Why the Simple Bull Thesis Behind Coinbase Was Wrong

All of a sudden, it seems, everything is going wrong for Coinbase Global (NASDAQ: COIN).

Shares of the cryptocurrency trading exchange have fallen 85% from their peak last November as cryptocurrency prices have plunged and interest in blockchain-based tokens has dried up. 

Adding insult to injury, Coinbase announced that it would lay off 18% of its staff this week as the company failed to anticipate that interest in crypto could cool after an unprecedented surge in 2021. Chief Executive Officer Brian Armstrong explained in a June 14 blog post: “In past crypto winters, trading revenue (our largest revenue source) has declined significantly. While it’s hard to predict the economy or the markets, we always plan for the worst so we can operate the business through any environment.”

That statement contradicts what was originally a favorite bull thesis behind Coinbase.

When the company went public in April 2021, many observers argued that Coinbase was the ideal way to play cryptocurrency because the company would benefit when crypto prices were rising and falling as Coinbase makes money by collecting transaction fees from customer trades. However, Armstrong’s statement above and the other evidence makes it clear that simply isn’t true. Coinbase isn’t protected from so-called crypto winters in the way that many investors once thought.

Crypto isn’t the stock market

It’s easy to draw parallels between the cryptocurrency market and the stock market. After all, both assets are liquid and trade on high-volume exchanges. Crypto, arguably, is even more liquid than stocks because it trades 24/7, while the U.S. stock market is open only from 9:30 a.m. to 4 p.m. on business days.

But the similarities mostly stop there. The stock market is hundreds of years old and has thrived in spite of dozens of bear market cycles. Stocks have real value. They represent a share of actual ownership in a business, which generally translates into dividends, or a share of profits, when that business is mature. Cryptocurrency, on the other hand, is a blockchain-based token whose underlying worth is valued mostly based on speculation, and whose utility is often limited. Crypto bulls, for example, argue that Bitcoin is “digital gold,” which is more of an idea than a provable fact. Bitcoin’s use as a medium of exchange is limited as well, because few goods or services can be purchased using the cryptocurrency, and transactions in Bitcoin tend to be slow and expensive. Crypto’s high volatility also makes it a poor store of value.

The stock market is also dominated by institutional investors like pension funds, mutual funds, exchange-traded funds, wealth management firms, and hedge funds. Data on the crypto market isn’t clear, but Coinbase said assets on the exchange were split 50/50 between retail investors and institutional investors. Retail investors tend to be more fickle than institutions, so it’s not surprising that crypto trading volume would decline as prices fall, while the stock market, though subject to ups and downs, is comparatively less volatile.

As cryptocurrency prices soared last year, trading volume also boomed. In May 2021, Bitcoin trading volume averaged $63.7 billion a day. By May 2022, that number had fallen to just $35.1 billion, down by nearly half.

The trading volume declines in altcoins — anything other than Bitcoin — were even starker. When interest in meme-coin Shiba Inu surged last October, daily trading volume was $8 billion. This May, after its value fell 90%, trading volume had shrunk to just $661 million. The pattern is similar for other altcoins.

According to Google search data, interest in Coinbase actually peaked around the same time that Shiba Inu’s price topped out in late October, which was shortly before Coinbase and Bitcoin’s prices both peaked.

Coinbase’s own results back up the trading volume data. Monthly transacting users fell from 11.4 million in the fourth quarter to 9.2 million in the first quarter, and trading volume plunged from $547 billion to $309 billion. Naturally, that weighed on the transaction-driven business model, and it only makes sense that traders who have lost money in crypto would lose interest in trading. The fad has rapidly faded.

What’s next for Coinbase

Armstrong’s blog post seemed to indicate that the company was steeling itself for a long crypto winter. “Coinbase has survived through four major crypto winters, and we’ve created long term success by carefully managing our spending through every down period,” he said. “Down markets are challenging to navigate and require a different mindset.”

No one knows where the crypto market will go over the long term, but in the near term there’s a good chance things will get worse before they get better. If the prices of cryptocurrencies continue to fall, more traders and institutions will become insolvent, and even Microstrategy, the software company that has spent billions on Bitcoin, is reportedly on the verge of a margin call if Bitcoin falls below $21,000, which is only a bit below its recent trading price.

For Coinbase, it’s clear that a decline in crypto prices is bad for business. While there’s a good chance that cryptocurrencies like Bitcoin will eventually rebound, that’s unlikely to happen until the stock market bottoms out, at the earliest, and with the Fed aggressively ramping up interest rates, that’s probably not going to happen soon.

Expect more pain ahead for Coinbase and the rest of the cryptocurrency market.

Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. Jeremy Bowman has no position in any of the stocks mentioned. The Motley Fool has positions in and recommends Alphabet (A shares), Alphabet (C shares), Bitcoin, and Coinbase Global, Inc. The Motley Fool has a disclosure policy.

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