw growth intra-quarter for those balances. So using our cash to support our products is a primary use case for us.
Technical Analysis
Coinbase appears to be working through a very large 5 wave pattern off its early 2023 low. If this is accurate, any additional weakness will need to hold $113, and then start making higher highs to the 5th wave target between $294 – $217.
As of now, the larger correction that started in March of this year appears to be supporting this. It is a 3 wave correction that has room for one more swing lower to complete. If the current bounce fails to break over $172 – $181.50, then we can see a final drop into the $137 – $127 region. If we can instead breakout above $181.50, the odds will start supporting that the 4th wave low is in, and we will likely be in the early stages of wave 5 to new highs.
This lines up with Bitcoin’s chart, as well. The pattern off the late 2022 low appears to be an unfinished 5 wave pattern. Note the current correction. It is messy, with many overlaps, which is typical of corrections within larger uptrends. The bigger pattern suggests that we should be heading to $78,000 – $85,000 next, which would give us the minimum waves required to complete the 5 wave uptrend. Once we get to this region, or beyond. How we correct from there will determine just how high into the $100,000 region we will go.
For now, the probabilities favor a swing higher. As long as we hold $42,750 on any additional weakness, this remains our expectation from the technical patterns in both Coinbase and Bitcoin.
Conclusion:
Publicly, our firm has become known for our Nvidia AI thesis, and how we have positioned our readers for this trend before 2023. Yet behind the paywall, our premium subscribers are well aware that our active management with crypto since 2019 is equal in terms of its performance. By championing active management for tech investors — which means weighing the probabilities to cut or trim at specific times with the goal of buying lower — the I/O Fund stands out in a crowded, noisy crypto space by offering tools to navigate the volatility in this asset class.
Coinbase’s move into the derivatives market, as well as being a trusted custodian for institutional investors in the crypto space, will continue to entice institutions to their platform. Being a publicly traded company, Coinbase is the only exchange that allows its financials to be analyzed and monitored. This is crucial for investors considering the lack of FDIC and SPIC insurance in this space. These exchanges are businesses that can be mismanaged, and if this happens, all the coins being held there will be appropriated and redistributed to creditors in the event of a bankruptcy. This is a risk that Coinbase offers a solution to through their business model and publicly issued quarterly financials. This makes Coinbase stand out amongst its peers in a way that creates a moat for institutions looking to expand into the crypto space beyond the limited and costly spot ETF options.
Coinbase’s stock pattern lines up with Bitcoin, as both continue to suggest another swing higher is likely. If COIN can continue to evolve with the crypto market, and continue to lead as a trusted institutional platform, it will likely continue to appreciate with Bitcoin over time.
Given Chainlink is becoming a beneficiary of Layer 2s like Base and Arbitrum, you can expect an updated 2024 deep dive on our favorite blockchain asset coming soon!
Please note: The I/O Fund conducts research and draws conclusions for the Fund’s positions. We then share that information with our readers. This is not a guarantee of a stock’s performance. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis.
The I/O Fund recently entered Coinbase primarily based on technicals. Coinbase offers investors a rare glimpse into the fundamentals of a crypto-related company, yet it’s clear to see Coinbase’s fundamentals are not a reliable indicator of future performance. Rather, asset prices and volatility in crypto are more important than traditional fundamentals for Coinbase because the company charges trading fees for each transaction.
Below is a clear picture that Coinbase trades in lock-step with Bitcoin. Due to it being a publicly traded stock, Coinbase can exceed Bitcoin at crypto peaks due to the ease of trading a stock compared to crypto assets.
Coinbase has primarily been a spot trading exchange, to where crypto traders buy the asset at current market prices. In November of 2023, Coinbase added derivatives trading which will help the exchange participate in a higher percentage of trading activity. Derivatives trading is roughly 2/3 of all crypto trading compared to spot trading at 1/3. Sometimes, derivatives trading is as high as 70% or even 75% of crypto trading volume, which means for the first time this year, Coinbase is able to participate in this lucrative space.
Equally as important (if not more so), Coinbase has launched a Layer 2 called Base over the past year, which has been growing in popularity and ranks #6 across both Layer 1 and Layer 2 chains in terms of total value locked (TVL). At one point, Base surpassed Solana in its first year of launching. Base facilitates faster and cheaper transactions, which is the most critical problem for the crypto complex to solve. If Coinbase has truly solved this pain point with Base, and it appears it has, then the company is setting up a nice future for itself by not only diversifying away from asset prices and crypto volatility, but is also opening up a new revenue stream that theoretically could eclipse platform revenue once the blockchain ecosystem is fully mature.
Before we sound the bull horn, Coinbase has an important hurdle to clear. Bitcoin ETFs are impacting Coinbase’s core business model of charging high fees for crypto transactions. It’s clear from the data we pulled below that ETFs are not additive for Coinbase, which is the opposite of what management had promised earlier this year. Instead, Coinbase is participating at a lower percentage when comparing to the last time Bitcoin reached an all-time high.
We look at these key points below. Please note, crypto is highly volatile. The I/O Fund plans to trade Coinbase as a momentum play and this stock is for Advanced Members only. Should Coinbase break key levels, we will close the position with no hesitation. As stated, technicals carry higher importance than fundamentals for crypto, and this is true for Coinbase due to its correlation with Bitcoin. You can find critical notes from Knox on his trading plan below.
Coinbase Overview
Coinbase is best known as a crypto trading platform, which accompanies high volatility and an overabundance of competition. The company charges transaction fees for each trade with fees up to 0.50% up to 4.5%. This is quite high when you consider money managers typically charge on average a 1% recurring fee to manage an entire account. The high fees are further brought into focus when you consider that equities, including ETFs, no longer charge transaction fees.
Coinbase’s success is tied to trading volumes, as higher volumes lead to higher fees for Coinbase. Even though we are seeing Coinbase successfully diversify their revenue, trading volume still accounts for the bulk of their revenue, and likely will for the time being. The arrival of Bitcoin ETFs is impacting Coinbase’s primary source of revenue, as ETFs offer an easy alternative to Coinbase’s fee driven trading platform. The ways in which Coinbase successfully pivots and differentiates its trading platform will be crucial for its ability to grow in the crypto space as the high trading fees will continually become disrupted.
We are seeing Coinbase’s trading platform to evolve to meet these challenges. Advanced Trade, previously called Coinbase Pro, is a platform for more advanced crypto traders that offers staking, decentralized app wallets, the ability to trade crypto derivatives and even a Coinbase credit card.
As discussed, the ability to trade derivatives on Coinbase is new this year. Derivatives are a large portion of daily crypto market activity. According to CoinDesk, derivatives were at 68% of the market in March of 2024, reaching a high of $6.18 trillion of $9.12 trillion in total trading volume. This is when Bitcoin was at all-time highs of $73,000+. Last month, CoinNess reported that derivatives reached a total of $5.22 trillion with $3.68 trillion or 70% being from derivatives trading.
Spot trading (which is your typical crypto trading) accounted for $1.54 trillion of crypto exchange volumes last month, or about 30% of volume. In March, spot trading reached a peak of $2.94 trillion for the highest monthly volume since May of 2021.
Coinbase reported a decline in spot trading volume of 28% QoQ citing volatility in crypto pricing. This quarter will be important for spot trading volume growth and derivatives growth as competitors Crypto.com have been reporting growth MoM on spot trading and up to $1 billion in open interest in derivatives, up 4X since January. Crypto.com has significantly lower trading fees of 0% to 0.075%, so it’s not too surprising it's gaining market share while Coinbase is struggling considering that spot traders will often use whichever platform offers the most competitive trading fees. Binance offers 0.1% fees on spot trading.
Coinbase One is a subscription plan that removes trading fees for $29.99 a month for the first $10,000 traded every month. This can work for investors who dollar cost average every month, yet is unrealistic for most crypto investors. One of the premiere features of Coinbase One is that it offers up to $1 million in insurance under certain terms and conditions.
The offer for no trading fees (or “gasless transactions”) is accomplished through Base, which is a Layer 2 built on the Ethereum network. Base offers 1 cent, 1 second transactions with the company currently seeing $20 billion per week in USDC transactions. By bundling hundreds of smaller transactions and processing them as one large Ethereum transaction with Ethereum as the settlement layer, Base reduces the transaction fee. The OP stack that Base is built on helps to deploy Rollup blockchains. We’ve discussed Rollups before in an Ethereum analysis as a key feature for the merge to Proof of Stake. Rollups allow hundreds of transactions to be rolled into one.
Base is compatible with the Ethereum Virtual Machine (EVM), which is the runtime layer that executes smart contracts on the Ethereum network. By being an EVM-compatible Layer 2 chain, Base offers interoperability with other EVM-compatible applications and the security and decentralization of Ethereum’s Layer 1 while improving on the Ethereum network’s scalability issues. We’ve covered the scalability issues in a previous analysis that discussed high gas fees on the Ethereum network. Due to lowering transaction fees, Base saw 300% QoQ growth in the number of transactions last quarter.
Due to Base resulting in faster transaction times, lower fees and offering compatibility with Ethereum, the Layer 2 chain is open sourced for developers to utilize these features for custom decentralized apps (dapps). The plan is to increase Base’s revenue potential after building a developer ecosystem around Coinbase’s unique ability to develop a Layer 2 that addresses gas fees: “We believe that this growth will then add users to develop products, we'll add developers and apps on Base. And that in turn will drive transaction volume and will drive down sequencer fees, and we will then see revenue as a result of those efforts.”
Coinbase is the sequencer, which manages the collection and publication of user transactions. For now, Coinbase controls the transactions, which will need to change in the future to adhere to blockchain’s ethos of decentralization. Coinbase is clearly profiting from Base with an estimated $52.5 million in the current quarter – exceeding even custodian ETF fees. By combining many transactions into one payment, Base can collect an arbitrage between the transaction fees and the network gas fees. There is also interest income from USDC on Base.
The Coinbase Developer Platform is a much larger initiative to become the backbone for financial-based decentralized apps (dapps). The platform offers APIs such as: building programmable crypto wallets to transfer crypto between two parties, or the ability to send, receive, trade and stake crypto. There are software development kits (SDKs) that help to integrate onchain AI, trading bots or automated payouts.
Bitcoin ETFs Having a Negative Impact on Coinbase
This year, the SEC approved 11 spot Bitcoin ETFs on January 10th, opening the door for more investors to gain exposure to Bitcoin without directly holding it. We stated at the time that the approval and subsequent widespread access for institutions and retail investors would shape up to be one of the most bullish fundamental moments in Bitcoin’s history.
Our paid research site has been anticipating this moment since 2019 when we stated: “One of the biggest hurdles for institutions, however, is not the idea of a world run on digital currencies, but rather the decentralization concept and the need for cryptocurrency storage. Institutional investors need to know the assets are secure, insured, and under the care of a trusted third party, per SEC rules, which requires advisers to keep client funds with a qualified custodian.”
Due to ETFs, the demand for Bitcoin has increased. Spot Bitcoin ETFs have seen a surge in net inflows, surpassing more than $30B AUM in mid-April after amassing $17B in funds in less than two months after a launch in mid-January. Trading volume on the ETFs nearly tripled in March, reaching $111 billion – for an asset class that had launched only two months prior, that’s a significant figure.
By mid-July, BlackRock Bitcoin ETF (IBIT) surpassed Invesco QQQ in year-to-date net flows despite total assets in IBIT being only a fraction of the Qs at $22 billion compared to $287.2 billion. At the time, two Bitcoin ETFs were in the top 10 including Fidelity.
In late August and early September, investors pulled roughly $1.2 billion or 3% of total assets from Bitcoin ETFs in the “worst string of outflows yet.” At eight of the eleven ETFs, this was the most consecutive days of net outflows that ETFs have experienced since the Jan 2024 launch. The 3% shows resiliency and may be leading to higher lows for Bitcoin, given the ETF outflows were not higher.
Since then, Bitcoin ETFs have seen their second consecutive week of inflows while Ethereum ETFs are seeing outflows. Since Ethereum ETFs were listed, Bitcoin has seen $5 billion of inflows while ETH products have seen $500 million of outflows (from Grayscale).
In the first eight months of the year, Bitcoin recorded its highest ever trading volume to-date, exceeding even the crypto bubble of 2021.
The most recent data from Dune shows Bitcoin ETFs having cumulative onchain holdings of $59.2 billion with BlackRock having 38% market share with $22.5 billion.
At the time of the ETFs launching, our team covered Coinbase and Robinhood in an analysis where we examined the impact of spot ETFs. Coinbase’s management team stated at the time:
Q: “Will Coinbase consider reducing transaction fees to make them more competitive with other platforms where ETFs are being traded at significantly lower prices?”
A: “We have no current plans to reduce transaction fees because of ETFs. If you just zoom out a little bit, spot ETF should be a positive catalyst for the entire crypto space. They should add credibility to the market, and we should see increased liquidity and market stability as we've seen with other asset classes such as gold.”have no current plans to reduce transaction fees because of ETFs. If you just zoom out a little bit, spot ETF should be a positive catalyst for the entire crypto space. They should add credibility to the market, and we should see increased liquidity and market stability as we've seen with other asset classes such as gold.”
It was our hypothesis at the time that lower volatility would mean fewer transactions for Coinbase, resulting in ETFs having a net impact on Coinbase.
In the Q4 call, Coinbase’s management team also asserted the ETFs will have a positive impact on the company’s revenue: “This will unlock new pools of capital to flow into the crypto space with Coinbase playing a key role here. We are earning revenue, not just on custody, but also on trading and financing.” It was also stated: “And we've always said that ETFs would be a win-win for Coinbase, and we're starting to see that play out on our platform.”
Being even more direct in the Q4 call held in February, it was stated: “For anybody worried about cannibalization, ETFs have been positive for the industry, which has been additive for Coinbase. We're seeing elevated engagement and net inflows across both retail and institutional Q1 to date” and also “ETFs are a massive way to get more capital to come in. So far, we have not seen any cannibalization. As Alesia said, it's been additive for Coinbase, and we're seeing elevated engagement and net inflows on both retail and institutional Q1 to date.”
However, the data we have pulled shows ETFs are not additive, and are instead, having a negative effect on Coinbase.
Source: I/O Fund
Description: Bitcoin hit all-time highs in Q4 2021 and again in Q1 2024. We can see from the data above that Coinbase is participating at a lower percentage of trading volume.
We would want to see higher institutional volume than the last ATH for the narrative that Coinbase is participating in institutions driving forward Bitcoin’s asset price in Q1 2024. Instead, we see it’s flat while consumer is more than 50% lower than Bitcoin’s last all-time high. The interpretation is that Bitcoin ETFs are not an additive for Coinbase at this time.
Similar to volume, we would want to see growth in institutional revenue help to offset a decline in consumer revenue.
Source: I/O Fund
Description: Transaction revenue from institutions was similar between Bitcoin’s previous all-time high, yet consumer is revealing that Coinbase’s fees are not attractive compared to the $0 trade fees from ETFs (albeit ETFs come with management fees).
The custodial fees of roughly $35 million, are up about $20 million since before the ETFs launched but do not help to absorb the combined $1.256 billion difference in transaction revenue between Bitcoin’s last ATH in Q4 2021 and Bitcoin’s ATH in Q1 of 2024.
The Bitcoin ETFs are cheaper to trade on stock trading platforms at $0 fees. As Bitcoin’s reputation has greatly increased with institutional participation, there may also be a psychological hurdle to trading and owning other cryptos, which in contrast, are high risk and have little to no institutional adoption. This would weigh on Coinbase compared to the last crypto boom as Bitcoin’s rising popularity erodes Coinbase’s value proposition to offer tokens that are hard to find on other exchanges.
Keep in mind, if this was purely a fundamentals play, the decoupling of Coinbase’s transaction revenue with the bellwether’s new all-time high would be concerning. However, Coinbase represents a means of trading crypto as a stock, and thus, even with a much lower revenue correlation to Bitcoin’s asset price, we expect Coinbase will continue to trade in lock-step with the bellwether.
ETF Custodian
Coinbase is the custodian for 10 out of 11 spot ETFs and eight of the nine approved Ethereum ETFs. In addition to being paid custodian fees, Coinbase can monetize ETFs through trading fees on the Prime product for institutions and financing for trade settlements.
We only have a two-quarter glimpse at results, yet the custodian fees are not able to offset the losses in transaction revenue. The custodial fee revenue for Q4 was $19.7 million, and grew 64% QoQ to $32.3 million in Q1. However, in Q2, the QoQ growth was only 6.8% QoQ.
Notably, this week, Blackrock has amended its custody agreement with Coinbase to require 12 hour withdrawals. According to the amendment, Coinbase Custody must now process a withdrawal of digital assets to a public blockchain address within 12 hours of receiving instructions from the Trust. This follows social media rumors that Coinbase was not purchasing Bitcoin with funds from ETFs, and was instead, issuing letters of debt. The pushback on these rumors is that Bitcoin’s price has been depressed due to other causes, and that Coinbase settles transactions on-chain even when some wallet addresses are concealed. The outcome is that there will be more liquidity and faster settlements for ETFs and institutions, and it’s likely Coinbase has to follow similar settlement times for consumers, as well.
Coinbase Financials:
Coinbase has tricky financials since it’s a crypto-related company. It would be tough to rely on fundamentals for an entry as it can change quickly in either direction. The metric that tends to track the best with Coinbase’s price action is asset prices and monthly transaction volume for crypto. However, the crypto market is largely dictated by sentiment, and we’ve found that Coinbase’s price is as an extension of this reality. The best indication of Coinbase’s trend is to track Bitcoin’s trend. They have been moving in lockstep since COIN’s IPO.
Coinbase’s forward estimates are meaningless as the estimates require predicting where crypto will trade in any given quarter. This is impossible for any analyst to do. Rather, for investors in Coinbase, importance should be placed on crypto transaction volumes, volatility indicators and pricing.
The company is also cyclical as it laps tough comps more often than a typical growth stock. By virtue of Bitcoin and crypto reaching a new high in March of 2024, the company is expected to see negative growth of (-12.08%) the following year in the March quarter of 2025.
Again, estimates are meaningless. If crypto is trading at all-time highs in March, then Coinbase will report growth – this company has seen growth of 1,100% in one quarter in 2021. During periods of crypto selloffs, the company has reported up to (-75%) revenue decline. As you can probably guess, this was in 2022.
Where Coinbase has seen a remarkable turnaround is with the cash flows, from (-51.6%) in 2022 to 27.7% in 2023. The company is prudent at keeping cash on its balance sheet with $7.23 billion in cash and $4.23 billion in debt for net cash of $3 billion. This is helpful as a stock, yet also helpful given the counterparty risks crypto exchanges carry; with nearly every competitor being private and not regulated by the SEC, the transparency of having $3 billion in cash and reporting quarterly is likely to attract institutional interest.
Revenue:
This quarter, the company is expected to report revenue of $1.28 billion for growth of 89.7%. Due to lapping tough comps, the growth rate is expected to slow considerably in early 2025 with current estimates expecting a bottom in Q1 2025 with growth of (-12.08%).
Notably, on a QoQ basis, Coinbase will be nominally up in revenue from Q4 2024 to Q2 2025 whereas it’s a tough YoY comp from Bitcoin reaching all-time highs in March of 2024.
Last quarter, Coinbase reported revenue of $1.45 billion for growth of 105%, beating estimates by 6.2%. This declined from the March quarter with growth of 112% and revenue of $1.64 billion.
If you look further out, you see that analysts shy away from predicting too much growth in either direction. This is why technicals matter quite a bit with Coinbase:
Pictured Above: Analyst estimates are essentially flat due to an inability to predict crypto trading volumes.
Key Segments:
Coinbase’s trading volume was $226 billion, up 146% YoY yet down (-28%) QoQ. This compares to $312 billion in the March quarter when Bitcoin was at all-time highs.
Coinbase’s transaction revenue was $781 million in the most recent quarter ending in June, representing growth of 138.7% YoY and a decline of (-27%) QoQ. During Bitcoin’s peak in March, the company reported transaction volume of $1.08 billion. Compare this to 2023’s transaction volumes, which were less than $500 million and often down up to (-50%).
Management stated that there is beginning to be a disconnect between revenue and volume due to wallet fees and derivatives being counted as consumer revenue yet do not contribute to consumer volume.
Within Transaction revenue, Consumer is the main driver at $664.8 million compared to Institutional volume of $63.6 million. The institutional percentage has been growing rapidly from $39 million in H1 2023 to $149 million in H1 2024 for 282% growth. Consumer grew 159% in the same period.
Base revenue has been moved to Other transaction revenue and was at $52.5 million in the current quarter. From H1 2023 to H1 2024, Base and other transaction revenue grew 145%. This means that Base revenue is higher than custodial fees.
Management stated they saw $210 million in transaction volume for July, pointing toward mid-$600 millions for transaction volume. This compares to $110 million for July of last year in the same period.
What we’ve extrapolated above is that Coinbase is not a beneficiary of Bitcoin ETFs as both trading volumes and transaction revenue are significantly lower than Bitcoin’s previous all-time highs but that institutions, derivatives and Base may (over time) help make up for consumer-related spot trading losses.
Subscription and services revenue was $599 million, compared to the guide for $525M to $600M, reporting growth of 78.6% YoY and 17% QoQ. This is an all-time high for Coinbase in this segment and helps to diversify from being dependent entirely on transaction volume. The growth was due to stablecoin revenue and a one-time blockchain validator reward of $8 million.
Within Subscription and Services:
Looking forward, subscription and services are expected to be “within a range of $530 million to $600 million.”
Stablecoin revenue of $240.4 million was up 59% YoY and reached an all-time high. The segment was up 17% QoQ. According to management, they are seeing almost $20 billion per week in USDC transaction volume. USDC is a 1:1 with the dollar and is used for global transfers. Advanced crypto traders and institutions will also settle a high-dollar token swap with USDC rather than token-to-token or transferring into cash to avoid high spreads and high fees.
Blockchain rewards was at $185.1 million, up 111% YoY and up 22.6% QoQ. This segment opens up an interesting opportunity as interest rates go lower. Staking yields are not determined by FOMC policy; instead, by the participation rate of coins being staked. As demand increases for crypto, yields will increase to entice more coins to be staked. As a non-correlated yield to traditional financial instruments, which are mostly tied to central bank policy, this creates an opportunity for portfolios to diversify incomes in an interesting way, and adoption should increase as rates go lower.
Interest and finance fee income of $69.4 million, up 34% YoY. This segment is tied to interest rates, as Coinbase offers loans against the coins being held in house. This is unlikely to sustain now that the FED has lowered rates. Yet, segments such as these can help stave off losses since crypto as an asset class tends to underperform in a high interest rate environment.
Custodial fee revenue was $34.5 million, up 103% YoY.
Other subscription and services revenue of $69.6 million was up 153% YoY.
Margins:
Coinbase does not provide a gross margin on their income statement. The operating margin fluctuates wildly aligned with revenue fluctuations. Last quarter, the operating margin was 23.7% compared to 46.4% in the previous quarter. A year ago, the operating margin was (-10.4%).
The operating expenses increased 26% QoQ to $1.1 billion primarily due to a loss of (-$31 million) on crypto assets held for operations in Q2 compared to a gain of $86 million in Q1 and Technology & development, G&A, sales & marketing expenses increased by $106 million due to higher USDC reward payouts, performance marketing spend, and policy spending.
Net margin last quarter was 2.5% for $36.1 million in profits. This was down considerably from 71.9% in the previous quarter with profits of 1.18 billion. In the year ago quarter, the net margin was (-13.8%) for losses of ($97.6) million.
Stock based compensation was $217 million or 15% of revenue last quarter. This is down considerably from 28% of revenue last year. However, management stated: “We expect technology & development and general & administrative expenses to increase Q/Q to $700-$750 million, largely driven by the non-linear expense recognition of our stock-based compensation.” This would imply a $40 million increase at the midpoint for $257 million in SBC or about 20% of revenue.
Earnings and EBITDA:
GAAP EPS of $0.14 last quarter compared to GAAP EPS estimates of $0.92. This compared to GAAP EPS of $4.40 last quarter and adjusted EPS of ($0.42) in the year ago quarter.
Adjusted EPS of $0.14 last quarter compared to estimates for $0.80 EPS.
Coinbase is expected to report adjusted EPS of $0.43 next quarter and GAAP EPS of $0.48. The expectation is that Coinbase remains GAAP profitable although this will depend on the level of drawdown seen in any future crypto selloffs.
The company reported adjusted EBITDA of $595.5 million for a margin of 41.1% compared to adjusted EBITDA of $1.01 billion last quarter for a margin of 61.9%.
Notably the company was adjusted EBITDA positive even in Q2 and Q3 of 2023 when it reported negative YoY revenue. At that time, adjusted EBITDA was in the range of 26% and 27% for $188.7 million and $178.3 million. When including stock-based compensation, the company would not be adjusted EBITDA positive as SBC was $199.8 million and $218.2 million, respectively, in those two quarters.
Coinbase Additional Notes:
More on Derivatives:
As stated, derivatives are about 70% of the trading market for crypto. A derivative contract is an instrument, such as a futures contract, option or perpetual contract, whose price is based on the underlying crypto currency. Unlike spot trading, where you are buying the asset and mostly participating on the long side, derivative trading allows the owner of the contract to speculate on both up and down price movements, hedge a spot position, or add leverage to a position. This allows an investor to bet on the inevitable downtrends in crypto, and therefore allows institutions, or retail traders, to hedge their positions.
Derivatives are a key element to attract savvy retail and institutional investors. Having a user-friendly platform to trade these instruments is an important piece to Coinbase’s evolution with institutional adoption. In the medium-term, derivatives will help to compensate for the lower consumer spot trading volumes on Coinbase’s platform.
Great. Thank you. Hi, Brian. Hi, Alesia I just want to ask a question about the derivatives platform and we're tracking just quarter-to-date, a continuation of building volumes there. And I know you're not breaking it out in revenues separately yet, but it sounded like it was a positive contributor in the second quarter.
Brian ArmstrongBrian Armstrong
Yes. So I'll start off and then maybe I'll hand over to you, Alesia on some of the margin questions. So just zooming out, derivatives is about 75% of all crypto trading activity by volume. And so it is the majority of trading volume. Now the take rates are lower on it, but it's really a key part of the market overall. And so I'm really glad that we are now in market, both the U.S. with Coinbase financial markets and then internationally with our international exchange as well
For Coinbase International Exchange, we also expanded our asset coverage quite a lot in Q2. We added 25 additional perpetual futures contracts. The volume has been really good today, actually, on Coinbase International Exchange. So you can check out at international.coinbase.com.
And so you can kind of just see Coinbase following this path of we're not always first-to-market, but we do it the do it the right way. We compliant way, the secure, trusted way. And so we're the trusted counterparty that many of these folks have been waiting for to enter the market. And I think that's going to pay off as a really good long-term strategy. Alesia, anything you want to add?
–End Quote
Base Layer 2
As stated above, the offer for no trading fees (or “gasless transactions”) is accomplished through Base, which is a Layer 2 built on the Ethereum network. Base offers 1 cent, 1 second transactions with Coinbase reporting there is $20 billion per week in USDC transactions taking place on the Layer 2. Base offers interoperability with other Ethereum network-compatible applications, offering the security of Ethereum’s Layer 1 while improving Ethereum’s scalability issues (primarily gas fees). Coinbase’s goal is to decentralize Base to make transactions faster while leveraging the security of Ethereum mainnet.
Total value locked (TVL) for Base was at $8 billion as of July 2024, making Base the second largest Layer 2 by TVL after Ethereum’s Dencun upgrade. Crypto has settled a bit since July, yet Base remains the second largest Layer 2 by TVL with $1.965 billion TVL. Base has seen trading volumes of up to $1 billion per day with up to 3 million transactions per day, whereas Coinbase sees about $2 billion in trading volume and Ethereum sees about 1 million to 2 million transactions per day. This means at the onset, Base exceeds Ethereum in number of daily transactions.
Base is further interesting for I/O Fund Members as the Layer 2 offers Data Streams from Chainlink, which is low-latency data that allows developers to build DeFi apps. Base also offers Chainlink VRF, the leading random number generator across Web3 with more than 21 million transaction requests completed and with a latency of about two seconds. We’ve covered Chainlink automation with up to 90% reduction in gas fees, Cross-chain Interoperability Protocol (CCIP) and Price Feeds in the past here. Our original Chainlink thesis is a must-read for anyone new to the I/O Fund, as LINK is an asset our firm has held since launching our research site in 2019.
Over the past few months, Base has been integrated by Stripe and Shopify, which is an important step forward to see onchain versions of Fortune 500 applications. Stripe uses Base for faster and cheaper money transfers by adding USDC to crypto payouts, and fiat-to-crypto for currency conversions. There is also an integration with Coinbase Wallet to allow users to purchase crypto with credit cards and Apple Pay. Stripe originally offered crypto payments in 2014 but ceased doing so in 2018.
The company has stated its focus is to build a developer ecosystem around Base first and foremost: “Our focus, as I mentioned in my opening remarks, is driving developer activity, we're driving those transaction volumes that we commented on. We're doing this by driving down fees, increasing the scalability and creating a powerful developer platform that's enabling anybody to build these onchain products.
We believe that this growth will then add users to develop products, we'll add developers and apps on Base. And that in turn will drive transaction volume and will drive down sequencer fees, and we will then see revenue as a result of those efforts.
Regulations
For institutions, there is a product called Coinbase Prime. This is a full-service prime brokerage platform, which facilitates trades as well as custodian services for large institutions. Management has stated institutions have maybe 1% to 3% of their funds in crypto. This is a low allocation, which has a lot of potential for growth. However, it is being stymied due to the lack of much needed regulations within the crypto space, which has been fraught with fraud.
For example, On November 11th, 2022, FTX, one of the largest crypto exchanges in in the world, filed for bankruptcy. At the time, it was the 18th crypto exchange to file for bankruptcy, and by far the largest, with an estimated $9 billion lost. One of the many fraudulent practices, which wasn’t limited to FTX, was that FTX would not register an internal transaction until a customer wanted their coins out of the exchange. This led to a scenario where 28 million Bitcoins had been bought with only 19.8 million in supply. Therefore, FTX created a crypto-version of a ponzi scheme that suddenly ended.
There have been a total of 20 crypto exchanges that have failed through 2024. The reason for their failures range from hacking events, mismanagement due to faulty business models, to outright fraud. We’ve even seen exchanges attempt a fractional reserves model where loans were offered based on a fraction of the total coins being held on their exchange.
These exchanges are all private businesses, except for Coinbase, so there is no way to see their financials. Furthermore, there are no mandatory audits to prevent fraud or mismanagement. When you factor in that over 50% of all cryptocurrencies have failed, it’s no wonder institutions managing millions to billions have been hesitant to explore this asset class.
As of now, Canada, UK, Switzerland, El Salvador, and China have regulations around crypto currencies. The United States is expected to follow, as the House just passed a meaningful crypto bill that defines regulations. The 200 page bill helps categorize a cryptocurrency and thus determines if should be regulated as a security by the SEC or as a digital commodity by the CFTC, through well-defined oversight. Furthermore, the bill would remove exchanges from comingling coins, as well as removing conflicts of interest, such as trading as an entity while also acting as a broker between buyers and sellers.
Whether it gets passed by the Senate is yet to be seen. With some of the world’s largest financial institutions now involved in the crypto space through Spot ETFs, it’s only a matter of time before much needed regulations will settle the nerves of money managers looking to diversify into this space. When this happens, it should act as a tailwind to Coinbase’s current business model.
Strong Cash on the Balance Sheet
As stated, free cash flow was $484.2 million or 33.4% of revenue compared to $151.1 million or 21.4% of revenue in the same period last year and 25.1% of revenue in Q1.
Cash was $7.23 billion and debt of $4.23 billion compared to $6.7 billion and $4.23 billion in Q1. The company issued $1.3 billion of convertible notes in Q1 and plans to use the net proceeds of $1.1 billion to repay the outstanding debt at or prior to maturity, depending on the market prices. Management also clarified in the earnings call that the other reasons for maintaining large cash balances were to support the ETF launches and for potential investment opportunities.
Here was a question on the earnings call:
Benjamin BudishBenjamin Budish
Hi. Good evening, and thanks for taking the question. I was wondering if you could give us an update on your balance sheet strategy. We noticed the cash build continues to really grow. And it seems like with the — the business generating cash and spending really kind of ramped down from a few years ago, there may not be as much of a need for it. So any update there? And then kind of along the same lines, you've been generating now a lot of your gross profit from interest income. And just curious, if there's any thoughts around the hedging strategy should rates start to come down. What's your kind of philosophy there? Thank you.
Alesia HaasAlesia Haas
Thanks for those questions. Yes, we're really pleased with the balance sheet strength. We are using cash, as we've mentioned in our prime financing business. A large amount of that cash was used to support the ETF launches in Q1 and Q2 with the Bitcoin ETF and now hopefully be a Ethereum ETF where you can see a lot of day-to-day or week-to-week volatility of those loan balances.
We did grow prime financing fees within the quarter. And so you can see while the balance at the end the end of quarter was down versus of Q2. We saw growth intra-quarter for those balances. So using our cash to support our products is a primary use case for us.
Technical Analysis
Coinbase appears to be working through a very large 5 wave pattern off its early 2023 low. If this is accurate, any additional weakness will need to hold $113, and then start making higher highs to the 5th wave target between $294 – $217.
As of now, the larger correction that started in March of this year appears to be supporting this. It is a 3 wave correction that has room for one more swing lower to complete. If the current bounce fails to break over $172 – $181.50, then we can see a final drop into the $137 – $127 region. If we can instead breakout above $181.50, the odds will start supporting that the 4th wave low is in, and we will likely be in the early stages of wave 5 to new highs.
This lines up with Bitcoin’s chart, as well. The pattern off the late 2022 low appears to be an unfinished 5 wave pattern. Note the current correction. It is messy, with many overlaps, which is typical of corrections within larger uptrends. The bigger pattern suggests that we should be heading to $78,000 – $85,000 next, which would give us the minimum waves required to complete the 5 wave uptrend. Once we get to this region, or beyond. How we correct from there will determine just how high into the $100,000 region we will go.
For now, the probabilities favor a swing higher. As long as we hold $42,750 on any additional weakness, this remains our expectation from the technical patterns in both Coinbase and Bitcoin.
Conclusion:
Publicly, our firm has become known for our Nvidia AI thesis, and how we have positioned our readers for this trend before 2023. Yet behind the paywall, our premium subscribers are well aware that our active management with crypto since 2019 is equal in terms of its performance. By championing active management for tech investors — which means weighing the probabilities to cut or trim at specific times with the goal of buying lower — the I/O Fund stands out in a crowded, noisy crypto space by offering tools to navigate the volatility in this asset class.
Coinbase’s move into the derivatives market, as well as being a trusted custodian for institutional investors in the crypto space, will continue to entice institutions to their platform. Being a publicly traded company, Coinbase is the only exchange that allows its financials to be analyzed and monitored. This is crucial for investors considering the lack of FDIC and SPIC insurance in this space. These exchanges are businesses that can be mismanaged, and if this happens, all the coins being held there will be appropriated and redistributed to creditors in the event of a bankruptcy. This is a risk that Coinbase offers a solution to through their business model and publicly issued quarterly financials. This makes Coinbase stand out amongst its peers in a way that creates a moat for institutions looking to expand into the crypto space beyond the limited and costly spot ETF options.
Coinbase’s stock pattern lines up with Bitcoin, as both continue to suggest another swing higher is likely. If COIN can continue to evolve with the crypto market, and continue to lead as a trusted institutional platform, it will likely continue to appreciate with Bitcoin over time.
Given Chainlink is becoming a beneficiary of Layer 2s like Base and Arbitrum, you can expect an updated 2024 deep dive on our favorite blockchain asset coming soon!
Bitcoin is an asset where the bulls pound the table to “buy, buy, buy,” and the bears relentlessly and stubbornly call it a scam. In reality, both are the wrong approach. This is because although Bitcoin is the highest performing asset in the past ten years, it’s also the one of the most volatile. Consider that it was trading at $58,000 in March of 2022, and by December of 2022 had lost 72% of its value. That year, the loud and proud Bitcoin bulls were not your friends.
Timing is everything. When it comes to timing, our firm has a proven track record of navigating the life-changing bull case that crypto offers while minimizing the volatility associated with different coins – we achieve this via a unique approach combining technical and on-chain analysis to identify major lows and major tops in each cycle. For example, we diligently detailed to our readers in December of 2022, when Bitcoin was trading in the $16,000 region, that we are “Bullish on Bitcoin”:
“Though we are in the 4th bear cycle in Bitcoin's history, the prior 3 cycles suggest where we are is a rare buying opportunity. There is ample evidence to support the $15,500 level is either a major low or very close to a major low. Both the technical and on-chain analysis support this. As Bitcoin continues to integrate into the global economy, we expect both the volatility and epic returns to calm down. For now, we are content buying Bitcoin at these lows with a long-term mindset.”
One year later, our most recent Bitcoin article stated that the coming pullback into the $39,000 – $35,000 region would likely be “the last great buying opportunity” in this bull cycle. At the time our upper targets were between $75,000 – $132,000. That correction bottomed around $38,500 then led to 90% rally, which topped less than 2% from our $75,000 target.
If Bitcoin were in the Mag 7, it would be the second strongest performer both YTD and on a 1-year basis, edging out Meta at returns of 133% in 1-year and 52% YTD. Had you bought in the $16,000 region, the returns would be 300% in about 17 months’ time.
Looking forward, an important question to ask is, are we at the end of a bull cycle or do we have more room to run? We believe that there is more room within this uptrend. As a result, we are raising our upper Bitcoin targets, as the current volatility appears to be another correction within a much larger uptrend.
In this article, we will support this thesis through on-chain analysis as well as technical analysis. We will also address how Bitcoin appears to be setting up for higher levels while equities look like they’re topping. The popular narrative is that crypto and stocks – especially tech stocks — are correlated. It’s our stance that these two investments are not as correlated as many believe, which lends credence to this potential divergence.
Updated Bitcoin Game Plan
We have remained steadfast on the long-term pattern for Bitcoin, which you can see was intact as far back as July of 2022. While the 2022 drawdown went lower than we anticipated, once we got signs of a bottom, we maintained this pattern around the $15,000 lows. The implication was that 2022 was a correction within a much larger uptrend, and that we were going to see a new bull cycle into 2023 – 2024.
As of today, we are more than halfway into the current bull cycle, which is the final 5th wave in a very large 5 wave uptrend that started in late 2018. What this means is that as we approach our upper targets, our game plan will shift from accumulation to distribution.
Source: I/O Fund
The current drawdown appears to be tracing a bull flag, which is a correction within an uptrend. The $57,000 region is very strong support, which is the upper range of our support zones that need to hold in order for us to push higher. This is over 25% lower than price currently is, which shows the level of strength still in Bitcoin. If we do see another drop, we can go as low as $42,750 without invalidating the larger uptrend in play. So, this ongoing pattern is comfortably intact and has ample room to drop, if we see more volatility.
While the pattern appears to be corrective, and tracing a standard pattern we see within larger uptrends, the momentum oscillator below price is at a major support zone. Note how this support region acted as key lows, especially in the current uptrend that started in late 2022. Also, note how much higher price is compared to other instances where this support was tested. This suggests a low being put in, while also suggesting that we have ample room to push higher in the coming weeks to months.
Because of this development, we are increasing our upper target zone from $75,000 – $130,000 to $106,000 on the low end, and $190,000 on the high end. As long as the $42,750 support region holds on any on-going volatility, then we have no reason to doubt the uptrend in place. That being said, we do not see the same upside within the equity markets, which begs the question – is Bitcoin highly correlated to tech stocks?
Bitcoin vs. Tech
On April 18th, we saw an escalation of the concerning geopolitical conflict between Iran and Israel. As a result, the NASDAQ-100 closed down over 2% the following day, with AI leaders like NVDA giving back 10% in a single day.
There were not many areas of tech that were spared on that day of selling, as investors sought to de-risk at any price. One would think Bitcoin would follow tech on this day, but it was instead up nearly 1%. In fact, many alt-coins shrugged off this news and pushed higher. Granted this is only one day, but it is an intriguing development. This was the first instance of panic selling in over 6 months where we saw investors dumping high risk tech stocks, and Bitcoin not only did not participate, but saw buyers.
If we look back at the long-term correlation to Bitcoin and the heavily focused NASDAQ-100, you will note that the majority of times, these two investments are closer to having minimal to to no correlation. This is in contrast to being highly correlated, as many would believe.
Source: I/O Fund
The above chart measures the correlation between these two investments. The best way to read the chart is when the line is moving up, it means the two are correlated and heading in the same direction, while the inverse indicates they are moving in opposite directions. Also, when the cumulative reading is above 0.5 (green), the two investments are highly correlated, between 0.5 and -0.5 (yellow) the two have minimal to no correlation, and when the reading is below -0.5 (red) they have an inverse correlation and are moving in the opposite direction.
Considering the correlation is cumulative on a weekly scale, the two investments have to stay inversely correlated for some time in order to cross below 0. As you can see, there are significant periods where the two have been inversely correlated, which I’ve marked with the gray vertical shades.
For reference, the below chart shows the correlation between the S&P 500 and the NASDAQ-100 through the same period. While there are brief periods where the two indexes have diverged, the cumulative correlation rarely goes below 0.5% (green), and only briefly crossed the 0 line.
Source: I/O Fund
The point is to show actual data in regards to the popular narrative that Bitcoin is just another tech equity play. The data shows that the cumulative correlation has periods where it is highly correlated to tech, but what is key to understand, is that it also has extended periods where it is inversely correlated. The norm is that the two investments have had a low to no correlation, which supports the inverse move that we saw between Bitcoin and tech stocks on April 19th.
This supports a probable scenario where equities could put in a top while Bitcoin continues to run higher.
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Equities Topping While Bitcoin Goes Higher
In our March report, we showed how the current bull market leaders, the Magnificent 7, were topping, one at a time, while the broad market was continuing to push higher. At the time of the report, only 3 of the Mag 7 were making new highs with the broad market. We then saw the AI leaders within the semiconductor space, including Nvidia, top around early March, while the broad market pushed higher into April.
Seeing the bull market leaders diverge from the broad market is usually a sign of coming weakness, not strength. More times than not, we will see the leaders top first when a meaningful change in trend is about to happen, which we warned our readers about. If we were going to push higher, these leaders needed to breakout to new highs, and until then, we were at risk of a trend change.
This lines up with the potential topping pattern we are seeing within the equity markets, compared to Bitcoin, which appears to have more room to run.
Source: I/O Fund
The above chart shows the NASDAQ-100 has completed a mature 5 wave pattern off the 2022 low, and has broken the first of two major supports – 17,265 and 17,000. Bitcoin, on the other hand, is still in an incomplete 5 wave pattern, which is still tracing the 3rd wave higher. Note the current correction is taking the shape of a bull flag, and is nearly 25% above the first critical support level.
The reason for this could have several explanations. For one, it’s worth noting that the demand for Bitcoin has increased substantially, while its supply has remained the same. Spot Bitcoin ETFs have quickly become a popular investment vehicle, and have seen a surge in net inflows, surpassing more than $30B AUM in mid-April after amassing $17B in funds in less than two months after a launch in mid-January. For example, BlackRock’s iShares Bitcoin ETF recorded 71 consecutive days of net inflows. In addition, trading volume on the ETFs nearly tripled in March, reaching $111 billion – for an asset class that launched only two months prior, that’s a significant figure.
Another explanation is the fact that not all markets top and bottom at the same time. For example, small caps topped in 2021 while the NASDAQ-100 continued higher into 2024. Therefore, Bitcoin could be one of the last assets to put in a larger top, after the NASDAQ-100. This would lead to several lower highs within a large range for the NASDAQ-100, while Bitcoin makes its final series of higher highs. After which, they would align in a potential downtrend.
Another answer could be something more fundamental. Bitcoin was created to answer a specific flaw within the centralized banking system. It is fundamentally different than a tech stock, and has the potential to provide a hedge against various banking and/or currency problems that tech stocks would not be able to address. In this case, Bitcoin could be picking up on some deeper issue within the system, which is causing the potential divergence.
The other scenario is that I could be wrong, and the NASDAQ-100 holds this support region, the Mag 7 and AI Semis find more strength, and push higher with Bitcoin, or vice versa. I’m open to this, but until Bitcoin starts breaking critical support levels in a direct fashion, like most equity markets recently have, there is no reason to pivot away from a more bullish outcome in Bitcoin.
On Chain Analysis
For those that are not familiar with on-chain data, it is the unique fundamental analysis within crypto, and a relatively new field of study. We partnered with WealthUmbrella, a team of Machine Learning engineers and professors, to provide this level of analysis within the crypto space. According to WealthUmbrella, the underlying strength that our technical analysis is picking up on is also being supported within on-chain data. The below section was written by Vincent Duchaine, CEO of WealthUmbrella.
Bitcoin’s recent move to $73,000 created some of the most overbought conditions we have seen throughout Bitcoin’s history. One of the indicators used to gauge these overbought levels measures the value of Bitcoin’s network through the increase/decrease in active users.
At the recent high in Bitcoin, this indicator, which only rose briefly to a historically high value, gave us a reading of 3.3. As you can see below, this reading represents an outlier in Bitcoin history.
Source: I/O Fund
A reading this high historically leads to a top, of sorts. The good news is that the recent volatility has taken this indicator back to a reading of 0.84, which is in the lower range of what we have seen during a correction in a bull market over the last 6 years. This further confirms our long-standing outlook that the bull cycle in Bitcoin will likely move higher.
Source: I/O Fund
This extreme overbought reading was also picked up by our SOPR Indicator, which stands for the Spent Output Profit Ratio. This indicator measures the daily transactions in Bitcoin and measures if the combined ratio has a profit or loss based on when they were bought. As the indicator moves up, it is signaling that all the majority of daily transactions in Bitcoin were sold for a profit.
As you can see, this indicator also reached a historically high reading when Bitcoin first hit $73,000. However, it has greatly cooled down since and is now slowly curving to the right.
Source: I/O Fund
These two metrics were warnings that a correction was likely coming due to being extremely overbought. However, since then, we have seen them cool off to a level that suggests we could be getting close to the bottom of the current correction and resume the uptrend.
This thesis is being supported by other metrics that we track. For example, since the arrival of the new Bitcoin ETF, the amount of Bitcoin that hasn’t moved in more than a year was in a constant drop, implying that long-term holders (hodlers) were finally taking gains, which was increasing supply. This selling by the Bitcoin hodlers has since stopped since April 2nd, which you can see in the chart below.
Source: I/O Fund
Like any asset, Bitcoin's price movements are the result of supply and demand. We are now seeing long-term holders of Bitcoin cease the selling that started in late 2023. This is bullish as it creates a constraint on the supply side of the equation.
Not only are hodlers not selling, but whales have also bought the recent dips in a notable way. The below chart measures large block trades within Bitcoin. The most recent spike happened last Thursday, April 18th, when whales bought 19,700 BTC at an average price of $62.5k.
Source: I/O Fund
Regarding the demand for Bitcoin, we have historically measured this through monitoring the number of newly created Bitcoin addresses with a non-$0 balance. As new addresses are created that actively buy Bitcoin, this implies that demand is increasing. However, this is likely not as relevant in light of the new Bitcoin ETFs.
Before the creation of these ETFs, the predominant means to access Bitcoin was through the creation of wallets or personalized crypto exchange accounts. Now, an investor can simply buy an ETF on a public exchange and get access to Bitcoin’s price movements. This has now opened the door to institutional investors as well as investors who want diversification but did not want to deal with the hassle of dealing with crypto exchanges and the safety concerns that come with them. Regarding demand, this development is arguably the most important element in Bitcoin’s history, and we view as quite bullish in regards to the demand side of the price equation. Lead Tech Analyst Beth Kindig went on Fox Business News and discussed how Bitcoin has never had a more fundamentally bullish moment:
In summary, the internals are supporting higher levels, as we are now seeing demand start to catch up with supply. We view the current state of Bitcoin’s pullback as a buying opportunity within a larger uptrend. This is confirmed by one of our most powerful tools, which we call the Kwiatkowski Indicator, named after its creator. This tool is designed to spot tops by looking at the profit of all market participants in an organized way. It is currently indicating a value of around 12, while we don’t expect a cyclical top until 35.
Source: I/O Fund
Conclusion:
We are seeing evidence that Bitcoin wants to go higher, while equities appear to be setting for a top. Bitcoin has a history of not being correlated with tech stocks, so this scenario is not as improbable as the popular narrative would suggest. Both technical and on-chain analysis support higher levels for Bitcoin, and as long as any further weakness holds $42,750, we view this dip as a buying opportunity.
If you own crypto or are looking to own crypto stocks, consider joining us for our next broad market webinar. Every Thursday at 4:30 pm Eastern, the I/O Fund team holds a webinar for premium members to discuss how to navigate the broad market, manage risk, as well as revealing our various long-term game plans regarding stock and crypto entries and exits. We offer trade alerts plus an automated hedging signal. The I/O Fund team is one of the only audited portfolios available to individual investors. Learn more here.here.
Please note: The I/O Fund conducts research and draws conclusions for the company’s portfolio. We then share that information with our readers and offer real-time trade notifications. This is not a guarantee of a stock’s performance and it is not financial advice. Please consult your personal financial advisor before buying any stock in the companies mentioned in this analysis. Beth Kindig and the I/O Fund own BTC at the time of writing and may own stocks pictured in the charts.
The I/O Fund has been an advocate of technical analysis since inception. Sentiment is a major driver in growth, and the only way to measure it with some accuracy is through technical analysis.
While we use this practice as an addendum to our fundamental analysis, it is the primary tool that we use within crypto. The reason for this is that crypto does not have consensus estimates or earnings reports. There are sparse news events regarding crypto, yet we tend to see wild swings in both directions. Though these moves may seem random, they are not. And, because of this reality within the crypto space, we lean into technical analysis more so than with equities.
In this report, you will get a snapshot of the larger pattern we believe is playing out, as well as the I/O Fund’s buy plans for each of our 3 crypto holdings, plus one new addition that we are watching – Solana.
Bitcoin (BTCUSD)
If we zoom out to a weekly chart, The larger pattern I am following has the 2021-2022 bear market as a correction within a larger uptrend. That would put us around the halfway point for the final 5th wave rally, which should take us to the $100,000 region.
The risk remains elevated until Bitcoin goes vertical. The current pattern off the 2022 low is only 3 waves up. Because the new bull cycle is only 3 waves, it leaves the door open to the possibility that the 2023 bull cycle is actually a correction within a larger bear market. As long as any further weakness in Bitcoin holds above $25,100 we see no need to game plan for this more bearish potential.
If we zoom into the new bull market structure, there are three paths this new bull cycle can take.
Red Count – This path has us in a large degree 3 wave pattern, marked with an (A), (B), (C). Here, we should see a deep retrace back into the $35,000 – $27,000 region. This will complete the (B) wave drop, as the following (C) wave will take us to our overhead targets.
Green Count – This path has the current bull cycle taking a standard 5 wave pattern. If this is in play, we should see the current bounce fail under $47,000, then drop back to the $37,000 – $36,000 range. We should then turn back up in a vertical move higher. This will be a more direct path to our overhead targets.
Blue Count – This is a more bullish variation of the Green path. This path will not see a further drop. Instead, we will see a direct breakout over $47,000 and head to $56,000 next.
These are all bullish interpretations of the current price structure. As long as any further weakness holds $25,100, then I see no reason to abandon these outcomes. Below this critical support, and the bull cycle that is targeting $100,000, is in jeopardy of not playing out. This would imply that all of 2023 was a large degree corrective bounce in a much larger bear market. The early tell will be a 5 wave drop through some of our listed supports.
Ethereum (ETHUSD)
All coins that we follow are tracking the larger crypto cycle that is expressed above through Bitcoin. Ethereum also has a large degree bullish pattern that is playing out.
When it comes to the potential bullish patterns, we find it helpful to always take it one step at a time. As of now, we are in a minor correction that must hold $1,650, then turn back up in a vertical fashion. If this happens, we will raise our critical support and fine tune our overhead targets.
When we zoom in on this pullback, we can get a better idea of potential targets.
It looks like ETHUSD needs one more drop toward the $2000 region in order to complete this pullback. If we instead continue to push higher, we will need to break above $2592 in order to suggest this correction is over. We could even see Ethereum push toward $1845 and $1645 and still maintain the bullish uptrend. However, below $1650 will threaten the larger bullish count we are tracking.
Chainlink (LINKUSD)
The larger pattern has LINKUSD in the 5th wave of a very large diagonal pattern. The 5th wave should play out as a large 3 wave pattern, marked A,B,C on the chart below.
If we zoom into the current uptrend, it appears to be developing into a solid 5 wave pattern. This is encouraging, and supports the bigger pattern above.
The current breakout above $17.60, if it holds, should see a move to the $20 – $23 region. This should complete the 1st series of 5 wave moves higher, and then give way to a notable pullback.
Solana (SOLUSD)
Note how vertical the uptrend in SOLUSD is. It is clearly a 5 wave pattern, that is incomplete. This is supportive of higher levels.
It appears that the correction has completed, and we are making a higher low before pushing into the $130 – $140 region. Ideally, we will get one more drop into the low $90 – upper $80 region. Any further weakness needs to hold $84, or we could see a deeper retrace back into the $70s. the critical support for SOLUSD is the $60 region. This level must hold if the larger uptrend is going to continue.
The I/O Fund has done some bold things, such as offer an audited portfolio to retail investors, call Nvidia an AI stock five years ago, and, at times, have hedged 100% of the portfolio in 2022 with the help of The Wealth Umbrella.
However, probably more bold than any of those was the decision to hold an altcoin permanently in our portfolio. This was done within a month after launching our site, when Bitcoin was on a downward trajectory, and we were up against an extremely high failure rate in altcoins. Chainlink had launched on Ethereum mainnet about three months prior to covering the token.
Some of my readers are averse to crypto, and for good reason as it can be extraordinarily volatile, so that is everyone’s personal choice to make. However, the number of stocks we’ve held without interruption since the day we launched our site four years ago is very few, not even Microsoft makes that list. But, Chainlink does.
With that introduction, I’d like to update my analysis as Chainlink has expanded from working with off-chain data to now also include cross-chain token transfers and messages. The broader vision is that Chainlink will become the blockchain backbone for the financial system, accomplished by partnering with SWIFT, the system that currently allows 10,000 banks and financial institutions to communicate with one another.
The Internet of Contracts
Before discussing how Chainlink is becoming a single access point for tokenized assets, and why this is needed by the banking system, it’s important to review smart contracts. Chainlink rephrased this to “the internet of contracts” and I think this describes smart contracts succinctly as Web3 proposes to replace the internet, but to do so in a secure, decentralized manner.
Decentralized systems require contracts if a system is to be created where all data, all messages, all token transfers, and all users are validated. Machines need contracts to offer ultimate security and decentralization as contracts ultimately allow for a revocation if a request if found to be fraudulent. In this case, the machine can shut the request down or otherwise deny the user/token transfer/data/message to move forward. The bilateral nature of contracts allows for a validation process to where nodes can determine if the action is trustworthy.
To put it simply, without contracts, trusted systems cannot truly exist as otherwise there is no penalty. This is why Web2, which is not based on smart contracts, is rife with bad actors. One centralized system can create thousands of bots, or a centralized tech company can push its agenda to the top of a newsfeed. There is no contract, and therefore, there is no revocation for unethical behavior.
The bot or the centralized Big Tech company simply does it again and again. In the vision of Web3, even the special interests of a powerful Big Tech company would not be able to dominate a newsfeed, rather all users would be equal and have to prove they are acting in an ethical manner in terms of how messages rank in the newsfeed.
Right now, you can assume what you’re seeing in newsfeeds and on search engines is ranked according to what Big Tech wants you to see and think – you will see more AI news because Big Tech wants you to support AI. You will see favorable news about their own companies because this ultimately helps their stock. We are coming into an election year, the candidates that most support Big Tech’s ambitions to further monopolize and offshore taxes will be seen favorably and/or rank at the top of a newsfeed. If you feel like there isn’t a problem with censorship, then perhaps consider that Big Tech has used its thousands of engineers and done its job quite well, which is to make it look as though it’s not even happening.
The more technical explanation is that rather than having backend code on a centralized server, backend code runs on a decentralized network, such as the Ethereum platform. Developers use a blockchain like Ethereum for data storage and smart contracts for the app logic. Chainlink was primarily built for off chain data for non-currency smart contracts. The principal is the same where there is a set of rules which self-execute – the more common analogy is that it operates like a vending machine to where there is no middleman.
Decentralized applications (Dapps) rely on smart contracts. Dapps deployed on the Ethereum network are controlled by logic written into the smart contract and cannot be altered by the developer. Smart contracts function like APIs (this was also discussed in the Chainlink webinar). This allows applications to build on one another similar to the way applications use APIs today; except blockchain applications will build on smart contracts.
The front-end application can be written in any language with calls made to the backend. The main qualities are that the applications are decentralized, can perform any action given the required resources (whereas Bitcoin is not Turing complete) and are executed in a virtual environment such as the Ethereum Virtual Machine. The virtual machine acts as a buffer to where if the application is faulty, it does not affect the blockchain network.
There are a few key benefits to dapps:
Dapps are more secure and inherently protected from denial-of-service attacks.
Censorship will be nearly impossible as a single entity will not be able to block users from utilizing the blockchain.
Fraud and other malice will be prevented as the data has complete integrity from the decentralized and cryptographic qualities of the blockchain.
Because smart contracts are self-executing, they remove the need for a centralized institution. Real world identities can also be anonymous with dapps.
There are also some drawbacks to dapps:
Most developers do not want to relinquish control over their creation
If there is a bug that need to be fixed, that developer is unable to take back control of the Dapp once it’s launched onto the Blockchain
Dapps will need to prove they can scale on Layer 1s with Ethereum’s Proof of Stake largely untested in the real world in terms of scaling to tens of millions or even hundreds of millions of users. Layer 1s such as Solana are competing with Ethereum specifically on its scalability.
Some developers may utilize centralized servers for the frontend or to store business logic which could eliminate many of the decentralized security/anonymity benefits of the blockchain.
Oracles:
The issue with smart contracts and the proposed use cases for the blockchain is … where will we get the off-chain data, which is key contractual data? When you go to trade a stock, where will the blockchain get the stock price in a way that is trusted, since this is off-chain data. Right now, in other applications, these are done through APIs which act as building blocks so the developer does not have to build the input/output.
Oracles are trusted third-parties that retrieve off-chain information and push that information to the blockchain at predetermined times. Oracles introduce a potential point of failure, however, and this is why Chainlink is critical middleware for Layer 1s.
Without Chainlink, Ethereum’s smart contract utility is confined to currency tokens on its Layer 1 only as data cannot be directly fetched from off the blockchain. The only secure input that can power smart contracts is data that exists on the Ethereum blockchain, which is token inflows/outflows. This becomes problematic for cross-chain token transfers as price also needs to be verified outside the Ethereum blockchain.
Chainlink uses decentralized oracles to solve the smart contract connectivity problem, which is that a smart contract needs to interact with external data feeds that are secure and trusted. There are many inputs and outputs in the form of data feeds and APIs, rather what Chainlink solves is a tamper-proof way of triggering smart contracts with events and data that is tamper-proof.
Decentralized Oracle Networks (DONs) are multiple, independent oracle nodes that incorporate three layers of decentralization: at the data source, at the individual node operator, and at the oracle network levels.
Cross-Chain Interoperability Protocol (CCIP)
Blockchains are fragmented, and naturally prefer to have users locked into their ecosystem. This is problematic as each blockchain and DeFi application has unique strengths, and thus, users often seek to use more than one blockchain and dozens of applications depending on their needs.
This is best illustrated with token transfers. The process to liquidate Bitcoin and buy another altcoin on a DeFi platform is time consuming and overly complicated. This friction is a primary pain point causing a low user adoption rate for crypto.
Clearly, cryptocurrency has its loyal enthusiasts, but what innovation needs is outsized demand. In tech, there is plenty of innovation and supply, whereas demand is the part of the equation that is much, much harder to solve. The friction that exists with transfers for currency and information, plus the overall user experience, must be solved for Web3 to become a replacement for Web2.
This means that Web3 must function seamlessly like Web2 to where the infrastructure (AWS, Azure, GCP), the protocols (TCP/IP, SMTP) the operating systems (Windows, Linux, MacOS, Android, iOS), the applications and the software are seamlessly working together without friction. In the majority of these cases, the user is unaware of the systems that support the user experience.
Chainlink’s CCIP sets out to solve this by providing a bridge between blockchains and DeFi applications. The protocol was launched in July of 2023 to solve the pain point of seamlessly transferring data and currencies across various blockchain networks. At launch, it was integrated with Ethereum, Avalanche, Polygon and Optimism. This allows users to use any decentralized application (dApp) on these blockchains for liquidity purposes and connectivity.
This is not a new concept, rather how it’s approached is what has evolved. Sidechains for popular applications, such as the popular game Axie Infinity, were developed to transfer assets between the game and Ethereum. This allowed Ether to be used for purchases and to also pay gamers with rewards. The sidechain called Ronin Bridge was secured by only 9 nodes, and hackers were able to compromise 4 of these nodes and exploit $25 million worth of Ether.
Clearly, any bridge needs to be handled carefully as this is one of a few hacks which occurred when developers attempted to develop a solution. However, in the past, dApps had to build in-house implementations for cross-chain interactions, which puts immense pressure on application developers to also provide secure interoperability.
At the time, it was presumed that decentralized was inherently “secure enough,” yet this has been debunked as bad actors only need to control the majority of the nodes. With enough incentive, such as $25 million worth of Ether, Ronin Bridge proved this can be accomplished.
This represents the issue for a popular gaming application, but a similar issue exists for banks and institutional investors. The fragmented layer 1 blockchain networks that compete with one another are not interoperable and each has their own functionality and liquidity profile. This creates friction and potentially security issues if layer 2s or sidechains are needed for token transfers or swaps.
Chainlink is uniquely positioned to solve the problem of bridging blockchains and popular applications because it has built a secure oracle network. CCIP extends the idea of an oracle network, which was originally designed to on-load off-chain data, to also offer decentralized oracle computation for performance histories and to monitor for malicious activity. Off-Chain Reporting (OCR) is used to aggregate a report from many validators, which reduces congestion.
In conversational terms, what this means is that Chainlink was once thought of as the Google of Web3, which it can still very well be. However, Chainlink is also evolving to become a critical security layer, which in turn, is what’s needed for blockchains to become attractive for banks.
The financial system has different goals for blockchains than Web3, which is to reduce fees and reduce fraud. What will likely unfold is that there is more urgency with the financial system than there is with Web2 users to advance crypto forward. Web2 users are fairly comfortable with the internet and native mobile apps they use today. Meanwhile, the financial system has serious pain points that blockchains can solve.
Instead of Chainlink only working with off-chain data, CCIP extends its use to include token transfers and messages. The broader vision is that this will be accomplished by partnering with SWIFT, the system that currently allows banks and financial institutions to communicate with one another.
SWIFT stands for the Society for Worldwide Interbank Financial Telecommunications (SWIFT) and is the system used by banks and institutions for money and security transfers. Currently, 11,000 banks use SWIFT across 200 countries, and it’s the largest and most streamlined payment system for international transfers. SWIFT facilities secure and efficient communication between institutions with 45 million messages sent in 2022.
Recently, SWIFT successfully completed a test using Chainlink’s CCIP to facilitate transactions with tokenized assets on public and private blockchains using back-end systems. This allows financial institutions to integrate blockchain technology into the existing infrastructure. You can read more about this on Swift’s website here.
The test was done with 10 banks initially to test the settlement process. Findings included a need for nonce management, which refers to transactions being mined in sequence. This acts as a counter for the number of transactions sent by an address, which ultimately helps choose the order that transactions are processed and prevents replay attacks.
Pictured above: By including a timestamp or a nonce, only one transaction is authorized.
Crypto nonces prevent replay attacks where a hacker on the network attempts to replay someone’s credentials or retransmit the login request to the bank server.
Another component to security that Chainlink provides is an abstraction layer. Payment abstraction layers are important because it provides the value of the token that is being paid. As a decentralized oracle network, Chainlink is the industry leader in providing price oracles. Chainlink’s data oracles provide the data that assigns value to cross-chain token transfers, and this is a primary reason SWIFT is partnering with Chainlink. Ultimately, a payment abstraction layer will allow users to pay with a credit card, a bank account, a native blockchain token, a stable coin, or a protocol token – safely and securely.
Chainlink’s Early Success
Chainlink launched on the Ethereum mainnet on May 30th, 2019. We covered the altcoin for the first time in August of 2019.
Prior to launch, Chainlink signed 30 partnerships. By 2020, when we covered Chainlink a second time, total value secured (TVS) had grown from $254 million to $6.3 billion, or 23,000% growth in TVS. At crypto’s peak in Nov of 2021, Chainlink had $75 billion in total value secured across up to 1500 protocols and hundreds of DeFi applications. This has declined to $17 billion today, yet the TVS from 2021 is important as it shows Chainlink is capable of securing $75 billion without a hack. As the CEO stated recently at SmartCon: “Right now, the Chainlink Network has provided the most cryptographic truth in history.”
To date, there has been 10.3 billion data points delivered on-chain. When taking the sum of the USD value of each transaction that has utilized an oracle, the transaction value enabled (TVE) by Chainlink is $8.68 trillion. As stated, there’s been no hacks or otherwise any tokens lost through Chainlink’s secure network.
There have been many oracle solutions launched to compete with Chainlink yet the company has retained 50% or greater market share. The predominant use of Chainlink is for market data for DeFi apps. DeFi apps have grown in total value locked (TVL) from $700 million in December of 2019 to mor than $200 billion today. With the launch of CCIP, Chainlink can use its strong track record in securing DeFi blockchain smart contracts to expand to cross-chain smart contracts.
Tokenomics
One area where critics find fault with Chainlink is the tokenomics. The monthly growth in Chainlink’s circulating supply is at 1.4% per month on average. Over the course of a year, this can dilute token holders 10 to 15%, on average.
Chainlink’s fully diluted market cap tracks 2.1X higher than its current market cap. There is a circulating supply of 568M tokens yet a max supply of 1 billion tokens.
Of the 1 billion tokens, at the initial coin offering, a little more than one-third was to go to node operators, a little more than one-third was sold in the public sale, and a little less than one-third went to the company to be held in reserves. The 350 million held at the company can be released anytime, which dilutes token holders.
When more of Chainlink’s supply is in circulation, there is likely to be stronger price action. About 56% is in circulation now, and so look for Chainlink’s price to be less volatile in 2-3 years if we assume the 1.4% per month rate in circulating supply continues.
Technicals, Technicals, Technicals:
I was recently on a Real Vision interview where they asked me what my investment framework for crypto is and I said: “Technicals, technicals, technicals.” If you want to buy Apple or Microsoft without using technicals, and hold over a long period, that will probably work out just fine. But to participate in these extraordinary companies at an early stage, it’s of ample importance to carefully consider technicals.
We lead with technicals on crypto given it’s early-stage tech. This is different than stocks, where fundamentals lead. The good news is that crypto is sentiment driven, and so it respects price and technicals work quite well when managing these positions.
Our history with Chainlink is quite good – we bought at $1.50 and trimmed in the $25 to $50 range, and then began buying again much lower in the $7 to $11 range.
Below, is Knox Ridley’s update on Chainlink. I asked him to provide an update on Ethereum and Bitcoin, as well, for one comprehensive view of our crypto buying plan. Real-time trade alerts are sent to Advanced Members.
Technical Analysis
By Knox Ridley
Chainlink (LINKUSD)
From a long-term perspective, Chianlink appears to be tracing a diagonal pattern. This is an overlapping uptrend that consists of 5 large wave. These are quite tricky, and exhausting to maneuver due to the relatively large swings in both directions. That being said, the recent bear market, within this context, was only correction within the larger uptrend pattern.
If we zoom in to the recent uptrend, it is moving in a more vertical manner than prior swings and taking the form of a 5 wave pattern that is incomplete. That means that we should see one more drop, then a continuation higher to complete the patter. The current correction appears to have one more drop in it that would be targeting the $12.8 – $10.75 region.
I do not want to see this drop go below $10.5, or else the next swing higher could be in jeopardy. If this happens, I still believe the larger uptrend is still intact, just taking an alternative route to our overhead targets.
On the other hand, there is a chance that the 4th wave is incomplete. If this is playing out and we do not get that final swing lower, then a break above $16.50 will be the signal that we are going directly to the $20 – $22 region next.
Bitcoin (BTCUSD)
From a long-term perspective, the 2022 bear market appears to be a correction within a much larger uptrend that started in late 2018. This uptrend is taking the shape of a 5 wave pattern that should hit the $100,000 – $130,000 target before putting in a bigger top. As of now, this pattern remains valid as long as we hold the $28,000 support level.
If we zoom into the pattern off the 2023 low, what is important to notice is the series of vertical moves higher, which are followed by overlapping corrections. In short, we see higher highs and higher lows, repeating over and over again. This is the hallmark of a classic uptrend.
It is our belief that the current pullback will be one of the last great buying opportunities before investors are forced to chase Bitcoin higher. Bitcoin is now setting up for another correction within this uptrend. Our targets are $38,000 – $35,000 for the most likely spot to find a bottom. However, we can see this drop go as low as $28,000 and still not threaten the larger uptrend we are tracking.
If these levels hold, the next move in Bitcoin should be vertical, which would be targeting the $50,000 – $58,000 region overhead. This will be the last big test for Bitcoin before confirming that we are heading to the $100,000 target.
I’m calling this region the “danger zones” because this is where my alternative count in red would likely top, if it is in play. This count suggests that 2023 was actually a corrective bounce in a much larger downtrend. If this is true, what will follow is a continuation of the bear market to new lows. So, how Bitcoin reacts in this region will be crucial for proper risk management of this position.
In summary, in order to reach the target we outlined over a year ago, there are many steps that Bitcoin has to take in order to get there. So far, it has pushed higher with many vertical moves, and held critical support on the pullbacks. In order for this target to remain valid, we need to hold $28,000 on any deeper pullback than expected, and then break above $58,000 on the next vertical move higher. If Bitcoin fails to make these two steps, then we will be forced to pivot, log our gains in Bitcoin, and regroup.
Ethereum (ETHUSD)
The larger pattern in Ethereum is similar to Bitcoin. The 2022 bear market was likely a downtrend in a much larger uptrend that is still playing out.
If we zoom into the bull market off the low, the posture appears to be in a notably bullish posture. Note the series of vertical moves higher, followed by overlapping corrections that make a higher low. There are three series of 5 wave moves higher that have held the below trend line. My targets for the next pullback are between $2,000 – $1,850. If we get a deeper pullback than expected, we must hold that below trendline, which comes into play around $1,700.
Like Bitcoin, the big test will be the overhead “danger zone” in red. If Etehreum can break above this region at $4,450, there will be little resistance as we move towards our targets around $8,000.
Conclusion:
The broader vision is that Chainlink’s Network and CCIP infrastructure will allow developers to build smart contracts with code across multiple chains similar to how web applications consist of code across multiple clouds. The lack of interoperability is holding Web3 back, and Chainlink is the middleware offering the way forward. The first customers to move forward are likely to be banks, and Chainlink is a clear choice as long as the SWIFT partnership continues to expand.
Chainlink’s story today is much stronger than when we added this altcoin permanently to our portfolio a month after we launched the site. The market has been intense since then, from the Covid pandemic in 2020, to the exuberant 2021 high, to the 2022 bloodbath – yet, Chainlink remained a staple in the I/O Fund portfolio through all of this.
We expect Chainlink to remain a staple for the long-term, which is saying volumes since it’s an altcoin, not to mention that Chainlink has held the conviction ranking of other major winners. In the meantime, while we patiently wait for the fundamentals and product to align, we will provide you all of the technical analysis you need to manage this position as well as humanly possible. As always, we have our eye on the ball.
That’s a wrap for 2023! Thank you for the wonderful year. Our team has never performed better and we are in gratitude for the opportunity to learn and grow together as we move into 2024. Look for a 2024 Annual Webinar plus Q1 Earnings Kickoff Webinar in early to mid-January.
On December 9th, we announced that we are buying Bitcoin and laid out the reasons why in a free article that was quite clearly named: “Bitcoin is Going to Rally Again: Here’s What You Need to Know.” Since stating that in that article that Bitcoin was at a meaningful low, Bitcoin is up ~62%. Here is what I said:
“Though we are in the 4th bear cycle in Bitcoin's history, the prior 3 cycles suggest where we are is a rare buying opportunity. There is ample evidence to support the $15,500 level is either a major low or very close to a major low. Both the technical and on-chain analysis support this.”
We then followed up that article on January 9th, stating that Bitcoin is likely in the early stages of a cyclical uptrend, and that we are continuing to buy at current prices. Since then, the price is up ~40%.
Not only is the on-chain analysis lining up with our technical analysis, but the fundamental story behind Bitcoin’s intended purpose is starting to manifest. Most forget that Bitcoin’s white paper was first introduced on the heels of a banking crisis that nearly brought down the global financial system. The intended purpose of Bitcoin was to be a hedge against failing banks, as stated by its creator in 2009.
“The root problem with conventional currency is all the trust that's required to make it work. The central bank must be trusted not to debase the currency, but the history of fiat currencies is full of breaches of that trust. Banks must be trusted to hold our money and transfer it electronically, but they lend it out in waves of credit bubbles with barely a fraction in reserve.”
The recent decoupling of Bitcoin from equities, we believe, is the start of a new uptrend that appears to be inversely correlated to the financial sector.
The financial media would have us believe that the current banking crisis is mostly US centric, and localized to regional banks. However, as we look at various charts from these banks, a different story emerges. This is not just a US problem, and it is not limited to regional banks. As more and more investors realize their deposits, once again, may not be safe, we should see an increase in Bitcoin’s demand, which is supported by the on-chain and technical analysis provided below.
Bitcoin and Banks
On Friday, March 10th, Silicon Valley Bank (SIVB) failed. With over $200 Billion in deposits, SIVB was one of the largest banks in the US, and therefore one of the largest bank failures in US history. This was quickly followed by the failure of Signature Bank in New York, with deposits of over $110 Billion. What followed was a mini panic out of regional bank stocks, as we soon saw depositors fleeing the more vulnerable regional banks and into the Too Big to Fail banks.
Interestingly, on March 10th, Bitcoin bottomed and began one of the sharpest jumps we’ve seen since 2021.
This may seem like a random occurrence, yet this move lines up with Bitcoin’s original white paper, first published on the heels of the Great Financial Crisis (GFC) by the mysterious Satoshi Nakamoto. The original intent of Bitcoin was to create a true peer-to-peer electronic payment network that did not rely on centralized institutions to facilitate transactions. In short, it was the first real attempt to disrupt the banking system, and remove the inherent risks in a centralized banking system.
Coincidentally, this white paper was released in February, 2009, which was at the height of despair from the global banking system melting down. Most people assumed their money was safe in a bank and that it would be there when they need it. Most people had no idea about fractional banking, let alone credit default swaps and collaterized debt obligations. What they did realize on a primal level in 2008 was that their money was at the mercy of a centralized system that was much more complex than they thought and not as safe as they previously believed.
What we are seeing today is a repeat of the same realization, only with different details. The popular narrative regarding the current banking crisis is that deposits are fleeing regional banks at a record pace and moving into the “Too Big to Fail” banks, like JP Morgan, Citigroup, Bank of America. Therefore, any additional weakness in banks should be localized to regional banks while the big banks continue to thrive, which should offset the current weakness.
This sounds plausible, and fits within the relative calm we’ve had since the FED has fenced off the problem banks. However, if we look at the big banks that should be receiving this tailwind of deposits, another picture emerges.
Bank of America (BAC) is one of the largest and most important banks in the US. After the epic consolidation from the GFC in 2008, it was deemed, along with a handful of other banks to be Too Big to Fail, and it remains so today. Just a simple glance at the price chart and we can see that BAC is comfortably below its October low with no buyers stepping in at a critical support level.
BAC is threatening to break a trendline that has kept the stock trending up since 2012. What is also concerning is that BAC has completed a large degree 5 wave uptrend off the 2009 low. Furthermore, the corrective pattern that began in late 2021 is incomplete and suggesting a test of the COVID lows is needed before some kind of meaningful low can be found. The failure to find buyers at such important support is alarming.
Another “Too Big to Fail” Bank is Citigroup (C). This chart is significantly weak, and has basically trended sideways since the 2009 low.
Like BAC, it has completed 5 waves up off the 2009 low; however, it topped in 2019, failing to make a new high during the COVID bull market. Also, like BAC, it appears to be pointing towards the COVID low to complete a large degree correction.
Another Bank deemed “Too Big to Fail” is Morgan Stanley (MS). It is also in a precarious position.
Though it is relatively stronger than BAC and C, it has also completed a large 5 wave uptrend off the 2009 low. The following correction, like most bank stocks, has not completed its corrective pattern and looks to be targeting a price below the October low of 2022.
These large banks have quite unhealthy and concerning charts. They suggest that what is going on in the banking sector may not be a tailwind for them, but in fact, a headwind that will offset any increase in deposits.
What’s more concerning is that the banking issues do not seem to be localized to just the banks. The below chart is Metlife (MET), one of the largest insurance providers in the US.
This is one of the weakest charts in the mega cap financial spaces, as the stock cannot catch a bid at major support. The corrective pattern looks to be a 5 wave move down that is incomplete. If accurate, it suggests that MET has put in a major top.
Capital One (COF) is another big financial stock that looks like it is in trouble. As a credit card and banking company, its chart looks to be heading much lower, as it attempts to find buyers at a key support level.
Furthermore, the issue is obviously not localized to the US, proven by the collapse of Credit Suisse. However, if we look at various charts from global banks, a similar pattern emerges.
The Royal Bank of Canada (YT) looks a lot like some of the bigger banks in the US. After completing a large 5 wave uptrend into the late 2021 high, we have an incomplete corrective pattern that should take us well below the October 2022 low.
A few additional bullets on the global banks:
Deutsche Bank announced that they will redeem $1.5 Billion of notes due in 2028. As a result, the cost of their credit default swaps increased sharply, much like we saw with Credit Suisse prior to their collapse. European banks have been down across the board on this news, as Deutsche Bank saw a 14% drop that day, and is down ~25% from its February high.
The French CAC has been one of the stronger indexes in Europe; however, under the hood, the banking sector is the weakest sector, much like in the US. BNP Paribas, Frances largest bank, for example, is down ~18% from its March high.
Now, UBS is being probed and possibly sanctioned due to their support of Russian Oligarchs.
Two of Japan’s largest banks, Mitsubishi UFC Sumitomo and Mitsui Financial, are down between 14% – 17% from March 9th.
The largest bank in Australia, the Commonwealth Bank of Australia, is down ~13% since March 14th, while England’s largest bank, HSBC, is down ~14% since late February.
Itaú Unibanco, Brasil’s top bank, is down ~15% since late February and over 25% since last November.
The point is that whatever is unfolding in the banking sector is not localized to US regional banks, and is certainly a global concern. The more uncertainty in the centralized banking system, the more that Bitcoin will fulfill its true purpose.
In our last free article, we discussed that inflation pressures are still quite high, especially within the service sector. Evidence is building that crude and gasoline are looking to breakout to higher levels, which was confirmed with OPEC announcing surprise production cuts this week.
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While the market is pricing in a FED pivot, we are getting mixed messages from the prior hawkish FOMC statement and a dovish speech that followed by the FED chair. If energy does break out, as we believe it will, we could see an unexpected inflation impulse at the worst time. With a Global Debt-to-GDP sitting at 338%, and an on-going global campaign to aggressively fight stubborn inflationary pressures, it’s no wonder that we are seeing cracks within the system.
If what the charts are suggesting does unfold, once again, most people will be confronted with the harsh reality their deposits are possibly not safe, which will only bolster the underlying purpose of Bitcoin. Not only is it a hedge against inflation, but it’s a simple and efficient means to store wealth, which can provide an alternative to gold.
Bullish Until
Analyzing price action is especially important in Bitcoin. It does not have earnings reports, and rarely has news events to move price. So, the majority of swings that we see in this asset happens based on sentiment. Because of this, it lends itself well to technical analysis. Our firm outperforms in this regard with active management and real-time trade alerts.
The big picture has Bitcoin starting its final 5th wave of a large degree uptrend that started in late 2018.
This will remain my thesis as long as any weakness holds above $19,550. We’ll now zoom in on the current uptrend, which is the boxed off region on the chart above.
What you can clearly see is a completed 5 wave pattern off of Bitcoin’s low. This is usually bullish. As long as $19,550 holds, any breakout above the current consolidation would be considered a buy from our analysis.
On-Chain Analysis
Our risk management partners, WealthUmbrella, are a team of AI and Machine Learning engineers and professors who have spent months analyzing all of the on-chain metrics in Bitcoin. The net result of their research led to a rather advanced risk-on/risk-off signal available to retail investors. The below analysis is the conclusion from their research.
We previously mentioned that many of our on-chain indicators suggested that the November 2022 low might be the cyclical bottom. Since then, the price surge in Bitcoin has confirmed this low, as we have now moved into what we call the “green environment.”
This environment has historically been where we see the start of a new cyclical uptrend. In such an environment, it's generally better, from our research, to stay in the market. However, just because we believe that the bear market is likely over, doesn't mean we are ready for a moonshot. Historically, once we initially move into our green environment, what follows has typically been quite uneventful. We tend to see price action trade sideways-to-up for many months with relatively low volatility.
This doesn't mean that, given the context, we couldn't see another black swan event interrupt the green environment. We saw this when COVID suddenly pushed us back into our “red environment” in 2020. This was an unusual event that is accounted for in probabilities, which are historically low.
That being said, now that we have a nearly 90% increase from the November low, we must conclude that this appears to be more than just a bear market bounce. In fact, many of our on-chain metrics (InvestorCap, RealizedCap, ThermoCap) are now out of their bottoming zone. This is telling us that the overall ecosystem's economic has recovered significantly.
What Our On-Chain Metrics Are Signaling
There is a popular saying in finance – “when there is no one left to sell, there is only direction the asset can go” Interestingly, this saying can be quantified through analysis of on-chain metrics and patterns. One way to monitor this is by looking at the number of newly created BTC addresses.
After the 2018 bear market, large upward moves in price were accompanied with a sharp increase of first time buyers in Bitcoin. The below chart measures newly created Bitcoin addresses with a starting balance of $0 (in blue) compared to Bitcoin’s price (in orange).
After a small dip in price in late 2021, we returned almost to the local high, but this time the number of new addresses decreased significantly. The same pattern occurred with the 2020 cyclical top, which saw a progressive loss of interest from newcomers. However, this is currently not the case, as we continue to see an upward trend in this metric in sync with the price action.
This increase in interest with Bitcoin is being accompanied with the largest spike in net positive posts about Bitcoin. Our Bitcoin Twitter Sentiment indicator recently clocked all-time record of 46,000 net positive Twitter posts about Bitcoin on March 16th, which was around the time the banking crisis in the US was at its peak.
Another interesting pattern can be found by analyzing the daily cost in US dollars to complete a Bitcoin transaction. Usually, as the price of Bitcoin rises, the cost to complete that transaction rises as well. Near a top, these fees often diverge and trend downward while the price continues higher. This is caused by fewer transactions being processed on the network. The current setup regarding this metric is supporting the bullish narrative, as both the price and this metric are trending in the same upward direction.
One of our personal metrics that we created to help us identify normal overbought/oversold conditions vs. cyclical tops/bottoms is called the Metcalfe Law premium/discount metric. This indicator is telling us that Bitcoin is currently priced just slightly above its fair value, and that it has ample room to run before we should get concerned.
Another interesting phenomenon going on right now is that as price has been pushing up, we consistently made new all-time highs in the percentage of supply that hasn't moved in more than a year. This is encouraging because it not only signals a reduction in Bitcoin’s supply, but follows the same pattern we have seen throughout history during each significant price increase in Bitcoin.
When Bitcoin starts to rise, this number tends to rise with price, further decreasing supply. As of recently, 68.09% of the supply in Bitcoin hasn't moved in more than a year, which is encouraging.
Also worth noting, the supply that hasn’t moved in over a year came down to 67.17% on Thursday, March 30th, 2023, due to a whale dumping around 20,000 bitcoins.
Our analysis confirmed that this was sold for a significant loss. There is something strangely bullish about a whale dumping a large amount of Bitcoin at a loss, and the market barely dipping, then recovering within a day. Similar significant dumps have previously resulted in massive downward moves that continued for weeks.
Conclusion:
In Conclusion, according to Bitcoin’s creator, the asset’s true purpose is to solve the inherent risks within a centralized banking system. We have had no reason to truly question the need for this thesis in 13 years. However, recent bank failure, coupled with concerning financial charts around the world, could be confirming the potential realization of this original thesis. We believe that if this banking crisis spirals, it will be the catalyst for Bitcoin to push higher. Interestingly, this narrative is being supported with on-chain analysis and technical analysis pointing in the same direction.
As long as WealthUmbrella’s signal stays in the “green environment” and price holds above $19,550, we will continue adding carefully to our Bitcoin position with real-time trade alerts sent to our research premium members.
What's next
My team’s impeccable track record on Bitcoin dates back to when we first launched our service in 2019. We’ve held Bitcoin at high allocations with the confidence that we will know when it’s time to add or time to trim substantially.
This helped us announce an audited cumulative return of +47% through 2022 when most all-tech portfolios were negative during the same time period.
Next Thursday, 4/13/23, at 4:30 pm Eastern, I will be holding a webinar for premium members to discuss the I/O Fund portfolio, plus if we will be buying, selling or hedging according to broad market signals and our automated hedge.
Not only did we identify a strong buy signal in Bitcoin in December, but we also identified Nvidia’s bottom in October. Bitcoin is a leading asset YTD in the market, and Nvidia is the leading stock in the S&P 500. We take gains often and we discuss this in our weekly webinars and on our premium site. Our automated hedging signal was developed by WealthUmbrella. All of this is offered in our premium service.
Bitcoin is the best performing asset of our lifetime. Given the history of Bitcoin’s awe-inspiring returns shown below, the single most important question for every investor in the market today is if this gravity-defying asset can do it again.
The Bears want you to focus on the -77% bear market, as they have for all of the four major drawdown Bitcoin has experienced. You will not hear one Bitcoin Bear admit the truth, which is that Bitcoin has smashed every single performance record in equities within 15 brief years.
Source: YCharts
Yet, there is key evidence that shows how Bitcoin is stronger today than it was during the previous three drawdowns. The reason you don’t want to ignore this is because – despite steep +80% selloffs — Bitcoin has reclaimed new highs within 3.5 years, every time. Therefore, it’s not only the size of gains Bitcoin has provided which places it as the #1 asset of all-time yet it’s the speed in which this is accomplished that is also remarkable.
I want my readers to be armed with facts – not emotion – and what I’m presenting below is the culmination of a history of accurate calls that I’ve made in the past on Bitcoin plus new quant-level information presented by Vincent Duchaine of Wealth Umbrella, who has created an automated buy/sell signal in Bitcoin using on-chain metrics.
Below is an illustration of the history of how quickly Bitcoin has reclaimed its all-time high in the previous drawdowns.
The average time period for Bitcoin to reclaim its all-time high is between two to three years, with 3.5 years being the maximum amount of time. The chart shows the max drawdown for each bear cycle in red, followed by the recovery in green.
Keep in mind, that in order to break even after an 80% drop, it requires a stock or asset to go up 400% just to break even. Qulacomm, for example, suffered a similar drawdown in the dot.com bust. It took about 20 years for QCOM to regain its 2000 high. Cisco, another darling of the late 90s, has never recovered its 2000 peak.
This asset came to market during the Great Financial Crisis, and unlike most tech companies on the market today, not only has survived an economic recession, but was, in fact, found traction in 2009 during a time when tech was faltering to withstand macro pressures.
On January 3rd, 2009, the bitcoin network was created when Satoshi Nakamoto mined the starting block of the Bitcoin chain. Within the coinbase of this first block was the text "The Times 03/Jan/2009 Chancellor on brink of second bailout for banks". This note references a headline published by The TimesThe Times and has been interpreted as both a timestamp and a commentary on the instability caused by fractional reserve banking systems. Bitcoin quietly set out to disrupt the centralized banking system, prior to which was inconceivable, at a time that was arguably more uncertain than what we face today.
One reason for this is because Bitcoin has successfully accomplished becoming a global store of value – a feat only a handful of currencies/commodities have accomplished. Many have argued against this claim based on bitcoin’s volatility. Those that make this claim fail to see that the two most popular stores of value – the US Dollar and Gold – have terrible track records.
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In 2022, gold topped with a ~45% drawdown. It took gold nearly 10 years to reclaim this high, which it was unable to hold. As of today, gold is about 8% below its 2011 high. The US Dollar, arguably, is the worst store of value. Since 1913 it has lost 97% of its purchasing power. Bitcoin, on the other hand, is up over 28 million percent since it first started trading in 2010, and has recovered from its bear cycles in a relatively short amount of time. It’s no wonder that citizens of emerging markets – who face extreme inflation — love this store of value.
This specific utility in Bitcoin is further backed when we correlate crypto adoption to a specific county’s level of corruption and/or monetary instability. For example, some of the counties with the highest crypto adoption are Ukraine, Russia, Argentina, Turkey, Brazil, just to name a few.
To these people, Bitcoin offers a secure and efficient exit from the inflationary turmoil and centralized manipulation of their personal earnings. In essence, the lofty goal Satoshi Nakamoto established in the October 2008 white paper, which was to offer an exit from the fiat system, has manifested today in real-time.
Bitcoin’s Upcoming Rally – What You Need to Know
Bitcoin has no earnings reports, management overhauls, or supply chain disruptions that can affect its price. Anytime humans come together in a codified arena and begin trading an asset with their instinct for security as the primary driver, patterns develop across price history. Therefore, in order to determine what Bitcoin does next, we must measure sentiment.
One of the simplest patterns to measure is that an uptrend moves in 5 waves up, then corrects in a 3 waves pattern down. Once we get 5 waves up and 3 down, we then repeat this pattern in a fractal manner. As of now, since the 2018 low, we only have 4 waves in place, which implies that we have one more 5th wave push before the larger bull cycle is over.
A few points I want to make about the above chart. We have from the 2021 top a very complete and filled out corrective pattern. Recently, Bitcoin pushed lower on the FTX scandal, which has now provided us with the first bullish divergence on a weekly chart since the 2021 bear market began. This is when price goes lower with less momentum. This tends to mark the near end of large drawdowns.
Another one of my favorite patterns can be found in the detrend oscillator below. This is simply measuring the difference between two moving averages, and when set to a seven-year period, it tends to provide very interesting signals. Most importantly, the oscillator is currently finding support at the 2018 low and the oscillator is now building a new uptrend. When a new uptrend is building, this oscillator will tend to build this new uptrend on prior crash lows, which is playing out now.
Note: Knox Ridley is holding a weekly market webinar on Thursday, December 15th at 2:30 p.m. Eastern for I/O Fund Members to go over a detailed buy plan for Bitcoin, plus how he hedges Bitcoin when needed. Sign up today.Sign up today.
The chart below shows a general early warning sign of when the trend is changing. The red line going down the chart is a 45 degree angle, and has stopped each attempt of a recovery since 2021. Once we reclaim this angle, it will mark an early and meaningful change in trend. As of now, that level is around $18,100.
On-Chain Analysis
This conclusion is further backed up by on-chain analysis, which is a field of study that ignores price action, and instead looks at the fundamentals, utility, and transaction activity of cryptocurrency and blockchain data.
Dr. Vincent Duchaine of Wealth Umbrella is an A.I. and Machine Learning engineer. His team spent several months analyzing on-chain metrics within the Bitcoin ecosystem to create an automated risk-on/risk-off signal for retail investors. Vincent stated that most of the on-chain metrics his team analyzed point towards Bitcoin forming a major bottom.
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The level of most metrics is such that we could have already seen it at $15.5k, while other metrics suggest that we could see the price drop down to $13.2K in a final spike down.
Here are some examples of on-chain metrics from Wealth Umbrella that are providing rare signals that have only been seen around major lows:
Shown below, the supply of bitcoin hasn’t moved in more than a year and was barely affected by the FTX scandal. Even after the recent drop, the supply of Bitcoin hovers at a near record high of around 67%, and again, this level hasn’t moved in more than a year
Previous major events, such as the Mt Gox debacle in February 2014, or the price collapse in November 2018, saw a retracement in the range of 2-3% on this metric. Meanwhile, the FTX scare only reduced this value by 0.81%. Ultimately, what this is telling us is that fewer market participants are now willing to sell their Bitcoin, which historically has put a floor under Bitcoin.
The recent low also was accompanied by a new considerable spike of outflows from exchanges. Despite a lower low on the price, this indicator didn’t make a new high, which shows that less and less people are now willing to sell their Bitcoin.
This type of behavior has been observed at bottoms (particularly in 2015). It’s also worth noting that the June spike was also in the same range than the 2015 bottoming zone and higher than what we saw in 2018.
Another interesting metric is the Bitcoin percentage of supply being held in profit for the addresses that were active in the last 7 years7 years. This is helpful to mitigate the effects of long term HODLers or lost supply. Here, we can see that we are now getting pretty close to the all-time low of ~30% of the supply being held in profit, which is the type of capitulation that marks meaningful lows.
Overall, most on-chain metrics from any layers of the Bitcoin ecosystem is providing rare readings that tend to flash around major bottoms. Until these metrics recover it is hard to say with accuracy if the bottom is already in or if we have more way to go in this correction.
One data set that suggests we could go lower is the relationship between Bitcoin’s Market Cap and its Thermocap. Thermocap is a more realistic means to calculate the size of Bitcoin, instead of using Market Cap. It was first introduced by Nic Carter in 2018, and is the cumulative sum of revenue in USD that miners have generated to secure the Bitcoin network. This can be calculated by doing a summation of the value of each of the roughly 19 million existing Bitcoins at the price they were issued. By using this metric, lost coins and static coins, like the 800,000 coins mined by the mysterious Satoshi Nakamoto, are counted in the total supply at the price they were originally mined.
Wealth Umbrella found that the price of Bitcoin relative to its Thermocap is a great method for identifying high value zones that tend to mark lows. We have entered that zone recently, which is rare, but also supporting another low deeper into this value zone is possible. However, this indicator, based on prior extreme drops, suggests that the current drawdown could see us go towards the $13,000 region before putting in that meaningful low.
Conclusion:
In conclusion, the adoption of Bitcoin beyond retail interest is growing. We are seeing more and more institutional investors, economies and businesses adopting Bitcoin. Though we are in the 4th bear cycle in Bitcoins history, the prior 3 cycles suggest where we are is a rare buying opportunity. There is ample evidence to support the $15,500 level is either a major low or very close to a major low. Both the technical and on-chain analysis support this. As Bitcoin continues to integrate into the global economy, we expect both the volatility and epic returns to calm down. For now, we are content buying Bitcoin at these lows with a long-term mindset.
On Thursday, December 15th at 2:30 pm Eastern, we will be providing our weekly market webinar where we will discuss a buy plan for Bitcoin, including how to hedge Bitcoin when needed. Our goal is to provide context, as well as identify actionable exits and entries for investors. We have used this information to successfully build positions at their lows this year plus we have successfully hedged our portfolio multiple times in 2022.
Given our high allocation to crypto and specifically Ethereum, we want to track any progress (or lack of progress) towards The Merge to Proof of Stake, and also Shards and Rollups. We’ve also recently placed Avalanche into the LTBH category and this analysis looks at why we plan to trim ETH slightly and re-allocate what we trim to Avalanche.
In 2019, we wrote that the catalysts for Bitcoin trading at higher price levels (and holding those levels) would be economic uncertainty, the Lightning Network for mobile payments and institutional adoption. These three things came to fruition and Bitcoin has held higher prices.
The upcoming catalyst for Ethereum to expand its network and host more apps is well-known, which is The Merge to proof-of-stake. We discussed in March of 2021 that proof-of-stake would be necessary to lower gas fees and to help realize Ethereum’s full potential as a network for decentralized apps (d’apps), which would ultimately function like an operating system. The issue is not what Ethereum needs to do to realize it’s vision rather the question is when will Ethereum do it? When will Ethereum complete The Merge?
The delays on The Merge are one reason we are diversified with a Layer 1 in LTBH. It’s likely you see us add more Layer 1s pending technical analysis, such as Solana. We discuss below the additional delays that Ethereum faces on PoS and the upcoming timing issue in June when Proof of Work is scheduled to “freeze” over a period of five months.
Quick note regarding crypto selling off, I had discussed how OpenSea received a 10X valuation right before crypto sold off. You can read the full forum post here:
“The Series C was led by Philippe Laffont of Coatue Management, who has successes on the public markets such as Anaplan, Snap, Spotify and Databricks not yet public [..] Certainly, OpenSea would likely go for a lower valuation today given the Luna bust and all altcoins being down in sympathy. However, rather than stress over a 4-month bad timing decision, private investors will simply hold until market conditions are favorable for their investments and then go for the exit. Private investors assume their timing will not be entirely perfect and instead they make their exits perfect.”
The reason we have been dollar cost averaging into the crypto selloff is that timing a bottom is futile. It’s much easier to time an exit. According to industry analysts, blockchain should scale rapidly between 2025-2030 from $176 billion to $3 trillion. I imagine we will see Coatue and others exit through IPOs around the later part of this time frame, and as early-stage investors in crypto, we will want to consider doing the same. This doesn’t mean we won’t trim, etc., rather it provides a nice timeline for an exit on middleware like Chainlink and also Layer 2s. I’ll touch more on those in an upcoming analysis.
Ethereum Network Delays on PoS
The primary difference between Ethereum and Bitcoin is that Ethereum is not trying to compete as a currency. The focus of Ethereum is on its network, not the coin. Vitalik Buterin’s vision is to create an open network for decentralized applications and smart contracts based on the Turing complete programming language Solidity.
Ethereum faces constraints in transactions per second (TPS) and how to overcome the high energy costs of mining that comes with decentralized security. The network simply can’t scale without the upcoming release of Ethereum 2.0.
In our premium analysis last year on Ethereum here, we discussed the difference between Proof of Work (PoW) and Proof of Stake (PoS). In addition to the Proof of Stake merge that Ethereum must complete, the network must also launch shards. In last year’s analysis, we said: “Shards are another critical improvement for network bandwidth and the low transactions per second (TPS) as Ethereum 2.0 (ETH2) allows for improved data processing. Nodes in the previous network must download a transaction, calculate it, archive it and read every transaction in Ethereum’s history, which is terribly inefficient. Shards create a subset of the network where nodes are dispersed for more efficient processing. The Beacon Chain ensures the nodes are synchronized and the validators are reporting the blocks of transactions.”
We went into great detail on ZK Rollups, as well. The quick summary on ZK Rollups is they allow for hundreds of transfers to be rolled into a single transaction. This will replace Plasma, the current option where only a single transfer is made per transaction. In this case, the smart contract will verify all of the transfers in the Rollups. The goal is to reduce computing and storage resources by reducing the amount of data held in a transaction.
In November, we wrote another update on crypto and Ethereum, stating that the expectation was for Proof of Stake to merge in late 2021 with Shards and Rollups expected by late 2022 or early 2023. The timeline for PoS is delayed yet again until Q3 2022, which puts Sharding and Rollups out another year potentially to Q3 2023.
Update on Proof-of-Stake (PoS) Merge
In August of 2021, Ethereum went through the London Hard Fork. This was a step towards PoS as Ethereum Improvement Proposal (EIP) 1559 changed the management of transaction fees on the network. Previously, the transaction fees would go to the miner directly. The London upgrade introduced a fixed-per-block transaction fee that is burned. This results in more predictable gas fees and also helps the blockchain network prepare to eliminate miners by Q3 of this year.
According to Statista, the average gas fee in August of 2021 was 136 Gwei. In January of 2022, the average gas fee was 122 Gwei. There have been some lower months for gas fees both pre-London upgrade and post-London upgrade, yet ultimately EIP 1559 will not resolve gas fees by any means and The Merge is still (badly) needed.
Gas fees reflect the fact that blocks reach their maximum capacity during peak transaction periods. However, this can actually work to increase the price of Ether in the event that transaction fees are prohibitively high to transfer ETH. The London Hard Fork also helps to create scarcity as ETH is burned with each transaction.
Ethereum’s Difficulty Bomb is Ticking…
The “Difficulty Bomb” refers to a deadline where Proof of Work (PoW) will become more difficult by impacting block times. The Bomb refers to the exponential difficulty that PoW will face, which will cause block times to implode similar to a bomb.
According to Tim Beiko, the block time will increase 487% from 12-14 seconds to 64 seconds about five months after the difficulty bomb is released. This is achieved by making it more difficult for miners to crack the cryptography, and the result is that it becomes too time-consuming to be profitable. This is referred to as the “Ice Age” when PoW will be effectively frozen and miners will be deterred from minting more blocks.
In addition to pushing miners to move away from PoW, the difficulty bomb also removes the ability to create centralized currency on the Ethereum network, prevents a blockchain fork that could occur if miners continue PoW, and also forces node upgrades.
There have been five delays on the Difficulty Bomb with the current deadline extended to June of 2022. For obvious reasons, it’s ideal if the Difficulty Bomb “goes off” after The Merge occurs otherwise the Ethereum network will be frozen without an adequate replacement for the consensus mechanism. As of early May, however, Ethereum developers have decided to ignore extending the Difficulty Bomb in favor of remaining focused on proof-of-stake.
I believe the (current) decision to ignore the Difficulty Bomb reflects the lack of patience that is growing across ETH investors and also Ethereum users (due to high gas fees) on the Proof-of-Stake Merge. This is the first time that the Ethereum Foundation has decided to forego delaying the ticking bomb as they must heavily weigh the pros/cons of delaying PoS again.
There’s a chance that the All Core Devs meeting on May 27th reverses this decision and chooses to focus on delaying the freezing of PoW. However, it seems that Vitalik Buterin, the co-founder of Ethereum, is prepping expectations that block time increases temporarily: “We have to evaluate the pain of doing an extra delay hard fork versus the pain of living with 21 or 25 second blocks for a while, which is something we have done and the world didn't end.”
Ethereum’s delays with the PoS Merge is one reason we added a second Layer 1 to the LTBH portfolio. To complicate matters, the Difficulty Bomb is now weeks away from detonating (sounds like we need Batman).
Although it’s hard to give up any allocation on Ethereum given its concentration in d’apps and developers, it’s also important to acknowledge that if other Layer 1s want to compete alongside Ethereum, June-September is their chance to lay some serious groundwork on building a developer and app ecosystem because Ethereum will be juggling two hot potatoes – The Merge to PoS and the Difficulty Bomb.
A Member shared the A16Z Crypto Report which helps to illustrate Ethereum’s dominance.
The decision that Ethereum must make between prioritizing Proof of Stake or the Difficulty Bomb is not lost on popular apps on the Ethereum Network as a slowdown in Proof of Work before The Merge would result in higher gas fees and more congestion. Investors should keep an eye out for popular apps diversifying their Layer 1 network due to high gas fees.
In our previous write-ups, we discussed how Time Magazine’s TIMEPieces resulted in exorbitant gas fees where 10 NFTs were priced at 1 ETH for $2500 or $2800 yet due to gas fees, one buyer paid as much as $70,000.
Yuga Labs is the creator of the Bored Apes Yacht Club and is a leading NFT creator. There are 10,000 apes with traits and unique characteristics, which you may recognize such as this:
Three weeks ago, Yuga Labs held a digital land sale that drove $285 million to the company yet resulted in $176 million in gas fees on the Ethereum Network. The average gas price was around 800 Gwei early Sunday and spiked to 6000 and 7000 Gwei during the sale, which equates to $3,000 or more per transaction in gas fees. In fact, there was one $25 NFT that carried a $3,300 transaction fee and complaints abounded on Twitter.
Yuga Labs issued an apology and publicly stated they are going to turn the lights off on Ethereum for a while.
In this high-profile decision, Yuga Labs is reportedly considering other Layer 1s.
Avalanche
The I/O Fund added a new LTBH position in Avalanche last month. We did a deep dive on Avalanche here.
What other Layer 1s will popular Ethereum apps choose to diversify with? We think Avalanche could be a top choice given it’s Ethereum Bridge, application-specific subnets and the launch of a consumer-facing app over the next few months/quarters. Avalanche also has a high Nakamoto Coefficient, which is a number that designates the number of nodes that would need to be corrupted to slow or prevent a chain from functioning properly.
Last quarter, Avalanche launched GameFi subnets with DeFi Kingdoms participating. The bridge protocol Synapse saw volumes surge from a previous high of $157 million to a record $330 million. This accounted for 82.5% of total bridging volume on Synapse.
Recently, the popular game Crabada migrated from Avalanche’s C-Chain to a subnet. This will help prove viability of subnets’ ability to scale and potentially attract more games as Ethereum goes through its growing pains over the next few months. Crabada draws in high daily volume of up to $1.5 million with transactions of up to 400,000 per day. The application has a total value locked of $50 million by the end of the quarter.
Avalanche launched with three chains. Per our YO/LO write-up: The X-Chain is for creating and exchanging assets including NFTs, the P-Chain validates and creates subnets, and the C-Chain is for executing Ethereum Virtual Machine (EVM) contracts. The C-Chain offers interoperability with Ethereum, which is why the Avalanche bridge is the most popular ETH Bridge currently. The P-Chain is what is used to create and manage subnets. The coordination of Avalanche validators occurs on the P-Chain and it can support thousands of subnets and millions of validators.
Subnets are important to reach scale. The customized chains allow blockchain verticals to have enhanced function by grouping together like-kind applications. Gaming d’apps are separate from Decentralized Finance apps (lending, borrowing, payments), which is key because these d’apps have different requirements.
As we stated in the AVAX write-up: “Ethereum is running into issues with 500,000 to 1 million daily active users. Meanwhile, a single mobile application sees hundreds of millions of users, such a Twitter or Spotify. What Layer 1 can handle this level of adoption? That is a platinum-level question for investors to answer. To be clear, it could be Ethereum in 2023 if the developers and users prefer to not migrate. However, if the ecosystem runs out of patience and seriously looks for an alternative, then Avalanche is a candidate.”
Avalanche came to market in 2020 yet in terms of total value locked, started to gain traction in August of 2021. The chart above by A16Z helps visualize how strong Avalanche has been out of the gate in terms of growth. I’ll repost it here for quick reference:
According to Messari’s Q1 report, Avalanche’s average daily transactions grew 82.8% sequentially and total revenue grew 72% from Q4 to Q1 2022. During this time, the market cap was flat at (5.4%) and price relative to revenue went from 160X to 91X (note: AVAX is two years old and very early stage).
In the first week of January, Avalanche had more active users than all of October 2021. The network averaged 70,000 daily active addresses, which grew to 92,000 in Q1. Average daily transactions rose from 473,000 last quarter to 865,000 in Q1 compared to Ethereum’s daily transactions of 1.17 million.
As stated above, some transaction fees on Ethereum were up to $3,000 during a popular NFT sale in the hundreds of millions. Avalanche surpassed $1 million in daily NFT volume for the first time with transaction fees of $0.67 per transaction. This helps illustrate the importance of Yuga Labs shopping for a new Layer 1 as one popular app can raise daily NFT volume substantially during auctions, helping to prove the ability scale for a competing Layer 1.
Perhaps most important for investors, there is an increasingly stronger correlation between revenue and market value for Avalanche. When daily revenue spiked in November, fully diluted value saw a similar spike. As Messari shows below, the spread between revenue and the fully diluted value had a tighter correlation, which helps prove fundamental value as the revenue has a closer relationship with network value.
An analysis on crypto this month would be remiss to not include a note on the Terra crash. TerraUSD (UST) or “Terra” is an algorithmic stable coin that automatically tracks the price of other currencies, in this case the United States dollar. The idea is that transactions will be predictable and investors can hold their assets without the level of volatility seen across fully decentralized currencies.
Luna is the native token of the Terra Layer 1 blockchain that is used for governance and mining. Luna is staked to validators to record and verify transactions on the blockchain in exchange for rewards and fees.
As a stablecoin, Terra was designed to use supply and demand to balance its price. If demand for Terra goes up, then Terra’s price increases, and if demand for Terra is low, the price decreases. The two cryptos, UST and LUNA, have an arbitrage-type relationship as the Layer 1 is made up of two pools. Atomic swaps are made possible through a market module.
Arbitrageurs sell LUNA for UST when the price is below $1 and they buy LUNA when UST is worth more than $1. If UST is priced at $0.90, then traders would buy that coin and sell it for $1 of LUNA. The prices were propped up by the protocol burning both UST and LUNA as they were being minted and converted, which helps bump up the price of the burned tokens due to the restricted supply.
Expansion occurs when Terra is higher than the pegged dollar, and the protocol incentivizes users to burn Luna and mint Terra. The new supply creates a larger pool for Terra, and users mint more Terra from the burned Luna until it reaches its target price. Contraction occurs when Terra is priced too low and supply exceeds demand. The protocol incentivizes users to burn Terra and mint Luna, which causes scarcity and an increase in Terra’s price to be more aligned with the dollar.
The arbitrage relationship between Terra and Luna is important to understand in terms of the Terra crash that occurred. However, the primary use for UST was not for the arbitrage opportunity but rather to earn yield on the Anchor DeFi platform.
Anchor is a DeFi protocol with $16.16 billion total value locked at the end of April, which included 72% of all UST. There was an additional $3.2 billion in UST on DeFi Llama and $152 million on Avalanche.
The reason Anchor had three-quarters of total value locked for UST is that the DeFi platform required funds to be held in UST to earn an interest rate of 19.46%. That yield drew a lot of attention and helped prop up Terra’s success as a Layer 1 blockchain. Between November and the May 2022 crash, UST’s market cap grew from $2.73 billion to $17.8 billion.
Expansion occurred because Terra was in high demand due to the attractive yield from UST. In addition to the expansion, the yield attracted a ratio of 4:1 lenders to borrowers. This meant Anchor’s reserves were becoming increasingly vulnerable to a “run on the bank” in terms of risk that an outsized number of lenders would withdraw their principal and yield. Basically, theoretically, if too many lenders withdraw at once, Anchor would not have enough reserves.
As this incredibly prescient article points out, there were warning signs.
The first was in February when the founder of Terraform Labs, Do Kwon, added $450 million into reserves with Arca CIO Jeff Dorman stating that Anchor would require more capital infusions to maintain the current yield. In late March, a proposal was passed to change the yield. Proposal 20 stated that the rate would change by a maximum of 1.5 percentage points once per month and would be a variable rate.
Here is what the Decrypto.co article stated at end of April in regards to the February cash infusion from Terraform Lab’s Founder and the subsequent decision to allow for lower interest rates:
“Without a clear, long-term solution, though, the rate will continue to decrease. After a certain threshold, which the market will decide over time, investors will generate returns elsewhere. This could lead to withdrawals from Anchor and investors potentially abandoning UST for another stablecoin that can be used for more lucrative opportunities in some other DeFi protocol. If this rotation were to happen en masse, it could be catastrophic for the health of UST as well as LUNA.”If this rotation were to happen en masse, it could be catastrophic for the health of UST as well as LUNA.”
We are not concerned about Terra in regards to our crypto holdings because on a granular level, the risk was unique the arbitrage relationship between Terra and Luna, plus the high yield of 20% on Anchor that was ultimately unsustainable. We will write an update on Aave soon.
Conclusion:
We have a large position in Ethereum that will likely be trimmed over time as we want to be prudent about the issues the leading network must overcome. This doesn’t mean we will exit entirely rather it means that 8% is too high when some of this can be allocated to an up-and-coming Layer 1, such as Avalanche. What we trim from Ethereum should be seen as diversification to lower risk during the transition to PoS and in anticipation of whether the difficulty bomb timeline is extended or not. We believe what happened with Yuga Labs and also the Axie Infinity sidechain hack (which was Axie Infinity’s solution to high gas fees covered here that ultimately hurt the company) could create a window of time where Ethereum sees heightened competition.
We’ve initiated a new position in Avalanche in the LTBH portfolio as we believe the Layer 1 network can compete with Ethereum long-term due to its ability to scale with application-specific subnets. We also like Avalanche for its ability to address security across subnets by leveraging the Primary Network’s validators.
Note: we are eyeing Solana and Aave for new Momentum positions, so keep an eye out for that analysis coming soon.
The crypto landscape changes quickly and owning crypto requires a more active stance. We cannot remove the volatility of crypto for an investor, and we also want to acknowledge that crypto is sheer speculation at this stage. With that said, blockchain is well worth the effort and can be an area where retail has a rare advantage over institutions. There are over 18,000 cryptos on the market as of March of 2022 and we hope narrowing down these names is helpful by showing you where we are invested and our conviction level.
A potential Solana momentum position would be for similar reasons as Avalanche, which are outlined below. To summarize, we want to diversify our Ethereum holding with more Layer 1s. If we enter Aave, this would be in response to Voyager’s most recent regulation as we are bullish on lending and Aave allows us exposure here without the regulatory pressure that Voyager and Coinbase must overcome. We will keep you in the loop on this.
Avalanche Layer 1 Network
As discussed in our YO/LO write-up in November and then our Crypto Webinar which focused on Layer 1s, the Ethereum network is struggling to keep up with traffic and this is illustrated through the network’s exorbitant gas fees.
The term “gas” refers to the computational effort required to execute specific operations on the Ethereum network. Each transaction requires that a fee be paid called “gas” to offset the costs of computational resources.
The market price for gas is determined by demand. If you want your transaction executed quickly or if you have a larger contract, you’ll pay more gas. As of August, the London Upgrade has changed how transactions are charged with every block having a base fee and a minimum price per unit of gas that is calculated based on demand for the block. Users also tip to compensate miners for executing the transaction.
Up until now, Ethereum has been using proof-of-work, which is an algorithm that requires a miner and large amounts of computational power to create blocks and to confirm transactions. Due to the proof of work (PoW) lacking the ability to scale meaningfully, the network can max out during peak traffic, which causes it to become very costly for the transactions being made during peak usage.
Regarding how exorbitant the gas fees have become; we used the example of TIME magazine’s NFTs in our YO/LO report. The NFTs were called TIMEPieces with a price for 10 NFTs costing around 1 ETH or $2500 to $2800. Due to gas fees, one buyer paid as much as $70,000 (?!) In addition, the wait time to transact ranges from 30 seconds to 16 minutes.
This is why Ethereum is merging to Proof of Stake (PoS). Instead of a large consumption of energy, PoS requires a financial commitment of 32 ETH to become a validator. With that said, for the full benefits of Proof of Stake to be realized, shards and rollups need to go live.
Rather than every node downloading every transaction, calculating it and replicating it, shards create a subset of the network where nodes are dispersed for more efficient processing. Rollups allows for hundreds of transactions to be rolled into a single transaction. This replaces Plasma, the current option where only a single transfer is made per transaction.
PoS is set to go live in 2022 while shards and rollups are set to go live in 2023. This provides competitors with an open window of opportunity through 2023 as competing Layer 1s launched with PoS and/or the ability to scale. We’ve covered these in more depth in the past so our Members would be aware that diversification is needed in terms of holding more than one Layer 1 position.
Grayscale recently added Avalanche to their large cap fund, announced April 6th.
We like Avalanche for its application-specific subnets, which has the potentialto scale better than other Layer 1 networks. We also like Avalanche for its endeavor to tackle the single largest issue that the blockchain faces, which is consumer accessibility. The power users for the blockchain today are niche groups: developers, gamers, NFT collectors. We believe Avalanche is attempting to break into a more mainstream audience through its Core Browser and mobile application. These are the main two points we cover below.
Avalanche currently holds the number four spot for Total Value Locked (TVL) at $10 billion yet there is very little separating AVAX from the others in overtaking the Layer 1. When we first covered the crypto, Polygon (MATIC) and Solana (SOL) both had higher TVL. Currently, Terra (LUNA) is in the number two position with $30 billion TVL.
Avalanche was founded on the idea that subnets are the proper way to increase speed and reduce network congestion and gas fees. Avalanche launched with three chains. Per our original write-up: The X-Chain is for creating and exchanging assets including NFTs, the P-Chain validates and creates subnets, and the C-Chain is for executing Ethereum Virtual Machine (EVM) contracts.
At the time, we had said the C-Chain was most critical for AVAX’s growth due to its easy interoperability with Ethereum. The C-Chain is also where DeFi apps are supported, such as Aave and Trader Joe (more on this below). However, in recent months, it seems the P-Chain is helping to carve out a permanent place as a Layer 1, as this chain is what is used to create and manage subnets. The coordination of Avalanche validators occurs on the P-Chain and it can support thousands of subnets and millions of validators, should this scale be needed.
The three primary chains are known as the Primary Network. Avalanche has taken a similar view towards subnets, which is that one chain cannot provide for all applications/use cases, and is encouraging developers to build out application-specific subnets.
Subnets are not an entirely new concept by any means. Ethereum has what is called sidechains. However, there was a major hack on an Ethereum sidechain on March 23rd and this is partly why we are tracking Avalanche more closely.
You can think of subnets as customized chains that allow blockchain verticals to have enhanced function by grouping together like-kind applications. Gaming d’apps would be separate from Decentralized Finance apps (lending, borrowing, payments), which is key because these d’apps have different requirements.
The benefit of subnets is scale. Ethereum is running into issues with 500,000 to 1 million daily active users. Meanwhile, a single mobile application sees hundreds of millions of users, such a Twitter or Spotify. What Layer 1 can handle this level of adoption? That is a platinum-level question for investors to answer. To be clear, it could be Ethereum in 2023 if the developers and users prefer to not migrate. However, if the ecosystem runs out of patience and seriously looks for an alternative, then Avalanche is a candidate.
To summarize, subnets will allow each application to have its own subnet, and subsequently scale without affecting other applications on the blockchain.
Axie Infinity’s Hack on Ethereum Sidechain
Before we talk more about Avalanche’s subnets, I think it would be good to talk about Ethereum’s sidechains. Recently, there was a major hack on an Ethereum sidechain operated by Sky Mavis.
Sky Mavis is the gaming studio that created Axie Infinity, a play-to-earn game that rapidly scaled from 35,000 users in May of 2021 to 3 million daily active users last Fall, representing 3200% growth. The game is especially popular in Southeast Asia. Per our note above, Ethereum has about maximum 1 million DAU, and therefore, Axie Infinity is quite the success story.
Axie Infinity has in-game economics, where you pay to play, and then play to earn. It costs a few hundred dollars to get started on Axie Infinity with game mechanics that are similar to Pokemon Go, except with creatures that trade through NFTs. Axie Infinity ranks third in overall NFT sales at $4.17 billion, second to Opensea’s $23 billion and LooksRare’s $18 billion.
The game is popular for its play-to-earn rewards that allow gamers to earn income from playing the game and building a virtual economy. Gamers have virtual pets that battle and breed, and gamers also raise kingdoms for their virtual pets.
Axie Infinity exploded after the launch of Ronin, an Ethereum sidechain, which removed Ethereum’s congestion issues and reduced transaction costs. Ethereum d’apps that need to scale have taken to sidechains, such as Axie Infinity with the 3200% growth from 30K to 3M users.
Sidechains require validator nodes to review transactions and to confirm that the inputs and outputs match. If any transaction is deemed not valid by the nodes, it will be rejected. However, sidechains are not fully decentralized and the validators can become compromised across both Proof of Authority (PoA) and Delegated Proof of Stake (DPoS). Sidechains are best used for smart contracts that do not hold or require large sums of money on the sidechain.
The unfortunate news last month was that Axie Infinity’s sidechain was hacked around March 23rd with over $600 million in Ethereum and USDC stolen from the Ronin Network. The issue with sidechains is they have fewer nodes validating transactions and this can become a security risk if the majority of the nodes become compromised. In this case, a hacker was able to compromise four of Sky Mavis’ nodes and one community-owned Axie DAO node.
By hacking five out of nine nodes, the hacker was able to override transaction security and withdraw funds. This brings up the discussion of what is decentralization if Sky Mavis operated nearly 50% of the nodes internally.
How Subnet Validators Are Different than Sidechains
Avalanche’s subnets have access to a set of validators already verified and ready to validate subnet blockchains. This is done by adding the subnets ID to a node configuration and by downloading the virtual machine binary. After this, the validators will sync to the subnet and start to validate.
Avalanche validators must validate all three primary chains – the X-Chain, the C-Chain and the P-Chain, also known as the Primary Network. By requiring all validators to validate the Primary Network, the subnets will benefit by instantly having access to a set of validators. In theory, this is more secure than Ethereum’s sidechain as Sky Mavis created their own validators for the Ronin Network.
Avalanche’s Primary Network and subnets are secured by the full staked value of the network. The consensus is inclusive and can be scaled to millions of validators. Subnets can improve the validation process by allowing validators to remain with their chosen applications (i.e., trading NFTs is very different from decentralized finance and validators may have a strong preference towards one over the other). This is an advantage as subnets can require validators meet certain criteria, as well, such as supporting trusted execution environments, which is a hardware isolation mechanism that provides a higher level of security than an operating system alone.
Subnets can also require higher validator uptime, which ideally is close to 100% unless the validator is doing an upgrade. Know Your Customer (KYC) may also become a required standard to where decentralized finance apps disallow full anonymity. In the case of Avalanche, a subnet could require validators adhere to KYC.
Subnets also allow for permissioned subnets to where a decentralized finance subnet could allow for more privacy and regulatory compliance, which is separate from gaming, which does not adhere to financial regulations. For process-intensive applications, rollup-based subnets can be created to process many transactions at once, which would benefit gaming. In this way, application-specific subnets can leverage customization.
Regarding Rollups, this article here points out on #17 something we have covered in the past, which is that time to finality is faster on Avalanche at less than 1 second compared to competitor Solana at about 13 seconds. The point in #18 the author is making is that time to finality becomes quite important for security purposes in the case of Rollups, which roll up many transactions into one. To summarize the author’s thesis: “Avalanche is not reliant on hoping someone checks every transaction afterwards, the entire network checks the validity of the transaction as part of consensus as it’s added to the chain, with sub second finality that can scale to millions of nodes offering incredible security.”with sub second finality that can scale to millions of nodes offering incredible security.”
AVAX’s Core Browser and Mobile App
We believe the best Layer 1 investment will help solve for accessibility around decentralized apps and put the benefits of the blockchain literally into people’s hands. The Core Browser and mobile application will both be live by Q2 of this year, although it’s important to note that Core also functions similar to an operating system.
Our three-part Bitcoin thesis included mobile payments as one tier for Bitcoin to reach its maximum market cap. This is a similar thesis for Layer 1s which is that to reach maximum market cap, the Layer 1 must break outside the niche power users to reach a wider audience for daily transactions and/or daily usage.
I believe Avalanche is attempting to solve the accessibility problem with the Core browser and the Core mobile application. It’s being called a wallet, yet functions as an operating system for d’apps. Metamask is currently on the market and is used for this purpose, yet Core will not be agnostic and will instead attempt to outperform Metamask by offering a cohesive Layer 1 experience for Avalanche chain users.
The customized wallet for the Avalanche chain will enable higher speeds and for subnets to be built out for a better user experience. In turn, more developers may build for AVAX similar to a proprietary iOS/app store. Avalanche is certainly not unique in these ambitions, rather it’s the first to release a browser/app as a means of reaching more users.
The browser extension will launch in March (this month) and the mobile app is expected to launch in Q2. This means Avalanche is moving quickly while Ethereum is stumbling. If Ethereum can’t match Avalanche’s speed and lower gas fees before 2023, then this leaves a year or longer for Avalanche to gain traction on its Core browser and application.
The company has stated specifically that they are going for “mass-adoption of Web3 systems with a smooth user-experience that has never been seen before.” Obviously, this is marketing language yet the statement is true that a great UX has not been seen before and this launch could connect a few critical dots in terms of blockchain users, developers, and the proliferation of the blockchain across devices.
The Core Wallet/OS will have the following features:
Enabled with Ledger, the leading hardware crypto wallet
Dashboard for cryptos and NFTs personally held by the user
Token swap powered by ParaSwap
Buy AVAX from the wallet with Moonpay
Address book for token addresses
Rather than challenge Ethereum head-on, Avalanche is being more courteous than other networks with the Avalanche Bridge. The Avalanche Bridge launched in July of 2021 a two-way token bridge that enables ERC-20 (fungible) transfers to Avalanche’s C-Chain. This allows ETH to be easily transferred and used on Avalanche. To help illustrate the demand for a new network that supports ETH, the Avalanche bridge has facilitated a total of $43 billion in asset transfers since last summer, eclipsing nearly 3X the total value locked on Avalanche.
The company has now launched a Bitcoin bridge to allow BTC to be used on the Avalanche’s Layer 1 network. This allows for more functionality across decentralized apps on the Avalanche network and also reduces the number of tokens a user needs to manage. Previously, a user would need to wrap ETH or BTC to be used on a network like Avalanche, which creates friction between new Layer 1 networks and these widely held tokens.
The issue that Bridge and Core will solve is that wallets do not function like operating systems so there is a need to transfer the tokens to/from networks for d’apps, and this creates an opportunity for hacks and also creates more friction. Avalanche will now compete with wallets such as Metamask while improving its functionality over other Layer 1 networks by becoming a one-stop shop. Being Ledger-enabled, the wallet should function securely with larger amounts of crypto easily held in cold storage.
Avalanche has a few popular apps, such as Aave which we have held in our YO/LO Fund in the past and we may initiate a new Momentum position. Aave allows users to earn interest by lending assets to creditworthy borrowers and has $21 billion in liquidity locked across 7 networks. As stated above, the #2 Layer 1 has slightly less than this in total value locked (TVL).
Trader Joe is a platform on the Avalanche network that could see a spike of interest when Avalanche releases Core. It includes an automated money maker to help stabilize tokens, allows for yield farming or the staking of tokens for interest, and allows tokens for lending/borrowing. There is $1.5 billion in assets staked to the platform.
Risks:
We’ve noted the sheer competition that all emerging technologies must overcome, with blockchain perhaps seeing more competition than most emerging technologies due to developers being naturally drawn to the philosophy and virtual economies of decentralization.
However, there are additional risks specific to Avalanche which a Member pointed out on our forum, which is the inflation rate of the AVAX token often being in the 20%+ range. It’s important to pay attention to this. The Member pointed towards this source:
It’s well worth the time to watch the video with some key points, such as:
Avalanche has over 100% inflation rate over the past 12 months with near doubling of circulating supply. This required $8.4 billion to keep it even.
The max supply has disappeared from Coin Market Cap, although as the comments out Ethereum and Solana also have no max supply listed. I also checked out Terra (Luna) and it has no max supply listed at this time. It could be due to the deflationary aspects of burning as to why max supply is missing, which is that the total number of tokens will decrease over time at an unknown rate. In Solana’s case, it is potentially missing because the circulating supply has no cap. That’s my best guess.
The next 144 million tokens will be released until September of 2024, which will require $450 million or roughly $6 billion per year to keep the token afloat.
The presenter expects inflation of 23.5% over the next 12 months.
The one counterpoint I would provide is that Avalanche has the max supply of 720 million (last on record) yet Cardano has low inflation of 1% and max supply of 41 billion. Considering AVAX has a decreasing supply, all things equal, I would prefer the first scenario. This is not a comment about Cardano, it’s only a comment about inflation relative to max supply.
Avalanche has heavyweight backers, such as Andreessen Horowitz and Naval Ravikant. This comes at a cost with insider shares, yet potentially lowers risk if the crypto is attractive to those who are typically very successful in early-stage tech.
Conclusion:
Certainly, crypto is speculative and carries risk, yet we believe this risk will normalize in the near future. The information above discusses why we believe Avalanche has staying power from a product perspective and how it could potentially outpace competitors on decentralization, security and scalability. In our original write-up, we discussed how every blockchain must compromise within these three requirements, and therefore, investors should be looking for which Layer 1 has to compromise the least. There is no simple answer, yet we appreciate (and accept) the challenge in analyzing cryptocurrencies as we believe the rewards will far outweigh the effort this asset class requires.
