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Coinbase
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==Strong user growth should drive strong top-line growth== Switching gears from the macro to the micro as it relates to Coinbase: while we expect strong growth in assets and customers on both the retail and institutional side of the business and view COIN as one of the best plays on the development of the crypto-native ecosystem, given the low commission rates on institutional volumes and the early stage of development for the crypto-native ecosystem, we believe retail trading will continue to dominate the P&L and make up the majority of COIN revenue for the foreseeable future. In this section, we provide our thoughts on retail pricing pressure, where we believe that pricing for retail crypto trading will likely follow similar trends to the brokerage industry over time, where commissions compressed over several decades as other revenue streams developed, and expect the existence already of free trading offerings in the industry will be hard to ignore as competition for retail relationships heats up. Additionally, we provide insight into some of the market share dynamics using the reported volumes of various crypto exchanges, where we show that COIN has 20-30% market share for trading volumes among other “fiat exchanges” (which comprise 30% of reported volumes) and roughly 7% of overall volumes. Finally, we demonstrate why we believe that while the prices of crypto are obviously important for revenue, in the near term the volatility of crypto asset prices is a very important, if not more important driver of revenue, as customer activity levels is highly correlated with crypto asset volatility over time. We use our price and volatility framework to flesh out COIN’s guidance for 2021 and provide a revenue sensitivity under various market conditions. '''Competitive landscape for crypto trading: we see a fragmented volumes landscape with a large share of volumes at unregulated exchanges''' Data sources on the crypto ecosystem remain somewhat fragmented. That being said, we have leveraged data from theblockcrypto.com, a crypto research firm and data provider to analyze the landscape of trading volumes. The data can be accessed here. The volume data is broken down into fiat exchanges, or exchanges that allow deposits of fiat currency from the traditional banking system and allow crypto/fiat trading pairs and crypto-only exchanges, or exchanges that do not accept USD deposits and largely offer crypto/crypto currency pairs. Among the fiat exchanges, Coinbase compares favorably with the highest market share for volumes of any player, with its next closest competitors, Upbit and Kraken roughly half the size of Coinbase. That said, when we include the international exchanges Binance, Huobi, and OKex, Coinbase emerges as the 4th largest exchange, with Binance appearing to be by far the largest, accounting for roughly 43% of the total reported volumes relative to Coinbases’s 7%, and likely representing COIN’s most significant competitor outside of the United States. By definition, the lower Know-Your-Customer (KYC) requirements and wider range of unregulated activities allowed on these platforms have the potential to drive more activity on those platforms than onto Coinbase, which performs identify verification on all users and prioritizes strict compliance with US regulations before adding additional features. We view Coinbase’s strict compliance policies as a competitive advantage, as the rapid increase in the crypto market is likely to attract more attention from governments, in our view, which has the potential to cause problems for unregulated exchanges with lax KYC policies and looser requirements for listing new cryptocurrencies (Bloomberg reported in March that Binance was under investigation by the CFTC for allowing US residents to trade unregulated crypto derivatives). The lack of access to the US banking system and US customers for these companies is also a key competitive advantage for Coinbase. In addition, this approach helps the company establish friendly relations with rulemaking bodies, which is particularly important given Coinbase will likely play a significant role in lobbying for more tailored regulation for cryptocurrency in the future. Lastly, it makes the United States somewhat of a captive market and acts as a barrier to international, non-compliant exchanges. That being said, Coinbase’s strict compliance approach has meant that less-regulated exchanges such as Binance have generated strong retail brand recognition outside of the United States and likely represents a significant competitor as Coinbase expands internationally. '''Retail pricing likely to be under structural pressure over time''' Coinbase makes roughly 50bps of revenue on the notional value of volumes traded on its platform, and on retail volumes it receives roughly 140bps on average, relative to the something on the order of 1bp or less that the online retail brokers receive in payment for order flow for their free trading offerings in the United States. This has led a number of investors to ask about the potential for pricing pressure over time. Coinbase management has said that similar to the pricing trends we have seen in traditional financial services, over a longer period of time it is likely they will see pressure on prices, but that there is nothing in the near term they see driving significant compression and that they do not seek to compete on price. We expect that pricing will compress over time, but similar to the pressure we saw in the brokerage space over time, the pressure is likely to be episodic, unpredictable and interspersed with times of relative stability. Below we highlight a handful of catalysts for price compression over time. Lastly, on the following page, we have attempted to compare pricing across various crypto venues. Note that given the variability of pricing across exchanges, as well as add-on fees, and the complexity of some pricing plans (particularly COIN’s base retail pricing) we would say the following chart is something of an oversimplification in some cases, but is good for illustrative purposes. * Free trading offerings: A number of firms have free crypto trading offerings today that have the potential to put competitive pressure on commission charging exchanges. In the fiat world, free online trading is generally supported by payment for order flow, which is effectively charged to retail investors through the bid-ask spread, but is generally extremely low (order of 1bps for retail equity volumes). In crypto, there is not the same market structure for payment for order flow, but there still exists the ability for companies to set bid-ask spreads for customers wider than they can otherwise source the inventory and thus earn a small fee. Thus “free” trading offerings have emerged where the trading cost is embedded in the bid-ask spreads of the crypto currencies. Further proliferation of crypto trading services marketed as free to the retail investor is likely to put incremental pressure on cryptoexchanges such as COIN to lower prices over time. * Platform harmonization: This is largely a Coinbase-specific risk. Coinbase offers two platforms, Coinbase and Coinbase Pro, to retail customers. While there are some difference in terms of the capabilities of each platform, in general, Coinbase Pro provides significantly lower prices for the customer, starting at 50bps, than the Coinbase platform, which has fees of 50bps up to 450bps and for small dollar transactions can have fees as high as 10%. Coinbase management has talked to the potential to see better integration of the multiple products into a more unified pricing tier, and has specifically mentioned reducing pricing on smaller dollar transactions, which are more likely to incur higher fees in the current pricing structure. We believe any restructuring of the various retail offerings is likely to result in lower pricing. * Reduced barriers to entry: One reason prices are high in the industry is the relatively young age of the crypto industry and the barriers to entry posed from the new forms of technology that crypto requires. We also highlight the difficulty of interacting with the crypto-native ecosystem at scale as a result of the difficulty in securing banking relationships to make cryptocurrencies easily convertible into fiat currency. For instance, Coinbase is at a premium price point to nearly every other major crypto exchange in the United States but is also one of the easiest cryptocurrency exchanges on which to open and fund an account via ACH as a result of Coinbase’s focus on regulatory compliance and their strong banking relationships. We believe this makes the pricing differential somewhat sustainable in the near term, but over time, reduced barriers to entry and higher competition from other firms is likely to result in pricing pressure. '''Delving into the 2021 revenue guidance''' On its 1Q21 earnings call, COIN provided a handful of scenarios that it used to illustrate how it plans for its volatile and difficult-to-predict revenue model. While its expense guidance was relatively prescriptive, the top-line commentary left some room for interpretation, as COIN provided thoughts only on where monthly users could be in different crypto pricing and volatility environments. Coinbase’s business is highly impacted by crypto prices, and many investors have asked what these scenarios imply for revenue and thus the bottom line in 2021. As shown in Exhibit 30 and Exhibit 31, the correlation of Coinbase volumes and revenue with the market capitalization of crypto is fairly high. That said, we do not believe the crypto market cap is the only driver of profitability and below, we seek to tease out the relationship between revenues and volatility and make the case that the sensitivity to prices is perhaps less than it appears, with volatility being a very important driver. We then use the historical relationship to derive ARPU assumptions to apply to COIN’s 2021 guidance. '''Crypto asset volatility is a large swing factor for revenue''' COIN talks about their revenue trends in terms of “monthly transaction revenue per monthly transacting user” (we will abbreviate as ARPU). We also note we are calculating this metric based on total transaction revenue, not just retail. In Exhibit 32, we show the historical trends in ARPU over time, which appears to be highly sensitive to volatility over time. Note that COIN didn’t provide quarterly income statements for 2018 and so we are using indicative take rates on their disclosed volume and Monthly Transacting User (MTU) numbers to estimate ARPU in 2018 and provide more historical context. As shown in the exhibit, ARPU has been highly correlated with the volatility of crypto prices over time. Note that the impact of volatility is particularly powerful, as not only do users tend to trade more, but more users tend to trade in general, demonstrated by the correlation between MTUs and volatility in the past (Exhibit 33). '''How to think about the impact of higher crypto market caps on volumes''' While volatility is a significant contributor to quarterly results, we believe there is a general perception that higher crypto prices in general directly impact revenue trends. While we do believe there is a relationship, we do not believe the sensitivity is as linear as investors perceive given the relatively low correlation of ARPU and crypto market cap. Instead, in Exhibit 34, we show that the correlation is actually closer to a logarithmic relationship, implying decreasing sensitivity of revenue as prices increase and higher sensitivity as prices fall. Based on the relationship laid out above, in the following exhibit we leverage COIN’s 2021 guidance for MTUs and the various volatility and price scenarios to show where the top line could emerge. After layering in our assumptions for subscription and services and applying COIN’s relatively prescriptive guidance for the line items of expenses, we derive a range for 2021E of $4.6-9.5bn in revenues and $1.7-$5.0bn in EBITDA (we emphasize that these company-based scenarios are separate from our own forecasts for 2021, which are in the column headed “GS” in the following exhibit). '''How do we think about out year forecast sensitivity?''' Lastly, in the following discussion we take the earlier derived regression on historical volatility and crypto market cap to derive a range of outcomes for the top line under different scenarios. Because both the number of users and the amount traded per user are linearly correlated with volatility and just logarithmically correlated with price, we find much greater sensitivity of revenues to volatility than with market cap over time. Exhibit 37 shows what our model predicts for transaction revenues under various scenarios and demonstrates the very wide range of outcomes that exists, although we note that the volatility environment appears to play a greater role in revenues than the absolute level of crypto market cap. Exhibit 38 back-tests this model historically (using the same estimated values for 2018 and 1Q21 that we have used throughout this section) and finds a fairly high correlation with reported revenues.
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