As Bitcoin ETFs Take Center Stage, Coinbase Diversifies

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Overview

Crypto exchange Coinbase has been an industry bellwether since it listed on Nasdaq in April 2021. It is again at the center of investor attention because it is a key partner to multiple spot bitcoin exchange-traded funds (ETFs). These products already have a cumulative $32 billion in assets under management and are expected to bring billions of additional investor dollars into the industry in coming years.

However, not everyone sees these ETFs as bullish for the firm’s stock. While Coinbase will benefit from the growth of these products using its brokerage and custody services, ultra-cheap ETFs will challenge Coinbase’s expensive fees for low-value trades. Should inflows dwindle, more weight will be placed on new products launched in recent years that do not rely on trading fees. This shift also transpires in the backdrop of a landmark suit from the Securities and Exchange Commission (SEC) that challenges many aspects of Coinbase’s business.

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Key Background

Coinbase launched in 2013 to provide retail access to digital currencies such as bitcoin via the Coinbase wallet, with a simple business model around transaction fees. The business grew to 56 million users and $1.3 billion in revenue before going public in April 2021. Its IPO led to the exchange briefly reaching a valuation of $86 billion, surpassing traditional exchanges such as Nasdaq and the Chicago Mercantile Exchange.

However, 2022 was a dismal year for crypto and Coinbase. Despite a 300% climb in value in 2023, the company’s stock, at a recent $142.55, is selling for more than 40% below its initial offering price today for a market cap of $33.9 billion.

In 2023, Coinbase’s other products and services surpassed revenue from trading fees for the first time. In Q3 2023, the company generated $334.4 million in revenue from subscription and services fees (e.g., custody, staking, USD Coin revenue sharing) and only $288.6 million from transaction fees. These numbers are continuations of a trend that started in Q2, 2023.

With the net flows of the newly launched spot bitcoin ETFs over $1.7 billion since launch, according to BitMex Research, we can expect to see a proportional rise in Coinbase’s revenues from these activities, given its plays the role of the prime custodian for most of these ETFs. Coinbase charges 0.2% to custody assets for ETF clients.

Coinbase may get respect from traditional financial firms such as BlackRock, Invesco, and Franklin Templeton, which use Coinbase for custody, but the SEC has a different attitude. The SEC filed a major lawsuit against the crypto exchange in June 2023, arguing that Coinbase is operating as an unlicensed national securities exchange because the SEC asserts that nearly every token sold on the platform is a security.


Key Statistic

Presently, Coinbase draws revenues from various sources, such as transaction fees, which account for 42.72% of its total revenues, and its subscription and services, which account for 49.55%.

Among subscriptions and services, stablecoin revenue (fees earned from investing collateral backing the $27 billion USD Coin (USDC) in short-term treasuries and other cash equivalents) grew along with rising interest rates but has also proven to be the most volatile category. Coinbase shares the USDC stablecoin income with primary issuer Circle Internet Financial Ltd on a 50/50 basis.


Outlook and Implications

Starting with trading, it is important to note that while bitcoin is the exchange’s highest single-asset trading by volume, it is much lower than the combined transaction revenue from ether and other crypto assets. This is a big plus for Coinbase. This trend will likely continue into 2024 and beyond since it is unlikely that other assets will get their own ETFs.

The one exception could be ether. Spot ETFs may soon be available for the asset as BlackRock, Fidelity, Grayscale, Franklin Templeton, and Ark/21shares all have pending applications before the SEC. The SEC will likely have to decide whether to greenlight these products by May 23, the final deadline for the first application in the queue. Coinbase will likely become their custodian, but it will lose transaction volume as people move from owning the crypto outright to buying an ETF.

It is also worth noting that Coinbase is ramping up its plans for international expansion. It recently registered in Bermuda and is beginning to offer offshore derivatives contracts to retail investors. These numbers do not yet appear in quarterly reports, but they could grow to become influential components of the firm’s financial future moving forward.

Despite their growing footprint, Coinbase’s subscription services are a mix of successes, failures (such as its NFT market), and projects whose fates are yet to be determined. The most successful category is stablecoin revenue. Coinbase receives 50% of all revenue earned by Circle through the investment of $27 billion of collateral in short-term treasuries and other cash equivalents. Thanks to higher interest rates, Coinbase could generate an additional $1 billion in revenue over the full year. Although USDC has lost market share to Tether over 2023, whose market cap is approaching $100 billion, USDC should remain a cash cow for the firm in 2024 and beyond.

Blockchain rewards, which primarily involve staking services offered to clients who deposit collateral such as ether to generate “interest” in exchange for helping to protect the network, should also remain a consistent source of revenue. It could become an even greater avenue for growth if the SEC approves spot ether ETFs. This could lead to additional institutional demand for Coinbase’s staking services. Coinbase’s staking services were specifically mentioned in the SEC’s suit against the firm as evidence of an unregistered investment contract. In contrast, the exchange offers no comparable service for bitcoin.

The biggest bet of Coinbase’s growing services is Base—the new Layer 2 network built on Ethereum, which enables cheaper and faster transactions. Launched to the public in April 2023, Base saw strong initial traction. Base currently has around 3.3 million accounts, over $400 million of ETH in total value locked, according to DefiLlama, and has pulled in over $5.9 million in revenue, according to TK-Research.

Base got off to a strong start but still has not achieved a critical mass of users. Some of this initial activity was likely due to opportunistic traders hoping to secure a spot for a potential airdrop, or giveaway, of a token from Coinbase as a reward or incentive for using the network. Coinbase has never promised that it will issue such a token. The jury is out on Base’s success, but it is likely a high priority for Coinbase.

Investors are split on Coinbase’s prospects. JPMorgan downgraded COIN to underweight on January 22, citing the potential for “cryptocurrency ETF enthusiasm to deflate further,” which could lower token prices, trading volume, and ancillary revenue opportunities despite the positive growth in flows from spot bitcoin ETF. Oppenheimer upgraded COIN in January, citing spot bitcoin ETFs as net positive and the potential of Coinbase either coming out positive in their SEC case or the court dismissing it.

Coinbase will report its Q4 earnings on February 15, and consensus estimates, according to Bloomberg, are that it will outpace every other quarter of 2023 in terms of overall revenue ($826 million) and transaction revenue ($418 million). Subscription and services are expected to come in at $347 million, which would break its streak of beating transaction fees. However, these numbers may be an outlier because transaction volume across the entire industry ticked up in Q4 last year as expectations of the spot bitcoin ETFs led to a bull run. The Q1 2025 numbers will likely be more telling for Coinbase moving forward.

Finally, Cathie Wood from Ark Invest is sanguine on the stock, telling Forbes in a January interview, “Regarding Coinbase, many people are discussing retail spreads coming in, but that’s missing the bigger point. The bigger point is that we now have an on-ramp for many more people to get the bitcoin experience. As they evolve in this journey, they’ll probably end up with self-custody digital wallets. We are looking at Coinbase as a prime candidate for the big winner in digital wallets […] I understand that the arithmetic says that spreads could come in the very short term. Shareholders might focus only on that, and we think that loses the forest for the trees. We also think that the regulatory dogfight here in the United States is a blessing in disguise and pushed Coinbase to accelerate its international strategy.”


Decision Points

Investors in Coinbase are counting on the firm’s international expansion, plus its revenue sharing arrangement with Circle, its blockchain rewards business, and its bet on Base to outweigh any fee compression from spot bitcoin and likely spot ether ETFs. Although these challenges will be significant, it is important to note that Coinbase’s successful pivot from trading fees, especially given the recent bear market, has demonstrated its ability to be proactive and agile.

Further, Coinbase is still the best bet for investors to get diversified exposure to the crypto space.