• Brett Schafer

Not So Deep Dive: Coinbase Stock



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Show Notes


(Ryan) What they do: Coinbase describes themselves as “a leading provider of end-to-end financial infrastructure and technology for the cryptoeconomy.” Basically, Coinbase is a platform where anyone can buy or sell a number of different cryptocurrencies or crypto-related products. It is the leading crypto exchange.


And they break up their revenue into two sources: Transaction revenue and subscription and services revenue.


Transaction revenue makes up about 90% of their revenue and is comprised of 3 basic products: (1) Sending and receiving crypto, (2) investing in it, or (3) spending it. Transaction revs are split up between retail users and institutions. And institutions tend to get much lower commission fees. So despite institutions accounting for 55% of assets on the platform in the latest Q, they only accounted for 6% of total revenue.


Subscription and services is a little more diverse. These products include (get ready for some unfamiliar terminology): Distribute, pay, store, save, staking, borrow and lending, and build. I spent time researching all of these, and although I now think I could explain them, I don’t think it’s worthwhile because it’s such a small part of the business. But they also have coinbase pro, coinbase prime, coinbase cloud, and some other stuff that we will touch on in future growth opportunities.


(Ryan) History: Brian Armstrong originally came up with the idea for Coinbase while he was working at AirBnB. So AirBnB launched in 2008 and he was hired as one of their early software engineers, and while he was there he came across the bitcoin whitepaper in Hacker News. The paper struck a chord for Armstrong and he grew fascinated with Bitcoin in 2010, so on nights and weekends he began coding what was essentially just a bitcoin wallet.


He pitched the wallet idea to Ycombinator and they basically said you have to go get a cofounder. So he searched for one. Found one that didn’t really work out, and then on his 2nd try came across Fred Ersham and the two hit it off. Originally, there wasn’t that much traction because it was pretty much just designed for storing bitcoin, but after talking to customers they added the ability to buy or sell on there. From that point on, growth really started to pick up. (company was known as BitBank at the time).


Fast forward some years, and they had 200,000 users. They started encountering 2 big problems. Fraud and working capital issues. On the fraud part, they were on the hook for money that was stolen then transferred to their wallet, so this became a big point of focus. And on the working capital part, they had to pay in bitcoin to the users when they bought but then had to wait some times 5 to 6 days to get the actual cash. This left them on the hook in a large way if Bitcoin moved around. They eventually got insurance for this and the Series A helped with it. They’ve since added lots of different cryptocurrencies and went public in April of 2021.


(Brett) Industry/Landscape/Competition:

  • Industry size: Crypto market cap hit around $3 trillion at some point in 2021. Now it is a bit lower but it changes by the day

  • Coinbase is estimated to have slightly less than 10% of total crypto assets out there

  • Competitors: FTX, Crypto.com, DeFi stuff, NFT marketplaces, Facebook (?), the Fed


(Ian) Management and Ownership:

  • Brian Armstrong is the CEO

  • Emilie Choi is the COO and President, she was previously at LinkedIn

  • “Coinbase is a mission focused company.”

  • “Some really sketchy behavior coming out of the SEC recently.”

  • We want the SEC to issue guidance and enforce rules

  • Pirates to Navy (Reid Hoffman)

  • He had a tutoring business prior to Coinbase, made money, funded life, but didn’t have the runaway potential he was looking for

  • Early in crypto, hard to remember that crypto wasn’t part of everyone’s thoughts in 2010-2012

  • He owns over 16% of the company, $8.1B

  • Andreessen Horowitz is the second largest holder (6.5% of the company)


(Brett) Valuation:

  • Market cap of $50.4 billion, ticker COIN

  • EV of $47.4 billion (they are very profitable so this applies here)

  • EV/s of 8

  • EV/OI of 14.8

  • Operating cash flow looks inflated due to change in operating assets, so I would ex that out when calculating a true cash flow number

  • Around 50 million options/RSUs outstanding vs. share count of 215 million. Not great


(Ryan) Earnings:

  • $5.9B in TTM revenue, up 600% from Q3 of last year

  • And they are profitable. Over the last 12 months, they’ve generated ~$3.2B in Adj. EBITDA. That’s a 54% Adj. EBITDA margin.

  • But they’ve spent $590M on SBC over the LTM, so I’d back that out.

  • Typically, I’d say ignore Adj. EBITDA and focus on cash flow. But in Coinbase’s working capital, they have to account for custodial funds and the recent influx of assets on to the platform makes OCF look really weird.

  • So over the last 9 months it shows $7.7B in OCF, but $5B of that was an increase in custodial funds.

  • They also have minimal depreciation and amortization, so Adj. EBITDA isn’t a terrible metric. (They do have interest expense though).

Most recent quarter:

  • They reported 7.4M monthly transacting users, up 250% YoY. But down 16% from Q2

  • Trading volume is also up substantially YoY, but down 29% QoQ

  • The majority of their revenue (90%+) still comes from fees on transactions.


(Ian) Balance sheet and liquidity:

  • $6.3B in cash

  • Issued $1.25B 0.5% 2026 convertible notes in May

  • Issued $2B of 2028 and 2031 notes at 3.375% and 3.625% respectively.

  • Also have a large line item called “Customer Custodial Funds”... not cash the company can use for operations, but they do earn interest on that cash.

  • At nearly $9B, it generated about $8mm in interest income last quarter. Fairly minimal, but could become more meaningful in a rising rate environment


Anecdotal Evidence:

  • (Ryan) Don’t think I’ve ever used it. But if I were going to buy crypto, I’d probably use Coinbase, maybe the cash app. With all the scammy things that have happened in the crypto space, security and trust are the two primary things I’d look for, and Coinbase has them.

  • (Brett) Seems like the best and most reliable for crypto transactions. I used to use it back in the day

  • (Ian) Bought some bitcoin in 2017, not much, but researched and coinbase appeared to be far and away the most legitimate. Moved my ethereum and bitcoin out of coinbase in 2020 to start earning yield on it.


Future growth opportunities:

  • (Ryan) Coinbase Prime. Rolled this out this quarter and this is basically an institutional interface for advanced trading. So for simplicity purposes think IBKR for crypto. They added in their announcement, “We will continue investing in the future of institutional crypto by building on these services and launching a mobile app that enables portfolio access and collaboration on the go.” I like that they are leaning into the institutional side, but I don’t have a great grasp on the competitive landscape here. Are there better institutional exchanges out there?

  • (Brett) Coinbase Cloud. This goes under the “Other services” revenue. This is kind of like SoFi’s Galileo product where Coinbase has APIs to help build your crypto project. THey bought Bison Trails (a crypto company) for almost $500 million to help bolster this, so it looks like a big project for them. This went from $0.6 million in revenue last year to $8.6 million in Q3, so it is growing rapidly.

  • (Ian) Coinbase NFT marketplace, but I want to talk about smart contracts.


Highlights and lowlights:

  • (Ryan) Highlights: They spend less than 10% of revenue on S&M, yet they continue to grow their market share across all crypto exchanges. I think there is a huge network effect in this industry. And they are extremely profitable. Lowlights: They are completely reliant on the success of the overall crypto economy.

  • (Brett) Highlights: Established brand, locked-in millions of users, incredible unit economics, and making moves with ancillary products that makes sense. Carrying value of strategic investments could be much larger than what it is now ($269 million) Lowlights: Investing strategy of marking up their own book, reliance on transaction fees which could be whittled down to zero, and the elephant in the room which is that this is all relying on an unproven industry with no “real world value” yet (all the crypto negatives everyone is thinking of). What is S&M spend as a % of revenue in a bear market? CEO performance award made me want to puke.

  • (Ian) Highlights: Great position and trusted. Growing industry. Lots of talent moving toward it. Lowlights: Don’t like that fees still make up the majority of the business. They need to watch what happened in stock trading and find a way to be like Schwab, many value add services around trading, not Ameritrade.


Bull case:

  • (Ryan) Funds continue to flow into crypto. At an EV/EBITDA of like ~12x, the ceiling for Coinbase is pretty damn high.

  • (Brett) Crypto goes brrr

  • (Ian) Crypto is just the beginning of Coinbase. It becomes the paradoxical centralized Defi.


Bear case:

  • (Ryan) We hit a peak in the crypto economy last year. Crypto believers probably just rolled their eyes, but look what happened this quarter. This is the most significant issue with the business model. They are reliant on increasing transaction volume and a decrease in the value of different cryptocurrencies could absolutely kill the business.

  • (Brett) Crypto goes bust

  • (Ian) Crypto crashes while Coinbase is still largely dependent on fee revenue.


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Disclosure: The author and podcast guests are not your financial advisors. Ryan Henderson and Brett Schafer are general partners and portfolio managers at Arch Capital. Clients of Arch Capital may hold securities discussed on this show.

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