I am a long term holder of Coinbase (NASDAQ:COIN). I will say I typically lean towards fundamental analysis and value stock when buying stocks. The last handful of years of investing have taught me to also not overlook the growth plays and especially some of the longer term growth plays. I am a long term holder of Coinbase and my reasons are not necessarily grounded in their current financials. More so in the potential that I see in the company. Although I think the company has made the appropriate moves to improve their financial position. I prefer a growth stock that is either making a profit or at least showing the signs of reaching that point.

So why am I a long term holder of Coinbase? The reason is simple. The future growth potential of the company. I think crypto is here to stay. It is still in the early stages of adoption. There are lots of potential future revenue channels for the company. I guess the real question is are you a believer in crypto as a whole. I am not saying a believer in Bitcoin or Ethereum, but in crypto itself. If so then I think Coinbase is the stock to buy. I will discuss some of the reasons why I choose Coinbase and the potential I see.

Why Coinbase over Competition

Coinbase is not the cheapest route when it comes to purchasing crypto currencies. There are lots of other platforms that are much cheaper to buy and sell crypto. In my opinion, the biggest advantage that Coinbase has is their user interface. It is far superior for the average buyer vs the competition. I know this is merely an opinion and many might disagree. I have used multiple platforms to buy crypto. Some are better than Coinbase if you are an active trader (although Coinbase offers a pro version for traders as well). But in terms of making it easy for the average investor to go on and buy crypto there is not a better platform. It is simple to navigate and they make the buying process as easy as possible. You simply put the amount of dollars you want to convert to whichever crypto you choose and they do the math to purchase the equivalent amount of crypto. While this seems simple, many platforms do not make this so easy. You have to choose how much of the crypto you want to buy and do the math as to how many dollars. I think user interface and ease of use is often underestimated. If a consumer has a good experience then they are much more likely to use and recommend your product. Quick note, Coinbase has a pro version which is built for traders. It offers more analytics and lower fees for those trading more frequently.

Another advantage they have is that they are reputable. The FTC noted that there were $680 million reported cryptocurrency fraud losses in 2021. You should definitely research a crypto before purchasing. From the beginning Coinbase has helped in this process. The cryptos that are available to purchase on Coinbase have been vetted to help mitigate issues with scams. This frustrates some users as the hot new crypto may not be available to purchase. It has not gone through the vetting process or does not meet the standards and is therefore unavailable to purchase. This is lost money to the company as many would purchase the hot new trend but in the long run I think it pays itself off. Coinbase Pro does offer a wider selection of cryptos to trade. Everyone should research a crypto before purchasing. If we are being honest, we know many are not researching before purchasing. Coinbase is able to provide a layer of protection against scams. This will build long term trust with many investors and help grow their platform.

Crypto Lumps and Bumps

The crypto market as a whole is still in the early stages. 2021 was a momentum year for the industry as a whole. The retail trading frenzy really took hold in the crypto market. There was more than $14 trillion in trading volume through centralized crypto exchanges in 2021. That is a 689% increase in trading volume compared to 2020. The numbers looked even better for decentralized exchanges, seeing an increase of 858 percent in trading volume from the prior year. Trading rose from $115 billion in 2020 to $1 trillion in 2021.

Then along came 2022 and everything changed. The market as a whole entered a risk-off mode. High growth and loss making companies saw a steep sell off. Crypto currency fell in with that bucket. As they say we entered the “crypto winter”. It has been a long winter for that matter. Many in the industry are wondering if spring is ever going to come or not. Trading volume dropped off from 2021. The trough bottomed in December of 2022 hitting the lowest volume in 2 years. This bottom can be directly related to the collapse of FTX. FTX filed for bankruptcy on November 11, 2022. FTX was one of the fastest growing crypto currency exchanges. It was also one of the largest. For the USD support exchange, FTX went from a market share of 2.72% in June of 2020 to a nearly 29% market share just two years later in June 2022. The collapse of FTX sent waves through the crypto market. Being one of the largest players in the space it caused a lot of doubt about the crypto market as a whole. This helped drive trading volume to the lowest level it had seen in two years.

The graph below shows this bumpy ride experienced in the crypto market. Also you can see the steady decline over the last year.

(Crypto exchanges finish 2022 with the lowest volumes in two years)

The trend does not look favorable. Trading volume has been on a decline for the whole of 2022. Now not all is bad in the chart. When you compare 2022 to 2020 you can see a massive increase. The frenzy that occurred in 2021 may have died down but the market is now substantially larger than it was in 2020. The growth trend has also turned from negative to positive to start 2023. December of 2022 had trading volume of 467.86b, it has since steadily increased over the last three months, climbing to 797.23b, 878.42b, and 983.42b in the months of January, February, and March, respectively. I think we are going to continue to experience a more steady growth rate for the crypto market. The crypto craze of 2021, and really the market as a whole, was something else to witness. Many of those who jumped in on the hype have been washed out of the market or are choosing to merely hold rather than try and buy each and every new crypto that enters the market. I think it makes for a much more stable market going forward.

The drop off in trading volume is obviously going to have an effect on Coinbase. They make most of their money when people buy and sell crypto. So if the volume is down so will be their income. We will review through the effects on Coinbase directly in a later section of the analysis.

Crypto Ownership

It is hard to nail down the exact estimate on the percentage of people trading crypto. Pew Research estimated that 16% of Americans had invested or traded crypto. NBC News estimated that 21% of Americans owned crypto currency at the end of 2022. There are differences in the results based upon who performed the study. One thing is for sure, there has been strong user growth. Regardless of the data point you choose, there is still a lot of room for growth. In comparison, 56% of American adults own stock.

There are also some strong demographic benefits to crypto markets growing. Young adults are the most likely to own crypto. Their incomes are growing. Also the younger generation is also much more likely to own crypto. As they begin their careers and investing then they are more likely to invest than the older generation. Pew Research also notes that 42% of men from the ages 18-29 have used cryptocurrency. Data from The Finder notes that 44% of crypto is held by millennials, 28.6% by Gen X, and 17.8% by Gen Z. Millennials own 44% of cryptos yet only make up 5% of the nation’s wealth. Data from Bankrate is also skewed towards the younger generation: 13% held by Gen Z, 58% by millennials, 20% by GenX, and 10% by baby boomers. I believe this bodes well for the trajectory of crypto. Assuming that wealth will pass down to the next generations (which seems like a safe assumption to me). Another interesting data point is that crypto is picking up many of the individuals that are not investing in the stock market. 35% of crypto accounts have annual household incomes of under $60k. It is estimated that only 12% of middle class families directly own stock.

Profitable to Not So Profitable

We can take a look at some of the metrics for Coinbase to get a better understanding of where the company is on a financial basis. During the periods of high trading volume in 2021 Coinbase was making money hand over fist. Then once the market began its rapid decline the company found itself overstaffed and falling into a position of steep losses. We can first look at the revenue drop that the company experienced. This is mostly due to the drop off in trading volume as that is where Coinbase generates the majority of its revenue. The table below outlines the revenues by quarter over the last 2 years. (Financial information taken from quarterly and annual filings)

Revenues dropped rapidly. The company was not prepared for that drop off in revenue. Their expenses were still way too high for their revenue and naturally that means the company started to lose money. The table below outlines the EPS for the company over the past 2 years.

The company was extremely profitable during 2021. They were not prepared for the slowdown in the market and entered a period of steep losses.

Coinbase Rightsizing

Coinbase has made different moves to help mitigate these losses. As losses peaked the company realized they were way overstaffed. They cut 1,100 people, or approximately 18% of its workforce, in June of 2022. They then announced in January 2023 that they would cut another 20% of their workforce, or approximately 950 people. This comes following the announcement from the CEO that they were planning to reduce operating expenses by 25%. This is an important step in right sizing the ship. They had overhired for growth that did not only continue but rather the opposite happened and things slowed down. This will bring costs down drastically and help return the company to profitability.

How would reducing operating expenses by 25% look? Their operating expenses at the end of 2022 were $5,904,416 thousand. If they were to reduce operating expenses by 25% that would equal savings of $1,476,104 thousand and leave operating expenses for the year at $4,428,312. If the company does not see any growth in revenues (2022 revenues $3,194,208) then even with the 25% reduction in operating expenses they are going to operate at a loss. Coinbase has not provided revenue estimates for the year as revenues have seen such large swings. I think it is likely that Coinbase will see a loss in 2023. Analysts following the company seem to agree with that. Although the company is expected to operate at a loss again this year things seem to have turned in the right direction.

The other part to consider is the strength of the balance sheet. Coinbase had $4,425,021 thousand in cash on the books to end the year. It only has $3,393,448 thousand of debt on the books. Free cash flow for 2022 was -$1,649,390 thousand. I do not think the company will experience that large of a loss again as they have taken measures discussed to reduce the losses. Even if it did experience a similar loss for 2023, the company has plenty of runway to operate at a loss without having to dilute or take more debt. Its balance sheet is in a strong position and gives the company time to grow revenues and regain profitability.

Unexpected Revenue Gains

Another positive is that the company’s revenue sources have been increasing in areas other than transaction revenues. The company saw their subscription and services revenue increase from $517,487 thousand in 2021 to $792,571 thousand in 2022. That is good for a 53% year over year increase. Also with the drop in transaction revenues it has become a much more significant part of revenue. In 2022 the subscription and services revenue made up almost 25% of revenues. That 25% of revenues is seeing growth of 50% year over year. That is a big part of the business growing at a fast rate. Even if transaction revenues stay flat then Coinbase is going to see a solid growth in revenues from the growth in the subscription and services business.

Now there has been a lot made about the subscription and services revenue. Mostly concerning the SEC crackdown on “staking”. Coinbase could lose their revenue from staking. In February, “crypto exchange Kraken agreed to shut down its US cryptocurrency staking service and pay $30 million in penalties to settle US Securities and Exchange Commission charges”. On March 22, 2023 Coinbase received a Wells notice from the SEC. Directly from Coinbase’s website:

“Today, we are disappointed to share that the SEC gave us a “Wells notice” regarding an unspecified portion of our listed digital assets, our staking service Coinbase Earn, Coinbase Prime, and Coinbase Wallet after a cursory investigation. A Wells notice is the way that SEC staff tells a company that they are recommending that the SEC take enforcement action for possible violations of securities laws. It is not a formal charge or lawsuit, but it can lead to one. Rest assured, Coinbase products and services continue to operate as usual - today’s news does not require any changes to our current products or services.”

If you want a good read on what occurs between government agencies and companies go and see the full write up by Coinbase. We could go down a whole rabbit hole on government “oversight”. What gains come from that oversight or what negatives? Who are these government agencies accountable to, since they are not elected? Are they even competent experts in the field? We will leave all that for a political discussion, not here and now. The only politics we want to discuss is how it affects the stock.

In this case politics could affect the company revenues directly. A lot of people have banked that Coinbase will lose its staking revenues just like Kraken. This is not a given to start out. It is a possible scenario and the likelihood increased with the Wells notice. The only thing is that staking, referred to in the financial statements as “blockchain rewards”, makes up only a portion of the subscription and services revenue. In 2022 it made up 35% of the subscription and services revenue. While this is not a small percentage, it is not the majority of revenue nor the fastest growing portion. Revenues from staking in 2021 were $223,055 in 2022 they were $275,507; that is growth of 23.5%, whereas the overall growth rate was over 50%.

The largest growth driver in the subscription and services revenue was “Interest Income”. It turns out the rising interest rates are helping Coinbase. I did not expect that to be a revenue driver for Coinbase. Rising interest rates are also the main cause of the drastic drop in trading in crypto as many have taken more conservative investments. I guess it was a double edged sword. Rising rates drove transaction revenue down but they have at least provided some form of relief by providing a large increase in interest income. Interest income rose from $25,835 in 2021 to $326,956 in 2022. That is over 10x growth in revenue. That part of the business is not at risk from the SEC like the staking business. Interest income makes up the largest portion of the subscription and services revenue, is the fastest growing, and is much less at risk. If interest rates go down again then the transaction revenue is likely to increase again as well. I believe these two help counteract each other. Lower interest rates help drive the risk on trades.

The loss in revenues from staking would for sure be a blow to Coinbase, but I don’t think it would be as dramatic as many have made it out to be. We will have to wait and see how it shakes out with regulators on the staking front. For the time being Coinbase is continuing operations as is, hopefully that is able to continue.

Path to Profitability

There are some positives coming into the next year. Transaction volume for crypto has started to climb from the lows seen in December 2022. Revenue and losses at the company have also turned a corner and started to recover. I expect to see continued growth within the crypto market and within Coinbase itself. I do not think it will jump right back to the levels that we saw in 2021 or even early 2022, but expect a steady growth from current levels. The price action in Bitcoin provides us with a good indicator. While Bitcoin is not the only crypto it is still the largest and most well known cryptocurrency. The price started the year right around $16,000 and has since increased to right around $28,500, an increase of approximately 78%. I think this is a good indication of the increasing demand for crypto to start the year.

I think Coinbase itself will continue to gain market share in the crypto industry as well. We saw this occur with the implosion of FTX. Many of those users may have left the market entirely but many went to another exchange. The chart below shows the increase in market share that Coinbase has been able to achieve following the collapse of FTX. Binance has also found itself in some hot water with regulators. It could push some additional users to Coinbase.

I discussed previously why I thought Coinbase would capture market share. I think as more uncertainty enters the market people will gravitate to the more trustworthy platform. I believe that will be Coinbase.

Payment Processing

There is one thing I have not seen discussed when reading about Coinbase. I think it is one of the largest potential revenue generators for companies in the crypto market. It could bring another revenue source and move Coinbase to the mainstream, as well as crypto. That would be payment processing. I run an online company and we have looked to integrate crypto payments onto our platform. There is no easy clean way to make this happen. There are some options on the market but they are not good systems. There is a lot of money to be made in payment processing. There are two pieces, one is business to business, the other would be business to consumer. As a business owner I can tell you both parts are a hassle and need upending. Business to business payments are still often done by check to avoid the high processing fees that are charged by payment processors. There are other options such as ACH but that system is not without its flaws and there is not a clean platform to use to make this happen. I feel there is a huge business opportunity for companies to jump in on this. I don’t think it is without reason to think crypto could get into it as the transfer fees are minimal. The business to consumer side is mostly a problem due to the fees involved. Most companies still take approximately 3% for each transaction made. That adds up for a retailer and kills margins. If there was a way to perform these payments at lower cost then I think many would be looking to adopt it.

The online payment processing market is massive. There are a few different numbers I have seen but they are all very large. Statista estimates that digital payments have a total transaction value of $9.46 trillion in 2022 and projects that number to reach $14.78 trillion by 2027. IR estimates that global digital payments will reach $10.72 trillion by 2025. The market is obviously massive.

Stripe, which is still private, is one of the leaders in backend payment processing. In March 2023 it announced a new round of funding with a valuation at $50 billion, that is down from its previous valuation of $95 billion. To give you an idea, Coinbase is currently valued at $17.7 billion.

I think this is a massive opportunity for crypto. I think a company like Coinbase would be a likely candidate to make it come to fruition. If they could even capture a small niche part of the market it could provide large revenues. I am not proclaiming to be an expert on blockchain, settlements, and the backend for crypto currencies. I do think it is a matter of time before companies are able to build a clean solid platform for crypto payments. Whoever does is bound to make some money.

Risks

There are definitely risks with Coinbase. I think the largest risk of all would be government intervention. The SEC seems keen on cracking down on the crypto industry. I think a big part of that is due to FTX. People want oversight and regulation. I don’t know what that regulation will look like but it will most likely not be a positive. I think Coinbase has been ahead of the game on this front and have been very transparent and upfront with regulation and regulators. It is one of the reasons I prefer it over other crypto companies. Regardless, if the government starts to intervene in the crypto market it could cause some problems for Coinbase.

Another risk coming from the government is competition in the form of central bank digital currency (CBDC). We have already seen this play out in China. I personally do not agree with CBDC and have 0 intention of adopting this form of payment. I think it goes against the whole nature of crypto in the sense that it is not centrally controlled by a government. I think many who use crypto would agree. That being said, it poses a potential risk and threat to individual cryptos and companies that operate in that space.

The other large risk is the continued fall of the crypto industry. Coinbase is only successful if the crypto industry is successful. If the market drops again or if there is more pullback in the space then Coinbase will feel the effects. I personally do not think crypto is going anywhere, unless government attempts to intervene. But that is not to say there is not a risk of it happening.

Conclusion

I think the crypto market is here to stay. The crypto space took a hit during 2022 but it still saw significant growth compared to a few years ago. I think the crypto market will see a more steady growth pattern going forward. The demographics support crypto growth moving forward. Coinbase took its hits just like the crypto market. It has made appropriate moves to remedy the situation. Coinbase comes across as a professional and trustworthy source for crypto. I think that will help it to grow its market share. I expect the company to continue to grow and return to profitability. I also think there are some potentially large revenue sources that the company could help capture.

I think the stock price was overvalued during the manic crypto days. It fell too far and has now seen a solid rebound, increasing by approximately 85% to start the year. Some might say that it has risen too high in the last 3 months, but I think it went down too far and has recovered to a more reasonable price.

I am an opportunistic buyer of the stock. There are large price swings in Coinbase. Look for a good entry point and pull the trigger if you want to jump into the crypto sphere.

This article was written by

Analyst’s Disclosure: I/we have a beneficial long position in the shares of COIN either through stock ownership, options, or other derivatives. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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