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==Best way to gain exposure to the expansion of the crypto-native ecosystem== Coinbase aims to be the primary financial account for users to access the “cryptoeconomy” or what we refer to as a crypto-native ecosystem, and we believe Coinbase is the way to gain exposure to the development of the crypto-native ecosystem given 1) its status as the largest fiat on-ramp in the industry for both retail and institutional clients, serving as the starting point for many users to interact with crypto, and 2) its focus on safety and security and regulatory compliance, providing one of the largest and most secure, institutional-grade custody solutions for crypto assets in the industry. That being said, we emphasize that our base case forecasts largely assume the status quo in terms of the ecosystem, and this section is largely geared towards highlighting why Coinbase is well positioned should the crypto-native ecosystem continue to develop. As we show in Exhibit 2, Coinbase has a strong track record of consistent market share gains in the amount of crypto assets held on its platform. While other fiat on-ramps exist, we believe COIN’s position as the number 1 on-ramp from the US financial system makes it a compelling play on the development of the crypto ecosystem. Coinbase’s 56mn users represent a sizable user base to expand the product over time, and we believe that if activity in the crypto-native ecosystem takes off, Coinbase will increasingly be able to capitalize on its leading market position. In the following section we highlight Coinbase’s unique position as the top fiat on-ramp to the crypto ecosystem, its strong position as the top institutional custodian (which should continue to support strong growth in the institutional business), as well as a number of potential catalysts for further development in the crypto-native ecosystem and providing some ways to help size the opportunity. That being said, we stress that the crypto-native ecosystem is still fairly undeveloped. We would describe the crypto-native ecosystem as all economic activity that is conducted using crypto-native technology that is separated from the fiat banking rails. Today we believe the bulk of the activity in the ecosystem is happening at the cryptoexchanges, which help facilitate transactions in crypto currency and charge a fee for these services. As a result, much of the ecosystem is market structure-oriented in nature as the various participants in the industry, such as Coinbase, have helped build the financial infrastructure on which the ecosystem can develop. Looking forward, however, we believe 1) the adoption of crypto-denominated payments, particularly through stablecoins, 2) further proliferation of non-fungible tokens (NFTs), and 3) considerable white space for the development of “DeFi” applications, or decentralized applications that run via smart contracts on blockchains such as Ethereum have the potential to drive considerable expansion of the economic activity in the crypto ecosystem. Should this occur, though this is not part of our forecast, we believe that the ecosystem has the potential over time to drive meaningful amounts of activity and commerce. '''Retail: Well positioned as number 1 on-ramp to the Crypto ecosystem''' Coinbase offers three primary retail platforms for buying and selling Cryptocurrencies: * Coinbase: Coinbase is a simplified, user-friendly interface that allows the buying and selling of cryptocurrencies geared towards more “everyday” use. While the Coinbase platform has a simpler user interface than Coinbase Pro, the fees are higher, sometimes as high as 3-4% of the transaction value. Coinbase also offers several other products to customers including a Visa debit card that is funded by cryptocurrency funds held in the account. COIN serves as the custodian for the cryptocurrencies held on the platform, meaning the company centrally manages the storage of private keys. * Coinbase Pro: Coinbase Pro provides users more advanced access to COIN’s cryptocurrency exchange, where the company manages a centralized order book and allows for various order types and trading strategies. The platform also offers more information on market liquidity and depth. The Coinbase Pro is geared towards institutions and more advanced retail traders but is available for anyone to use. Fees are much lower on the Pro platform, starting at 50bps and decreasing to 0-5bps in an exchange style maker-taker pricing plan with volume-based tiers. * Coinbase Wallet: Coinbase wallet allows users to store and send/receive cryptocurrency to/from other users. The Coinbase wallet app is a user-managed wallet and the user’s private key, the cryptocurrency equivalent to an account password, is stored on the device itself. If the private key is lost, the users funds can never be recovered although the company has introduced cloud-based backup solutions to address this risk. Coinbase offers this solution in part to allow Coinbase users to interact with other parts of the crypto ecosystem such as decentralized applications. '''Competitive dynamics are heating up with increasing competition from fiat native firms''' We expect strong user growth to continue over time on the retail side as Coinbase leverages the accessibility of its platform to the mass market. COIN has grown its verified user base over time at a 35% CAGR since the beginning of 2018 with monthly transacting users increasing to 6.1mn in 1Q21 and averaging 5% of total verified users over time. As shown in Exhibit 8, COIN appears to dominate the retail mind share for full-service crypto exchanges, measured by mobile app downloads, with a distribution platform more in line with other mass market fintech offerings such as Square’s Cash App, Paypal, and E-Toro. We believe this demonstrates the competitive position relative to other crypto native firms, making them well positioned to continue to acquire new customers who wish to interact with the crypto ecosystem. That said, a number of investors have highlighted the increasing competition from fintechs, as well as from traditional brokerages (Fidelity is a large digital asset custodian and SCHW and IBKR are both reportedly working on crypto offerings). While these firms do not have the technological advantage of being fully crypto-native companies and often rely on outsourced solutions for crypto, we believe their significant investment resources derived from their non-crypto-related activities makes them a competitive threat over the longer term, although this would likely require significant investments or acquisitions to catch up to COIN’s considerable lead. '''Institutional: Top-tier custody and execution services are set to drive increasing institutional market share''' On the Institutional side, we believe Coinbase is one of a handful of venues to offer full service institutional capital markets services for the crypto ecosystem and believe COIN has a significant moat against the competition as a result of its top-tier custody offering as well as the 2020 acquisition of Tagomi, which powers the institutional platform and drives a compelling multi-venue trade execution offering. This has allowed institutional assets to grow to comprise over 50% of the assets on the platform over a relatively short period of time. Given the large sums of money at stake and the risk of theft or loss of funds due to the inherent nature of cryptocurrencies as digital bearer instruments, we believe custody is a central part of the conversation with institutional clients. Coinbase’s widely lauded custody platform, with a track record of having never lost customer funds, is a strong competitive advantage relative to other less proven platforms, in our view. We believe increasing institutional adoption in the latter half of 2020 and into 2021 has been a material driver of the acceleration in the institutional business and would highlight the significant flows into the Grayscale investment trust (GBTC), a publicly traded investment vehicle that has reached $38.4bn in AUM (Exhibit 10), and which custodies the underlying bitcoin at Coinbase. That said, we see increasing interest among other institutions, particularly from traditional financial institutions (through white label offerings), fintechs, wealth management platforms, family offices and endowments as catalysts to drive further growth in the institutional business over time. While the revenue generation on institutional assets is fairly low given the lower trading take rates and negotiated rates on custody, we see significant runway for growth and view the institutional part of the business as important for the normalization and adoption of crypto assets. '''Charting the development of the crypto-native ecosystem: Moving from store-of-value to crypto as a means of exchange''' While Coinbase today largely provides crypto trading services, the company has a goal of being users’ primary financial account for the “cryptoeconomy,” or the crypto-native ecosystem as we refer to it, leading many to ask what exactly is the state of the ecosystem and where are we in its development. While our base case assumes largely the status quo in terms of the state of the ecosystem, to answer this question, we find it helpful to look at cryptocurrencies and the activity they facilitate on a spectrum between “store-of-value” activities and “means-of-exchange” activities. In the classical definition of money, currencies tend to fill the role of being both a store of value and a medium of exchange in the economy (we would also include “unit of account” for completeness). The crypto ecosystem today is heavily skewed towards “store-of-value” types of activities. This largely includes the pricing, trading, and custody of crypto assets. However, since inception, blockchain technology has allowed for peer-to-peer payments between wallets, which form the basic building block for more means-of-exchange type of activity in the crypto ecosystem. So far, however, we have yet to see significant amounts of non-capital markets-driven payment activity or widespread adoption of crypto payments. This is due to a handful of factors, including 1) the high volatility of crypto prices, 2) capacity constraints given the relatively low transaction throughput of most blockchains relative to traditional payment rails, and 3) the challenges of driving network effects for adoption from the ground up. While there is still much progress to be made to reach widespread acceptance, and we note that broad acceptance is not our base case, below we highlight several potential catalysts over time to ease barriers to adoption. We believe each of these catalysts provides an opportunity for more value-added means of exchange activities in the ecosystem. '''1) The rise of Stablecoins: Blockchain-based, fiat denominated, instantaneous, cross-border payments''' Stablecoins are digital tokenized representations of fiat currencies that maintain a peg to an underlying currency (e.g., 1 stablecoin = 1 USD) by holding reserves on a one-for-one basis in an audited bank account. The supply of these currencies is variable and they can be minted/burned based on demand by either redeeming a stablecoin for the underlying deposit or paying dollars/fiat in exchange for receiving a stablecoin on the blockchain. Unlike Bitcoin and other cryptocurrencies, the value of stablecoins does not fluctuate, providing a constant value to use as a means of exchange. While stablecoins’ values are tied to fiat currency, they also have the convenient “programmable money” attributes of cryptocurrencies, allowing for blockchain-based payments and the integration of fiat currency into blockchain-based smart contract applications. We believe that the price stability of stablecoins likely makes them strong contenders for near-term adoption of cryptopayments, and makes them more of a pure play on the benefits of blockchain technology as a whole without the associated price volatility of cryptocurrencies. Tether (USDT) and USD coin (USDC) are the two largest stablecoins, accounting for the majority of the market (Exhibit 13). The outstanding supply of stablecoins has grown rapidly over the last year (Exhibit 12). That being said, we believe much of the activity in stablecoins today still facilitates more store-of-value activities, such as serving as a reserve currency for market markers on various exchanges who wish to keep idle capital denominated in crypto, as well as representing stand-ins for fiat currencies on unregulated trading venues (i.e., users on Binance transact in BTC/USDT currency pairs instead of BTC/USD). Recent events, however, have pointed to continued progress in the adoption of stablecoin denominated payments, such as a recent announcement by Visa that the company had begun processing payments denominated in USDC from the cryptoexchange Crypto.com, allowing the crypto-native firm to pay third parties directly in cryptocurrency without the need to convert crypto into fiat currency to make payments. Stablecoins provide a low friction payment mechanism with fast settlement times, allowing users to bypass fiat payment rails (ACH, Fedwire, SWIFT, etc.) that are not available 24/7 for instant settlement. Stablecoins can also run on multiple blockchains, making them portable to more scalable blockchains in the future that are better suited to high-throughput payment situations. On this last point, we note that people often raise the issue of transaction throughput as a gating factor for the adoption of cryptopayments, which is something we are less focused on. While it is true that most of the mainstream blockchains such as the Bitcoin blockchain have relatively low throughput compared to a fiat payment networks, there are numerous projects (examples: Lighting Network, ETH 2.0) aimed at reducing traffic congestion on blockchains as well as alternative blockchains under development aimed specifically at high volume situations. In other words, the industry is working on upgrading from “dial-up” to “broadband” over time, to use an internet analogy. '''2) The rise of DeFi: decentralized smart-contract enabled money applications can drive real activity in the crypto-native ecosystem''' The term DeFi (short for decentralized finance) in a general sense pertains to all aspects of decentralized cryptocurrencies in the sense that blockchain technology facilitates an inherently decentralized financial system. That said, over the past 2-3 years, DeFi has taken on a more specific meaning pertaining to cryptocurrency applications that are built on top of smart contract platforms, which allow developers to write code that executes on the blockchain and determines how transactions are executed. This has given rise to several new platforms that allow various activities to take place in a fully decentralized manner where no centralized authority governs the application’s operation. Most DeFi applications today (ranked by “Total value locked”, similar to Coinbase’s assets on platform metric) fall into two main categories: 1) decentralized exchanges (DEX), performing functions similar to Coinbase for buying and selling crypto currencies (examples: Uniswap, Sushiswap, Curve Finance), and 2) lending protocols, which allow for decentralized borrowing and lending of cryptocurrency at programatically determined interest rates (examples: Maker, Compound, Aave). However, there are various other DeFi platforms facilitating other activities such as derivatives and payments. The development of DeFi applications is still in its infancy, and relative to the nearly ~$2+ trillion market cap for crypto currencies, the total value of crypto on DeFi applications is still relatively low at just ~$67bn. In addition, the current use cases involving exchanges and collateralized lending (the latter of which we would argue more closely resembles margin loans than true lending) don’t do much to move the needle of crypto-native activity more towards the means-of-exchange direction, in our view. That being said, we believe they represent important proofs of concept for more complex applications in the future. One of the most important features of many of these protocols, in our view, is that many DeFi applications have native “governance tokens” (for example, UNI for Uniswap, COMP for Compound) that allow the holders of the token to vote on changes to the protocol’s operations. In addition, it is possible to configure these protocols to pay the holders of the governance tokens a share of the revenue generated by the protocols (for instance, the token holders for a decentralized exchange might receive a share of the trading fees or a share of the interest on a decentralized lending protocol). These two components of governance and a claim on the income stream provide a framework for thinking about decentralized autonomous organizations (DAO), the crypto version of a corporation, and their associated governance tokens, a crypto version of an equity security. While there are a number of regulatory hurdles to overcome in order to normalize this, we believe this emerging framework represents one of the larger longer-term opportunities for the development of the crypto-native ecosystem. '''3) The rise of non-fungible tokens: decentralized tokenized ownership of goods''' Much of the focus around NFTs centers on digital artwork and collectibles and some of the recent sales prices for NFTs, such as the $69mn sale price at Christie’s for an NFT representing a piece of art by the artist Beeple, or the significant volumes of NFTs being sold on the NBA Top Shot platform. NFTs at their core leverage blockchains to tokenize the ownership of unique goods and reduce transaction costs by simplifying the exchange of ownership. In our view, it is the crypto analogue to the title to a vehicle or a house: It’s not the physical asset itself but it does verify the holder of the token as the owner of that asset. Beyond the current use case of digital art, we believe NFTs have the potential to facilitate high friction and low liquidity transactions, such as in real estate, physical artwork, and certain areas of the credit market, such as leveraged loans, to list a handful of examples. While it is still early days, and there remain a number of legal hurdles to overcome, including how NFTs are regulated and how to handle the fractionalization of NFTs over time (which could lead to more security-like tokens), we believe NFTs represent another potential avenue of development for the crypto-native ecosystem over time. '''A bottom-up approach to the crypto TAM''' We believe drawing direct parallels to the fiat world as a model for the market opportunity for crypto is challenging, as we believe crypto has the potential to alter the economics, reduce spreads, but also expand the market size of financial activities in the traditional financial industry. That said, a number of investors have pointed to the various profit pools of traditional financial services activities to contextualize the activities that crypto could facilitate in the future. We separate financial activities into more store-of-value oriented activities and more means-of-exchange oriented and lay out the rough market size of each to give a sense of the relative magnitude of each. In general, while the store-of-value TAMs are much larger than the exchange-oriented activities, we believe the revenue margin / take rates tend to be much lower on store of value activities than in medium of exchange-type activities and pricing / take rates on store of value activities have tended to be more deflationary than in payments. '''Forecasting assets-on-platform''' On the next page, we show the mechanics of our model for forecasting assets-on-platform over time. We break up growth in assets-on-platform into 1) organic growth, defined as a net new asset growth rate, representing new deposits of assets onto the platform over time, and 2) market impacts, which are driven by changes in the value of the crypto assets held on the platform. While Coinbase does not provide this breakout of the flows on the platform, we attempt to back into the number historically by estimating the impact of market levels on assets by looking at the change in the overall crypto market capitalization. We attribute the remaining piece to organic growth. * Retail NNA growth: Retail net new assets (NNA) growth looks to have slowed somewhat in recent quarters. COIN has said that they expect retail to be the slower growing platform in the near term given this segment is more mature than its institutional business, but has not spoken to recent growth trends. We highlight a few potential explanations including large increases in asset levels, leading to profit taking and withdrawals from the platform or transfers to self-custody solutions, but given the lack of detailed quarterly trends, the organic growth rate of retail assets is something we are watching in the near term. * Institutional NNA: Our math implies that institutional NNA growth has been very robust recently, with significant new deposits of assets on the platform. We think this makes sense the last 6 months have seen a number of headlines around institutional investors taking stakes in crypto, leading to chunky deposits of assets on the platform. In line with COIN commentary, we believe the organic growth rate in institutional will remain very robust, leading to mix shift in assets-on-platform over time. * Market impacts and implied market share: We note that our baseline forecast doesn’t take an explicit view on crypto prices, and mechanically we are modeling a flat crypto market capitalization over time. That being said, we are also modeling significant amounts of new assets-on-platform over time, with assets increasing to nearly half a trillion dollars by 2025, which under a flat market scenario, would imply market share approaching 25% of all crypto assets. The value of a currency is derived in part from the public’s perception of that currency as a viable store of value and means of exchange. Thus, it is difficult to imagine a world in which COIN’s user growth remains at ~20%+ over time off its current 56mn verified user base and public acceptance of crypto doesn’t increase, and therefore, we feel that the flat market assumption in our model could overstate the market share gains.
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