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A New Era for Crypto as Coinbase Goes Public

Coinbase entering public markets on April 14, 2021 is the most anticipated IPO of 2021. The fintech veteran is the leading US cryptocurrency exchange and fresh off of a stellar Q1 performance. It’s a monumental milestone not only for the company (operating since 2012), but the emerging cryptocurrency sector.

Despite its industry leadership and profitability, there are concerns with market volatility, business operations, licensing, and regulatory climate that can deter the company’s long-term sustainability. As a pioneer over the last decade, Coinbase is experienced in being a first mover and addressing risk requirements to protect users and its platform.

coinbase DEBUT with PEAK PERFORMANCE

As one of the few, noteworthy fintech startups turning a profit, investor demand is at record levels. Retail and institutional investors eye this opportunity as a way to get indirectly involved in cryptocurrency markets. For 2020, Coinbase posted $322M in profit (off $1.2B in revenue) — up from a $30M loss in 2019.

Coming off its strongest quarter of growth, share price (privately averaged $343 in Q1) and reach new heights quickly (up o $429 in intraday trading). The explosive upward trend of the crypto market as whole in the last 4 months was a key driver of recent performance. The company estimates 4M-7M monthly active users on its platform for 2021 (up from 2.8M in Q4 of 2020). It also projects ARPU (average revenue per user) to be above $35-40 (Coinbase’s historical range from 2019 - 2020).

As the cryptocurrency sector grows in adoption, many traditional and emerging financial services companies are adding capabilities for accepting and storing crypto. Brian Armstrong (CEO of Coinbase) still sees the firm as uniquely differentiated since its core focus remains on digital assets and prioritizing compliance. Coinbase’s experience, traction, and growth with enterprises should also help keep it ahead of competitors for now. About half of the company’s $223B AUM (assets under management) comes from institutional investors.

CONCERNS and HURDLES for coinbase

As well-positioned as Coinbase is in early 2021, there are still key concerns facing the company and overall industry. These issues can derail the crypto leader’s public growth over the next year. Here are the top 4 factors to be aware of:

Market Volatility: Over the last decade, cryptocurrency markets experienced extreme highs (such as the current upswing since Q4 2020) and downturns with over 70% declines in valuation. Being highly cyclical correlates with the performance of exchanges and trading volumes. The next market slide can cause Coinbase’s share price to tank as revenue is tied to transaction activity. Coinbase has no control on how crypto markets behave, making quarterly projections and analysis challenging. The firm believes the current cycle should last about 2-4 years and drive bitcoin prices even higher.

Potential for Conflict of Interest: To help customers fulfill orders on its platform, Coinbase facilitates transactions through its own cryptocurrency holdings. This helps the firm cover times of system outages and order sizes beneath minimal thresholds. As a crypto market maker and owner, the platform can take advantage of sell prices (of their own assets) and bolster margins at the expense of customers. Other exchanges are neutral to this type of activity as they don’t take any position or holdings. Coinbase’s model blurs the line between principal OR agent in transactions, therefore increasing the regulatory risk in its operations.

Proper Registration and Licensing: Coinbase is currently registered as a money service business (MSB) and regulated as a money transmitter (licensing for entities that facilitate transfers between multiple parties). This scope does not include formal oversight on trading activity by regulators, which is a main revenue driver. This position may have been acceptable as a private company, but in public markets there will likely be increased scrutiny in updating the company from money transmitter towards a broker-dealer (based on current activity).

Non-digital asset platforms are commonly listed as alternative trading systems (ATS), which must abide by guidelines for consumer protection and securing the financial system. The lack of clarity from regulators is concerning since it leads to modifying its business practices and/or registering for additional licenses — both scenarios impacting established revenue and capital costs. In its S1 filing, Coinbase did confirm participation in broker activities (e.g. credit offerings allowing advances for trading) in which it isn’t regulated.

Regulatory Oversight and Changes: The current lack of transparency and guidance from US regulators has allowed crypto exchanges to experiment with risky transaction flows and increase exposure to losses. For example, platforms use customer holdings as leverage (in purchasing more crypto) or as a hedge in trading positions. When markets see high volatility, these exchanges can decide to temporarily shut down to protect their liquidity. If there’s a lack of controls, clients would struggle with accessing their funds in a timely manner.

Regulators have started to take action and impose guidance in the cryptocurrency sector over the last 4-5 months. Ripple was recently called out by the SEC in Q1 for some of its business activities and company classification. Other agencies, such as the CFPB and IRS, are also likely to step in soon regarding proper disclosures and tax reporting. New identity requirements are being proposed when transacting more than $3K from a private wallet.

OUTLOOK on crypto adoption post-ipo

The true wildcard to consider is this last concern on future regulation. Multiple regulatory bodies exist in the US that can directly impact Coinbase and its operations. These agencies can disagree on proper oversight or guidance, which forces platforms to hold off on launching new products or services. The first regulatory hurdle has to do with how long Coinbase can operate under its current model and licensing.

When regulators do announce changes, new requirements in identifying customers and monitoring transactions may be added. If the crypto sector is to make gains in adoption and legitimacy, exchanges must be able to deliver this additional data on clients. Unfortunately, privacy and anonymity are core tenets for enthusiasts and investors of cryptocurrency.

The intent of consumer protection and securing the financial system needs to be balanced properly with new offerings and investment options. Top fintech companies have already asked for improved policy and collaboration with regulators — no where is this most important than in the cryptocurrency sector. For the US to maintain a leadership position in global financial innovation, regulators and fintechs must work together.

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