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.
Source: CoinDesk and Kaiko
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.
Here was a question about derivatives on the most recent earnings call:
Devin RyanDevin Ryan
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!
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