A wager on crypto takes a strong stomach. Throw in uncertain court rulings and a battle royale with Wall Street giants, and it gets more treacherous.
For the foreseeable future, that’s what investors are getting in the stock of
Coinbase Global
(ticker: COIN), the largest U.S.-based crypto trading platform. While there is a bull case on the stock, it isn’t worth the gamble.
Coinbase has been a superstar this year, rising more than 135%. The gains have come on the back of
Bitcoin,
up 65%, and a 35% rally in tech stocks. But Coinbase has also benefited from some key crypto legal rulings, including a federal court decision this past week that could open the door to a spot-based Bitcoin exchange-traded fund.
The prospect of a Bitcoin ETF tantalizes Wall Street and Coinbase bulls alike. Several fund companies, including Fidelity Investments and
BlackRock
(BLK), are clamoring to launch Bitcoin ETFs. If they get the green light, some experts say, it could funnel billions of dollars into crypto—pushing up demand for Bitcoin and other tokens, and unleashing a gusher of fees.
But investors shouldn’t extrapolate the court wins and bout of exuberance into a long-term bull case for Coinbase. The Securities and Exchange Commission could still throw up roadblocks to a Bitcoin ETF—indicating this past week that it would delay a decision until at least October. Coinbase’s regulatory problems run deep, including a lawsuit filed by the SEC over its core trading business. Other revenue drivers look dicey. And more money flowing into crypto will heat up competition for investments, chipping away at trading fees.
“The regulatory and litigation risk encompasses most of the business,” says Berenberg analyst Mark Palmer. “The stock is really uninvestible at this stage.”
Founded in 2012, Coinbase now runs a multifaceted crypto business. Trading revenue brought in $327 million in the second quarter, about half its net sales. Coinbase also earned more than $200 million of interest income largely from its partnership with USDC, the second-largest stablecoin on the market. Smaller business lines—but ones that analysts see as prime candidates for expansion—include cloud services and a high-yield token “staking” product.
“We’ve built critical infrastructure that’s going to facilitate this growth and let a thousand flowers bloom,” said Coinbase Chief Financial Officer Alesia Haas in an interview with Barron’s.
Yet despite building a premier crypto platform, Coinbase has hardly been a winning stock. At about $83, it trades far below its opening price of $381 on its first day of trading in 2021. Its market cap is $20 billion, down from a closing high of $86 billion.
The declines mirror the malaise in crypto, still reeling from the FTX scandal and a collapse in token prices. And a recovery in Bitcoin this year hasn’t fueled a profit rebound for Coinbase. While the company boomed during the crypto rally of 2021—posting net income of $3.6 billion—it has since reported consecutive quarterly losses adding up to $2.8 billion as of June 30. Sales have gone from $7.8 billion in 2021 to an estimated $2.9 billion this year, according to consensus forecasts.
Coinbase’s trading volume remains depressed. Between the first and second quarter, volume on its platform declined 37% to $92 billion, leaving it 58% below the second quarter of 2022.
Coinbase now faces two major headwinds: a hostile SEC, which has sued the company, and stiffer competition from fund companies and brokerages.
As the SEC sees it, Coinbase is operating an unregistered securities exchange. The agency for years has said Bitcoin falls outside its purview. But virtually all other tokens, in SEC Chair Gary Gensler’s view, are securities whose issuers need to register. The SEC’s case, filed in June, centers on 12 such tokens, as well as Coinbase’s staking service, but in essence, Gensler’s argument is that the bulk of Coinbase’s business violates the law.
Coinbase and token issuers say there’s no legitimate path to register with the agency. By extension, if courts side with the SEC, it could effectively shut down much of the U.S. crypto market. The industry would need to restructure how it does business and stop offering many products to U.S. customers.
Muddying the waters, judges in related cases have made conflicting rulings. A federal judge in July, for instance, sided with crypto firm Ripple Labs, suggesting that most token transactions don’t meet the legal test to qualify them as securities. Then, a judge in the same district a couple of weeks later directly contradicted the earlier judge’s reasoning, in a case against a different crypto firm.
“For most tokens, a fair-minded lawyer could write both sides of the case,” says Philip Moustakis, a former SEC enforcement attorney whose clients now include crypto firms. “Some of us may be retiring from the law before this is over.”
Coinbase is trying to move things along faster. Chief Legal Officer Paul Grewal says the company has asked the judge to quickly resolve the fundamental issue of what crypto transactions fall under securities laws. The company is also lobbying Congress to pass legislation that would clarify the rules.
“A multifront approach gets us to clarity sooner rather than later. But the process, regardless of how long it will take, we think will ultimately provide answers that we’ve been asking for for some time,” Grewal says.
Coinbase, meanwhile, aims to operate business as usual, including plans to expand. The firm in August received regulatory approval to offer futures products to U.S. customers. It also launched its own blockchain, dubbed Base, that will pull in fees from crypto developers.
“This is going to evolve,” says Haas, adding that the “goal is to be innovating, drive more users on our platform,” and “follow how our customers behave.”
The problem is that the core trading business is suffering. Fees haven’t fallen as fast as transaction volume, but that’s because the company has been able to increase the “take rate” it earns on trades. Some analysts think that can’t last as competition heats up, especially since Coinbase already seems to be losing market share to lower-cost brokers like
Robinhood Markets
(HOOD).
Company executives argue that Coinbase will make up for declining trading revenue by entrenching itself in the crypto ecosystem. Haas says many companies will bring on Coinbase as a partner rather than build blockchain apps and services from scratch. “There’s just not enough crypto engineers, frankly, in the world that can rebuild all of this architecture at every single major financial institution,” she says.
The stock still has its fans on Wall Street. MoffettNathanson analyst Lisa Ellis, for one, views Coinbase as a “picks and shovels” play on crypto becoming a major part of the world economy. She expects the court case, while costly in the near term, will ultimately clarify U.S. crypto regulation, lifting the legal overhang on the stock. Wall Street’s expansion into crypto, she adds, should lift all boats.
For now, though, trading is the primary reason customers come to Coinbase. And without it coming back, the other services may not take off, says
J.P. Morgan
analyst Ken Worthington. “If trading isn’t popular, the ancillary businesses are not going to grow over the longer term,” says Worthington, who rates the stock Neutral with a $64 target.
The stock still isn’t cheap; it trades at more than seven times estimated 2023 sales, above its valuation before the crypto crash wiped out much of Coinbase’s revenue and profits.
Competition, meanwhile, is getting tougher. Fidelity recently launched retail crypto accounts to buy Bitcoin. Robinhood already earns more transaction revenue from crypto than it does from stocks. Fund companies like Cathie Wood’s ARK Investment Management,
Invesco
(IVZ), and BlackRock could soon offer Bitcoin ETFs. If you want to buy a little Bitcoin directly, you can always go through
PayPal Holdings
(PYPL) or
Block’s
(SQ) Cash App.
Even if Coinbase resolves its litigation, it “wouldn’t represent a permanent reprieve,” says Berenberg’s Palmer. “It would only invite competition from traditional players that are extremely well capitalized.”
Shorting the stock may be tempting, but it is high risk. Short interest is high, at about 14.5% of the stock’s float. That makes it vulnerable to a squeeze, whereby prices shoot up on a whiff of positive news. Positive headlines regularly send the stock up by double digits. Don’t expect those gains to last.
Write to Joe Light at joe.light@barrons.com
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