LD Capital: Analysis of Investment Logic and Growth Potential (23Q3 Update) for Coinbase
1. Investment Logic
I: Asset Class — Exposure to the U.S. Stock Compliant Cryptocurrency Market.
This year, Coinbase’s stock has surged by over 173%, attributed to the 122% increase in Bitcoin since the beginning of the year and a 40% increase in the technology sector. Simultaneously, in line with the trends in the U.S. stock market and the cryptocurrency market, this dual-market correlation tends to generate returns surpassing those of both markets when the trend is upward.
The chart illustrates the correlation between COIN and ETH as well as other related assets (MARA, HUT, GLXYCOIN, MSTR, etc.), all of which closely follow the trend of ETH. (Note: The content has been translated from Chinese to English.)
Untapped Growth Potential in Core Business
II. Coinbase’s core business is transaction revenue, and recently, the market has responded positively due to macroeconomic factors such as the pause in interest rate hikes, industry cyclical events like the halving, and speculation driven by events like the spot ETF. However, over the next 8–12 months, the continuation of a macro environment unsuitable for the growth of cryptocurrencies, characterized by high inflation and high-interest rates, may still adversely impact Coinbase’s core business.
For Coinbase, which went public in May 2021 amid a bear market, growth is a key driver of stock price appreciation. Coinbase’s global platform and derivative trading were officially launched only in May of this year, with the global platform expected to bring in more spot trading volume, and the derivative business being a significant driver of transaction revenue growth. On August 14th, Coinbase announced its official entry into Canada, launching in partnership with Interac payment rails, among other collaborations, highlighting Coinbase’s emphasis on growth (both regionally and in terms of business expansion). Therefore, despite the limitations on business growth in the next 12 months due to external conditions, coupled with numerous untapped positives, the revenue growth potential remains significant within the next 24 months.
III: Total Trading Volume Falls Short of Expectations, but Adjusted EBITDA Continues to Far Exceed Expectations
In the third quarter of 2023, Coinbase achieved an adjusted EBITDA of 180 million, although lower than the 194 million in the second quarter, it still far exceeded expectations. Compared to the same period last year, the decline in trading volume was mainly due to a 60% decrease in cryptocurrency volatility. Consequently, the market had lower profit expectations for Coinbase. However, in reality, Coinbase’s Q3 performance was impressive, realizing a net profit of 81.6 million through discounted bond repurchases. Additionally, due to the positive expectations stemming from the macroeconomic environment with no further interest rate hikes, Coinbase exceeded expectations in adjusted EBITDA through strategic bond repurchases and the positive macroeconomic fundamentals. The fourth quarter is expected to achieve positive EBITDA.
IV: Coinbase’s Strong Development of Subsidiary Businesses Brings New Growth Opportunities
- International Platforms and Derivative Trading Business: Coinbase’s derivative exchange is still in its early stages, having only launched the API test version in Q2-Q3 with a limited number of customers. As a next step, Coinbase plans to integrate it into the retail application. In August, its wholly-owned subsidiary CFM received regulatory approval from the U.S. Commodity Futures Trading Commission (CFTC) and became a Futures Commission Merchant (FCM), allowing it to offer federally regulated cryptocurrency futures trading to eligible U.S. customers. The official launch of international platforms and derivative products is expected to bring substantial revenue growth.
- USDC Business: Coinbase acquired a minority stake in Circle, with specific investment figures undisclosed. The nature of this investment implies greater strategic and economic consistency between Coinbase and Circle in the future development of the financial system. This suggests broader prospects for USDC, potentially expanding from cryptocurrency trading to areas such as forex and cross-border transfers. Coinbase’s senior executives downplayed competition with PayPal entering the stablecoin space (PYUSD 44 million supply market share is still small). Q3 saw an increase in stablecoin revenue, primarily attributed to a higher average interest rate on USDC reserves, rising by 375 basis points or 420%. Coinbase and Circle will continue to derive income from interest on USDC reserves.
- On-Chain Business: The additional MEV revenue generated after the launch of Base represents direct profits for Coinbase. Besides direct profit opportunities, Coinbase CFO Alesia stated in a conference call that Base’s usage would create opportunities for all other products and services offered by Coinbase. For example, users may utilize Coinbase’s payment channels and wallet products, leading to additional ancillary revenue. Additionally, the ETH Staking business brings at least $100 million in revenue to Coinbase.
V: Coinbase May Continue to Gain More Market Share, Surpassing Binance as the Largest Exchange
The SEC’s charges against Binance are more severe, including allegations of operating an unregistered securities exchange, broker-dealer, and clearing agency, as well as engaging in activities similar to FTX: deception, cross-entity mixed asset transactions, and trading against customers. The SEC has not levied similar charges against Coinbase. The global suppression of competitor Binance is advantageous for Coinbase, indicating that Coinbase is likely to replace Binance as the most influential exchange.
VI: Having the necessary compliance qualifications positions Coinbase as one of the primary beneficiaries of Spot ETFs.
After traditional asset management institutions obtain approval for spot ETFs, Coinbase, as a potential custodian, stands to benefit significantly. Coinbase will generate substantial income through AUCC (average annual custodial cost) from the custodianship of the upcoming spot ETF. In the future, additional income may be derived through clearing and other services. However, there are still many issues to be addressed before this can happen, and there is a considerable time window.
VII: Regulatory Pressure Leads to Increased Compliance Costs
Despite Coinbase’s strong performance during the ongoing crypto winter, persistent regulatory uncertainty remains the foundation of negative prospects for the company. Regarding the SEC’s lawsuit against Coinbase, the company is seeking to dismiss the lawsuit filed in June (accusing the company of operating an unregistered exchange, broker-dealer, and clearing agency). While the SEC may not necessarily win the case, a settlement is highly likely and could significantly impact the company’s profits (Kraken settled for $30 million). This will affect the company’s fundamentals, but the market may interpret it as a positive development.
Regarding the expansion of financial services such as banking/financial institution deposits, Coinbase may need licenses from the Federal Reserve System, the Federal Deposit Insurance Corporation (FDIC), the Office of the Comptroller of the Currency (OCC), or state banking regulatory agencies. This would increase operating costs (compliance costs), and until the necessary licenses are obtained, the company may face fines and shutdowns at any time. Divergent regulatory environments worldwide also limit Coinbase’s international business expansion.
In summary, current expectations suggest that Coinbase’s profit outlook is better than in the first half of 2023. However, profits are likely to be suppressed as the crypto market has not truly entered a bull market. Still, with the right on-chain and derivative development strategies, the growth potential of its income and profits will be unleashed. Income growth not yet fully priced in includes: 1) substantial revenue growth expected after the official launch of international platforms and derivative products, 2) continued growth in the staking business, including MEV revenue from Base Chain (and other chains), staking business revenue, and incremental usage of Coinbase’s other products and services (wallets, etc.) brought by on-chain users, and 3) potential volume recovery in USDC leading to increased interest income on reserves and fee generation from distributions. However, due to the strong correlation with the crypto market, it is expected that the transaction revenue of the core business will not significantly increase in the next 8–12 months in the background of a macroeconomically pessimistic environment with ongoing high inflation and high-interest rates not conducive to crypto growth. But in the subsequent bull market, the growth rate will surpass the 515% growth in 2021.
Valuation indicates that in the base-case scenario, Coinbase’s fair value is $89, currently priced at $74, undervalued by 16%. However, considering the high sensitivity of the discounted cash flow (DCF) valuation model to forecasted business growth and the terminal EV/EBITDA multiple, it is essential to consider the intrinsic cycle of crypto market trading and market sentiment. In the short term, with the dual situation of the recent U.S. stock and crypto markets coming out of a minor bull market, a significant rebound is expected. A practical operational recommendation would be to buy during the short-term pricing of macroeconomic favorable factors, and to consider the risk of overvaluation when the P/B exceeds the high point in July of this year. At EV/EBITDA 7x, fair value is $89, and at 14x, fair value is $170.
2. Company Background and Business Overview
Founded in 2012, Coinbase operates a diversified cryptocurrency business and is the largest cryptocurrency asset trading platform in the United States, serving over 108 million customers. Users can utilize the platform for purchasing, selling, and trading cryptocurrency assets. On April 14, 2021, Coinbase successfully went public on Nasdaq, becoming the “first cryptocurrency stock.”
Specific business lines include:
1) Coinbase Application — Targeting Regular Traders
Users can engage in token trading on the platform. The first fee option involves paying transaction fees based on a transparent pricing plan, including transaction fees and spreads added to transactions when consumers buy, sell, or convert cryptocurrency assets in fiat-to-crypto or crypto-to-crypto trades. These transaction fees are fixed as a percentage of the user’s trading volume on the company’s platform, simplifying trading (excluding small transactions, which have a fixed fee), with tiered pricing for advanced trading volumes. The second option is through the company’s subscription product, Coinbase One, where consumers pay a monthly fee instead of transaction fees until reaching a certain trading volume threshold. However, for simple trades, spreads are still charged.
The Coinbase application has an expanded proprietary product experience, providing customers with peer-to-peer payments, remittances, direct deposits, and access to its Coinbase Card (Coinbase-branded debit card). Additionally, users can earn returns on cryptocurrency assets through various methods, including staking rewards, DeFi income, and other unique methods specific to certain cryptocurrencies.
For most consumers, staking cryptocurrency assets is a technical challenge. Independent staking requires participants to operate their own hardware, software, and maintain close to 100% uptime. The company offers a genuine Proof of Stake service, reducing the complexity of staking and allowing consumers to earn staking rewards while fully owning their cryptocurrency assets. In return, the company charges a commission on all staking rewards. Recently, its Cloud product also integrated the Kiln on-chain staking protocol, providing Ethereum staking below the 32ETH limit.
2)Two Wallet Products
Web3 Wallet
Consumers can access third-party products by adding a “web3 wallet” within the Coinbase application. The web3 wallet allows Coinbase’s customers to interact with certain DApps, including trading on decentralized exchanges or accessing art and entertainment services. This product provides consumers with convenience, enabling easy access and interaction with DApps, and shares the responsibility of knowing and storing customer security keys between the consumer and Coinbase, making wallet recovery possible. The company generates profits by charging fees for certain transactions conducted on decentralized exchanges.
Coinbase Wallet
Coinbase also offers a software product called Coinbase Wallet to consumers in over 100 markets, enabling them to participate in and interact with DApps and cryptocurrency use cases without a central intermediary. The Coinbase Wallet product experience is similar to the Web3 Wallet but with key differences, including consumers having full control over their private keys and seed phrases and having a broader range of assets and use cases within web3. The company generates profits through transactions conducted on DApps, such as charging fees for fiat-to-crypto transactions and/or fees for transactions on decentralized exchanges.
3)Institutional Business
Coinbase offers two products catering to institutional clients (including but not limited to market makers, asset management firms and owners, hedge funds, banks, wealth platforms, registered investment advisors, payment platforms, as well as public and private companies).
Coinbase Prime is a comprehensive platform designed to meet all institutional spot crypto needs on an agency basis. It provides institutions with services such as trading, custody, transfers, staking, and financing. Through Coinbase Prime, institutions gain access to deep liquidity pools in the crypto market, and the platform ensures optimal price execution through connections to various trading venues, including the Coinbase Spot Market. The company provides volume-based pricing and charges transaction fees for each matched trade.
It also offers market infrastructure for trading venues through Coinbase Spot Market and Coinbase Derivatives Exchange.
Coinbase Derivatives Exchange launched the first regulated derivative products, namely Nano Bitcoin futures and Nano Ethereum futures contracts. Coinbase is the first crypto-native platform to gain approval in a regulated derivatives market. It provides an opportunity for other derivatives intermediaries to trade on its derivatives exchange. Once regulatory approval is obtained, the company will directly offer these derivative products to its customers (currently only available to institutions).
4) Developer Suite
The developer suite includes some of the latest products, including Coinbase Cloud and Coinbase Pay.
Coinbase Cloud provides encrypted payment or transaction APIs, data access, and staking infrastructure. These tools enable companies to build cryptocurrency products faster and simplify their interactions with blockchain technology. Coinbase Pay and Coinbase Commerce allow developers and merchants to seamlessly integrate cryptocurrency transactions into their products and businesses.
3.Financial Analysis — Part Three
Business Model and Revenue Growth
In Q3 2023, Coinbase achieved a revenue of $674 million. A breakdown of the detailed revenue components reveals that transaction revenue and subscription/service revenue remain the primary sources of income. While ancillary business revenue has grown in tandem with transaction revenue, it is evident that, in Q3 2023, transaction revenue constitutes 43% of the total revenue, a decline from 48% in Q1 2023, and a notable decrease from 61% and 52% in Q3 and Q4 2022, respectively. The development of other businesses such as subscriptions and services has contributed significantly to Coinbase’s revenue and continues to show an increasing trend in terms of proportion.
Transaction revenue experiences explosive growth during bull markets but exhibits a declining trend during bear markets. On the contrary, subscription services and other businesses tend to show stable growth during bear markets, with an uptick in bull markets accompanying increased transaction revenue.
Classification of Business Revenue
Transaction Revenue
Transaction revenue was once the primary source of income for Coinbase, generating $288 million in the third quarter. However, it has now been surpassed by subscription and service revenue ($334 million). Coinbase makes money by buying and selling cryptocurrencies. It typically depends on the transaction value or may be based on fixed income. Components include:
- Spread: The difference between the buying and selling prices of cryptocurrencies.
- Conversion Fees: Fees for converting one cryptocurrency to another, derived from income streams generated by the company’s transactions.
- Over-the-Counter (OTC) Trading: This service targets institutional buyers and high-volume traders.
- Leveraged Trading: Allows users to borrow from the platform, involving interest and borrowing fees paid by users.
- Payment Processing Fees: Enables users to make payments using cryptocurrencies on their platform.
Subscription and Service Revenue
Coinbase offers custody subscription services, including Coinbase Pro, Coinbase Prime, and Coinbase Custody.
- Coinbase Pro: An advanced trading platform for professional and institutional investors, offering some free features and advanced features under premium subscriptions.
- Coinbase Prime: Designed for institutional investors, providing enhanced trading features, dedicated account management, and access to liquidity solutions.
- Coinbase Custody: Typically provides secure custody solutions for institutional clients to store cryptocurrencies, offering insurance coverage for digital assets. Subscription and service revenue also include stablecoin income, block rewards, interest income, etc.
In Q3 2023, subscription and service revenue for Coinbase was $334 million, constituting 49.55% of total revenue for the quarter.
Other Revenue
Other revenue channels for Coinbase include Coinbase Commerce, Coinbase Cards, interest income, institutional services, and other products and services. In Q3 2023, it accounted for 7.5% of total revenue, showing a gradual increase.
Regarding regional revenue distribution, while Coinbase has customers in over 100 countries, the majority are concentrated in the United States (approximately 40%) and the United Kingdom/Europe (about 25%). However, the proportion of revenue from the U.S. has been significantly higher, accounting for 78%, 76%, 81%, and 84% of total revenue for FY2019–2022. Despite Coinbase’s expansion into the Canadian market in August of this year, growth in other regions will be limited by local regulatory environments and competition from local exchanges.
Profit Breakdown
Coinbase exhibits a remarkably high overall gross profit margin, a characteristic common in Software as a Service (SaaS) companies, with a gross profit margin of 85% in Q3 2023. The main sources of profit are still the aforementioned transaction revenue and subscription services. The MEV (Maximum Extractable Value) income from the Staking business and revenue generated from USDC are integral components. The net profit increase from bond repurchases, reaching $81.6 million, has significantly impacted the net profit margin and was the most substantial change in the third quarter.
Staking Business and Base MEV Income
Coinbase is the sole Sequencer for Base, enabling it to capture all priority gas profits resulting from sequencing.
Based on the formula:
L2Earnings=L2TransactionFees−L1DataStorageCosts−L1VerificationCosts
Estimating sorting fees based on the current cumulative fees for Base, it is expected that subtracting half of $5.46 million from $3.54 million would yield approximately $1 million for Coinbase (though, in reality, Coinbase relies on charging a 25%-35% commission on staked ETH as income).
Revenue Contribution from Base Chain to Coinbase: The revenue generated for Coinbase from the Base chain amounts to $1 million (this figure could be even smaller when considering the actual absolute values charged by Coinbase). Furthermore, when examining the quantity of ETH staked on Coinbase, which holds the top rank among all Centralized Exchanges (CEX) with a market share of 8.6%, it stands below Lido in the overall ranking. The realized ETH income is approximately 187,000 ETH, equivalent to around $300 million. From the Staking business alone, Coinbase generates revenue of about $100 million, charging a commission of 25%-35% on staked ETH.
Coinbase EBITDA Margin and Market Conditions
Coinbase’s EBITDA margin is consistently maintained at around 40% of revenue. This ratio may decrease when the main revenue faces challenges such as a stagnant market due to cycles, macroeconomic influences preventing growth, and external costs rising due to regulatory penalties. However, with the arrival of a bull market, the EBITDA-to-revenue ratio is expected to increase correspondingly.
USDC Business
USDC Holdings and Market Dynamics
Currently, the Coinbase platform holds 132 million USDC. Due to the Q1 banking crisis, resulting in the Silicon Valley Bank failure and substantial USDC redemptions, and Binance swapping USDC for another stablecoin, the USDC market value has declined. However, Coinbase CEO Brian Armstrong believes that increased regulatory risks in the United States may pose challenges for USDC. Compared to other stablecoins like Tether, USDC is perceived to have more U.S. ties, potentially causing short-term difficulties.
The overall market value of USDC has seen a decline, with the stablecoin market share currently standing at only 21%. Perhaps in consideration of this, Coinbase introduced a strategic move to prevent further decline in market share. This involved Coinbase becoming an investor in USDC and planning to launch USDC on six new blockchains between September and October. It’s evident that Coinbase values its stablecoin business and aims to maximize revenue in this sector.
3. Costs
In January 2023, the company announced and completed a restructuring, impacting approximately 21% of the total workforce as of December 31, 2022 (referred to as the “2023 Restructuring”). The restructuring aimed to address ongoing market conditions affecting the crypto economy and align with continued business priorities to manage the company’s operating expenses. As a result, around 950 employees from various departments and locations were laid off, receiving separation compensation and other personnel benefits.
Cash payments related to this restructuring were essentially completed in the second quarter of 2023, with the remaining expected to be paid by December 31, 2023. The reduction in labor costs, leading to a significant 50% decrease in operating expenses, has been a crucial factor contributing to Coinbase’s performance exceeding expectations in Q1, Q2, and Q3 of this year.
Regarding operating expenses, on March 3, 2023, the company completed the acquisition of One River Digital Asset Management, LLC. (ORDAM), acquiring all issued and outstanding membership interests of ORDAM. ORDAM is an institutional digital asset management company registered with the U.S. Securities and Exchange Commission (SEC) as an investment advisor. The total consideration paid for the acquisition was $96.8 million. The company believes that this acquisition aligns with its long-term strategy, providing more opportunities for institutional participation in the crypto economy.
4. Borrowing Costs
In August and September 2023, Coinbase’s Chief Financial Officer, Alesia Haas, led the repurchase of Coinbase’s 2031 debt, amounting to $263 million, but only spent $177 million. This involved using a significant portion of profits to repurchase convertible senior notes (issued in September 2021, maturing in October 2031). The corresponding net income from the disappearance of long-term debt amounted to $81.6 million.
On August 7, 2023, Coinbase announced a cash tender offer at a price of $0.645 per share (before August 18) or $0.615 per share (after August 18 but before September 1), to repurchase up to $150 million of its senior unsecured notes due in 2031. Coinbase would fund this transaction through its operating cash flow. In June 2023, the company repurchased $645 million of 0.5% convertible senior notes due in 2026 at a 29% discount, involving approximately $455 million in cash. Considering Coinbase’s ample liquidity and the absence of recent refinancing risks, this transaction was deemed profitable and not expected to create a cash crisis for Coinbase. The transaction would further increase excess cash reserves for debt repayment at a discount, reducing annual interest expenses by approximately $5.4 million.
In theory, Coinbase’s proactive use of a cash tender offer to repurchase a portion of its future maturing debt helps reduce the burden of debt and lowers future interest expenses, enhancing financial stability. Boosting market confidence: The improved ability to repay debts and increased financial strength may boost market confidence in the company, potentially raising stock prices and credit ratings, and helping to lower borrowing costs.
4. Valuation
Discounted Cash Flow (DCF) Analysis
To perform a discounted cash flow analysis, the current debt-to-value (D/V) ratio (67%) and equity-to-value (E/V) ratio (33%) were utilized based on Coinbase’s capital structure. The leveraged beta for Coinbase was calculated as 3.15. The Capital Asset Pricing Model (CAPM) was employed, assuming a market risk premium of 7% and a risk-free rate of 5.5%, to calculate the cost of equity. The cost of debt was determined using the cost of the company’s senior notes, and a post-tax cost of debt was obtained by incorporating an effective tax rate of 27%. The Weighted Average Cost of Capital (WACC) for the company was thus calculated as 23.58%.
Given the current high-interest-rate environment, it is anticipated that this elevated level may persist until a gradual decline around July of next year. Consequently, in the DCF model, the terminal value is inclined towards a more aggressive level. The growth rate projections for FY2023–2025 are estimated to be -5%, 10%, and 500%, respectively.
Valuation indicates that in the baseline scenario, Coinbase’s fair value is $89, with the current price of $74 undervalued by 16%. However, considering the high sensitivity of the DCF valuation model to forecasted business growth for the fiscal year and the terminal EV/EBITDA multiple, it is recommended to assess the market sentiment and the inherent cycle of the cryptocurrency market. In the short term, the stock price is under downward pressure due to the bearish situations in both the U.S. stock market and the cryptocurrency market. A practical recommendation is to sell in the next 12-month cycle, followed by buying in the subsequent 24-month cycle. At an EV/EBITDA of 7x, the fair value is $89, and at 14x, it is $170.
5. Risk — Regulatory Uncertainty
Coinbase is currently seeking to dismiss the SEC lawsuit filed in June in the federal court in New York against the U.S.-compliant cryptocurrency trading platform Coinbase, Inc., and its parent company Coinbase Global, Inc. The lawsuit accuses the company of operating an unregistered exchange, broker, and clearinghouse. This regulatory uncertainty poses a significant risk to Coinbase’s operations and market sentiment.
The key points of the lawsuit are as follows:
Under the Securities Exchange Act of 1934, the traditional functions of brokers, exchanges, and clearing agencies in the securities market are separate. However, Coinbase’s platform combines all three functions and has not registered with the SEC, nor has it obtained any applicable exemptions. Over the years, Coinbase has disregarded regulatory structures, evading disclosure requirements from Congress and the SEC.
Coinbase also provides two additional services to investors, involving its operation as an unregistered broker. First is Coinbase Prime (Prime), which forwards orders for cryptocurrency assets to the Coinbase platform or third-party platforms. Second is Coinbase Wallet, which routes orders to third-party cryptocurrency asset trading platforms to access liquidity outside of the Coinbase platform.
While Coinbase has primarily focused on providing cryptocurrency asset trading services as its main source of revenue, it has overlooked the fact that these assets may have securities attributes. Since 2016, Coinbase has acknowledged that cryptocurrency assets should be subject to regulatory oversight, positioning itself as a compliant platform in its marketing. Despite verbal commitments to comply with applicable laws, Coinbase has consistently allowed cryptocurrency assets that meet the Howey test standards to be traded.
Since 2019, Coinbase has offered Staking services, allowing investors to earn returns by staking cryptocurrency assets, with Coinbase receiving a 25–35% commission. However, Coinbase has never registered with the SEC for the issuance and sale of Staking projects, preventing investors from obtaining crucial information about the plan, harming their interests, and violating the registration provisions of the Securities Act of 1933.
The revenue earned by Coinbase ultimately flows into its parent company, CGI, making CGI the actual controller of Coinbase. Consequently, CGI has also violated the same transaction regulations as Coinbase.
The SEC seeks a final judgment to: (a) permanently enjoin the defendants from violating relevant securities laws; (b) order the defendants to surrender ill-gotten gains and pay prejudgment interest; © impose civil penalties on Coinbase and require it to provide appropriate or necessary equitable relief for the benefit of investors. (Note: In the SEC’s judgment against Binance, it also seeks a permanent ban on engaging in financial industry-related business.)
In summary, it is currently believed that Coinbase’s profit expectations are better than those in the first half of 2023. However, profits are expected to continue to be suppressed due to the cryptocurrency market not truly entering a bull market. Nonetheless, the growth potential of its income and profits will be unleashed due to strategies such as on-chain developments, derivatives, and other factors. The income growth that has not been fully priced in includes: 1) substantial revenue growth expected after the formal launch of international platforms and derivative products. 2) Continued growth in the staking business, including sorting income from the Base chain (and other chains); staking business income; incremental use of other Coinbase products and services (wallets, etc.) brought by on-chain users; 3) Potential volume recovery of USDC bringing growth in interest income from reserves and generating fees in distribution. However, due to the strong correlation with the cryptocurrency market, it is expected that the main business’s trading revenue will not show significant growth in the next 8–12 months in the macro-pessimistic backdrop of high inflation and high-interest rates, which goes against the background conducive to the continued growth of the cryptocurrency market. However, in the subsequent bull market, the growth rate is expected to surpass the 515% growth in 2021.
Valuation indicates that, in the base-case scenario, Coinbase’s fair value is $89, and the current price of $74 is undervalued by 16%. However, considering the sensitivity of the DCF valuation model to the forecast business growth and the terminal EV/EBITDA multiple, it is advisable to consider market sentiment along with the inherent cycle of cryptocurrency trading and the current macroeconomic environment. In the short term, with the recent dual situation of positive trends in the US stock market and the cryptocurrency market, there is a significant rebound. A more practical operational recommendation is to buy when short-term macroeconomic positives are being priced in, and to consider the risk of overvaluation when the P/B exceeds the high point in July of this year. At an EV/EBITDA multiple of 7x, the fair value is $89, and at 14x, the fair value is $170.
Appendix
Compliance Status
Coinbase’s CEO believes in the passage of the MiCA bill in Europe, but the United Kingdom, Singapore, Brazil, and every financial center are actively working to pass legislation, with other countries leading ahead of the United States in this regard.
Coinbase is also working to provide regulatory clarity for the entire industry. One of the significant problems hindering the adoption of this technology is the lack of clear rules and the enforcement regulation carried out in the United States. While the rest of the world has made significant progress in accepting cryptocurrency and web3 technologies and has enacted clear legislation, the United States has faced difficulties in catching up. Coinbase has a crucial role to play here. When the SEC refused to create rules and instead chose an enforcement regulatory approach, Coinbase used the courts to help bring regulatory clarity to the United States and played a role in creating legal precedents. Coinbase is also actively involved in congressional activities, where bipartisan support for cryptocurrency legislation can be seen.
In the past two months, the House Financial Services Committee and the House Agriculture Committee have passed landmark cryptocurrency market structure bills (FIT21) and stablecoin bills with bipartisan support. These bills will be submitted to the full House for a vote later this year and then sent to the Senate. Coinbase has committed to helping ensure that the United States passes cryptocurrency legislation and is not left behind. It has also started mobilizing cryptocurrency users nationwide to ensure their voices are heard in Coinbase’s democratic body. Currently, one-fifth of Americans have used cryptocurrencies — a higher proportion than those holding union cards. So far, the “Support Crypto” movement has attracted about 60,000 cryptocurrency advocates, covering 435 congressional districts. Coinbase’s political influence is also expanding, with previous live gatherings held in Senator Joe Manchin’s office, Mayor Adams’s office, Governor Hochul’s office, and hundreds of cryptocurrency enthusiasts in August.
Coinbase is subject to various anti-money laundering and counter-terrorism financing laws and regulations, including the United States’ Bank Secrecy Act (BSA) and similar laws and regulations abroad. In the United States, as a registered money services business with the Financial Crimes Enforcement Network (FinCEN), the BSA requires the company to develop, implement, and maintain a risk-based anti-money laundering program, provide anti-money laundering training programs, report suspicious activities and transactions to FinCEN, comply with certain reporting and record-keeping requirements, and collect and maintain information about its customers. Additionally, the BSA requires compliance with certain customer due diligence requirements as part of fulfilling anti-money laundering obligations, including developing risk-based policies, procedures, and internal controls, reasonably designing identity verification for customers.
Coinbase has implemented a compliance program designed to prevent its platform from being used to facilitate money laundering, terrorist financing, and other illegal activities, whether domestic or involving countries, individuals, or entities on the Office of Foreign Assets Control (OFAC) list.
In the United States, Coinbase has obtained licenses to operate as a money transmitter or equivalent money transmitter in states where it conducts business, including the District of Columbia and Puerto Rico. Additionally, it has obtained the BitLicense from the New York State Department of Financial Services (NYDFS).
Outside the United States, Coinbase has obtained a license from the German Federal Financial Supervisory Authority to provide custody and trading of cryptographic assets. The company is also registered in Japan as a cryptographic asset exchange service provider, providing cryptographic assets and first-party payment services, covering cryptographic assets and first-party payment services under the jurisdiction of the Kanto Local Finance Bureau of the Ministry of Finance. In Singapore, the company operates under the Payment Services Act and is supervised by the Monetary Authority of Singapore (MAS). The company is currently in a preliminary approval state, requiring final approval from MAS to become a major payment institution. Under these licenses and registrations, it is subject to a wide range of rules and regulations, including anti-money laundering, customer asset and fund protection, regulatory capital requirements, eligibility and suitability management, operational controls, corporate governance, customer disclosure, reporting, and record-keeping.
Coinbase’s subsidiary, Coinbase Custody Trust Company, LLC, is an approved limited-purpose trust company by the New York State, regulated, examined, and supervised by the NYDFS. NYDFS regulations impose various compliance requirements, including but not limited to operational restrictions on the nature of cryptographic assets that can be held in custody, capital requirements, BSA, and anti-money laundering program requirements, restrictions on related transactions, and notification and reporting requirements.
Coinbase provides services to customers through an electronic money institution authorized by the Financial Conduct Authority in the UK and the Central Bank of Ireland. The company complies with rules and regulations applicable to the European electronic money industry, including rules related to fund custody, corporate governance, anti-money laundering, disclosure, reporting, and inspections.
Coinbase has established a set of policies and practices for evaluating every cryptographic asset it considers for listing or custody and is a founding member of the Cryptocurrency Rating Committee. Coinbase’s brokerage business operates under Coinbase Capital Markets and Coinbase Securities, both registered with the SEC as brokers under the Exchange Act of 1934.
Coinbase Q3 Financial Report Update
In general, Coinbase’s profit and revenue for the third quarter exceeded expectations, although the total trading volume did not meet expectations. The financial data is similar to the second quarter (adjusted earnings per share for the third quarter were $0.01, better than the expected loss of $0.55 per share according to FactSet, marking the third consecutive quarter that Coinbase has exceeded profit expectations). The total revenue for the quarter was $674.1 million, surpassing the expected $650.9 million.
Despite the contraction in trading volume due to unfavorable market conditions, Coinbase performed strongly in the third quarter, reflected in:
1.Discounted Repurchase of Notes, Realizing a Net Profit of $81.6 Million, Strong Cash Flow
Coinbase CFO Alesia Haas led a buyback of Coinbase’s 2031 debt, amounting to $263 million but only spending $177 million. The majority of the profit was used to repurchase convertible senior notes issued in September 2021, which are due in October 2031. This transaction occurred in August-September 2023, resulting in a net income of $81.6 million as the corresponding long-term debt disappeared. This strategic move demonstrates that Coinbase is not facing cash flow challenges.
2.Continued Emphasis on Developing On-chain Business, International Expansion, and Derivatives Business
Coinbase’s derivative exchange is still in the early stages, having launched only an API test version in Q2-Q3 with a limited number of customers. As a next step, Coinbase plans to integrate it into the retail application. In August, its wholly-owned subsidiary, CFM, received regulatory approval from the U.S. Commodity Futures Trading Commission (CFTC) to become a registered futures commission merchant (FCM), allowing it to offer federally regulated cryptocurrency futures trading to eligible U.S. customers. The official launch of the international platform and derivatives products is expected to bring substantial revenue growth.
Looking ahead to the fourth quarter, trading revenue for October is estimated to be around $105 million. Coinbase expects to achieve “meaningful” adjusted EBITDA for 2023, with a slight adjustment to the previously stated goal of “raising” 2023 full-year EBITDA.
Note: This article represents the author’s personal views and does not constitute investment advice.
LD Capital
As a global blockchain investment firm, we have built a portfolio of over 250 investments since 2016, spanning across various sectors, including infrastructure, DeFi, GameFi, AI, and the Ethereum ecosystem. We focus on investing in projects with disruptive innovations, actively taking on the role of primary investors, and providing comprehensive post-investment services to these projects. We employ a combination of direct investment from our own funds and a distributed fund model to cover all-stages of investment.
Trend Research
Trend Research division specializes in crypto hedge funds focusing on secondary areas within the crypto market. Our team members come from top platforms and institutions like Binance and CITIC. We excel in macroeconomics, industry trends, and project data analysis, with trend, hedge, and liquidity funds.
Cycle Trading
We specialize in Web3 project investment and service, with a strong emphasis on Infra, applications, and AI. We have a team of nearly 20 senior engineers and dozens of crypto experts as advisors, assisting projects in strategic design, capital platform relations, and liquidity enhancement.
website: ldcap.com
twitter: twitter.com/ld_capital
mail: BP@ldcap.com
medium：ld-capital.medium.com
