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==Significant white space for additional products over time== While we expect transaction revenue to be the largest driver of the P&L for the foreseeable future, we believe the subscription and services line will be the primary place in which the development of the crypto-native ecosystem manifests itself overtime. As of 2020, these line items were just 4% of overall revenue, with custody and staking representing roughly 2/3s of the overall pie. These line items are generally more correlated to the asset levels as opposed to the flows, or the trading volumes, on the platform, and because the volumes / turnover of assets is a multiple of the assets on platform and occur at higher weighted average take rates, we expect trading revenue to continue to comprise the bulk of the revenues for the foreseeable future. That said, should the crypto-native ecosystem build out and the profile of business activities transition from capital markets / speculative / store-of-value activities to more commercial / economic / means-of-exchange activity, we would expect to see greater emphasis on the subscription and services fee growth. Below we review each item and then show how we are deriving our forecast. '''Custody: Likely to grow with institutional assets over time''' Coinbase is the world’s largest digital asset custodian for cryptocurrencies and is the administrator of several high profile institutional accounts, including the custodian for the Grayscale Investment Trust, the largest publicly traded Bitcoin investment vehicle with $38.4bn in AUM as of March 2021. Coinbase also sourced Tesla’s BTC purchases in 1Q21, and has facilitated the purchases of BTC by Microstrategy. In addition, Coinbase has referenced university endowments as Coinbase institutional clients, at a time when several large Ivy League university endowments have been reportedly building direct BTC positions. Custody for crypto assets has some of the same record keeping requirements as traditional securities custody in the financial sector but the real crux of crypto custody is the secure management of crypto wallet private keys, which serve as digital passwords for crypto wallets. Cryptocurrencies are bearer instruments, and whoever holds the private keys is the owner of the digital assets in the wallet, and thus the storage of private keys serves as both a cybersecurity function as well as a custody function. Coinbase was the first digital asset custodian to receive SOC 1 and SOC 2 reports, which are industry standard reports certifying the quality of internal controls. We view COIN’s custody offering as a cornerstone of the business, as COIN has invested significant resources in de-risking the storage of crypto and becoming a regulated and fully compliant destination for institutional clients to interact with the crypto-native ecosystem. We believe the average institutional client’s first real step to engage in the holding of crypto begins with custody, and view COIN’s status as the largest custodian as a key competitive advantage for winning institutional business, as well as a key driver of investors’ faith in the Coinbase platform, particularly if we see high profile custody failures in the industry in the future. '''Staking: increased adoption of staking and ETH 2.0 transition to drive staking revenue growth in excess of asset growth''' The second largest component of Coinbase’s subscription and services revenue is staking revenue. Staking is conceptually similar to mining, and the revenue is derived from the rewards that accrue to the validators (analogous to miners) when they validate a new block on the blockchain. Staking does not happen with all cryptocurrencies; it is dependent on the “consensus mechanism” that the various blockchains use to add new blocks to the blockchain. Bitcoin uses a “proof-of-work” consensus mechanism, whereby miners compete on computing power to solve a mathematical puzzle, and the first to solve the puzzle gets to add the next block to the blockchain and is rewarded a preset amount of newly minted coins (each new BTC block mined currently produces BTC 6.25 for the miner). (On an unrelated note, we would note as a “fun fact” that the first transaction on a new bitcoin block, representing the payment (BTC 6.25 currently) to the miner in exchange for adding the next block to the blockchain, is called the “coinbase transaction.”) In contrast, blockchains that run on proof-of-stake allow validators (instead of miners) to “stake” their holdings of a currency to the blockchain. The blockchain protocol then allocates each new block pseudo-randomly (the more tokens one stakes, the higher probability of being selected to validate the next block) to the next validator. The validator receives the transaction fees associated with that block. This yields an interest-like income stream for validators who stake their cryptocurrency to a proof-of-stake blockchain, with the amount of income proportionate to the amount of currency staked, and the interest rate defined by the supply and demand of transaction fees and validators on the network. Coinbase hosts a number of proof-of-stake currencies on their platform, including Algorand (ALGO), Cosmos (ATOM) and Tezos (XTZ). In addition, in 1Q21, COIN added support on the retail platform for Cardano (ADA), which currently is by far the largest proof-of-stake currency (Exhibit 45), and we would expect staking to follow at some point in the future, as staking is already supported for the other PoS currencies above and Coinbase already announced in 4Q20 they would be adding staking support for ADA on the custody platform soon. Coinbase earns staking revenue by taking a 25% cut of the staking rewards from its users in exchange for providing the infrastructure for users to stake their PoS holdings, as well as covering the potential for losses of user funds if Coinbase incorrectly validates a new block (this is the punishment mechanism for PoS blockchains that ensure validators do not incorrectly validate transactions). As an aside, we are interested in seeing where this 25% cut of the revenues goes over the longer term. On one hand, it is a seemingly very large take-rate and one might think it has the potential to compress over time, particularly when the fee is high compared to competitors such as Kraken and Binance, which don’t charge staking fees at all. On the other hand, this activity seems eerily similar to bank-like intermediation by taking idle customer funds and putting them to productive economic work (i.e., if you have an 8% yield and you pay customer 6%, it resembles a 2% net interest margin). In the traditional banking system, the best banks are those that share the least amount of total interest income with customers through lower deposit costs, which is usually because customers are going to them for more value added services rather than being lured in by higher deposit rates. These companies tend to capture the greatest percentage of the revenue generated from deploying those funds. Thus, as the economic utility of the Coinbase platform to its users increases over time, we could see an argument for its share of these sorts of yield generating activities increasing, although this is by no means our base case and would probably be accompanied by lower yields. '''Transition to ETH 2.0 could be significant driver of staking revenue going forward''' As a final point on staking revenues, Ethereum, the second-largest cryptocurrency, currently runs on a proof-of-work consensus mechanism, but given some of the scaling problems and the proliferation of smart contract and DeFi applications running on the Ethereum blockchain, there is a transition underway to migrate Ethereum to a proof-of-stake mechanism (dubbed ETH 2.0), which is less energy-intensive and potentially more scalable. While it remains uncertain how successful this transition will be, COIN is already operating an ETH 2.0 node and has a wait-list for ETH staking. Given that ETH is currently 14% of the assets on platform, this has the potential to provide a significant uplift in staking revenues should this occur, which is generally expected by the sector to happen over the next year or two. Exhibit 46 provides an estimate of this benefit based on our Assets on platform forecasts, which shows that depending on the percentage of customer ETH that is staked, ETH 2.0 staking could generate ~$120-210mn in annual revenues over time at current market levels. '''Earn: DTC marketing tool to drive increased awareness likely to grow as the crypto-native ecosystem expands''' “Earn” is the smallest crypto-native income stream in the Subscription and services line. Earn revenues are generated when users participate in educational programs to learn about new tokens and activities in the crypto ecosystem. These are often sponsored by third parties and users generally receive rewards based on the completion of the educational campaign, often in the form of the token they are learning about, with Coinbase receiving a commission for sponsoring the activity. We view this as a form of direct-to-consumer marketing for crypto to increase the awareness of newer parts of the ecosystem. '''Interest income: largely driven by customer cash balances and interest rate environment.''' Coinbase generates interest income off of customer cash balances in a very similar way to how Charles Schwab generates net interest income off of customer cash. COIN’s 1Q earnings release showed that roughly 3% of assets on platform at the end of the period were in the form of fiat currencies, which are held in traditional bank accounts with COIN’s bank relationships. These balances earn interest income, which, similar to an online broker monetizing customer float, COIN keeps as revenue. Given the zero interest rate environment, the amount that Coinbase earns on these balance is fairly low. That said, in the following exhibits we show how this revenue stream would increase if rates were to rise, resulting in higher interest rates on customer cash. '''Lending opportunities: We see significant opportunities to provide collateralized lending that could be a double-digit uplift in EBITDA over time''' Increasingly, centralized participants in the crypto ecosystem have been providing crypto-collateralized lending to holders of cryptocurrency. Our sense is that currently, the majority of this lending activity most resembles either capital markets-oriented portfolio leverage like margin lending, or short financing. In our view the addressable market for this type of activity is fairly limited (at least relative to the size of the crypto market cap), as it largely resembles over-collateralized asset transformation rather than true economic borrowing activity. If we look at margin financing and short interest (which is correlated to securities lending activity) in the traditional financial system, these items account for a relatively low percentage of the outstanding market cap of stocks (~2% margin loans relative to NYSE and NASDAQ market cap in the United States, roughly 2-2.5% average short interest in the S&P 500). Thus, we believe the addressable market for crypto collateralized loans is likely in the mid single digit percentages of the outstanding crypto market cap. Using this range for the addressable market for crypto-backed lending, Exhibit 50 shows the impact that building out lending products on the platform could have over time on our base case EBITDA estimate, for which, depending on the degree of penetration and the amount COIN holds on balance sheet (we believe the opportunity may be too capital intensive for COIN to fund the entirety of these loans), we see the potential for a ~10% uplift in EBITDA over time from the build-out of lending products. Transitioning to more means-of-exchange style lending: That all being said, we believe the much larger opportunity over the long term is true credit creation in the crypto-native ecosystem, where crypto is lent in an uncollateralized fashion, or is secured by hard assets (potentially tokenized versions on a smart contract platform?) or working capital. In addition, the significant price volatility of crypto assets makes crypto-denominated debts challenging, and if we do see this type of activity arise, it is more likely to occur in stablecoins, which are pegged to fiat currencies rather than floating crypto. True lending is inherently more risky, as the lack of liquid collateral creates material amounts of credit risk and subjects the lender to a potential loss of funds, and we are not sure that COIN has a desire to be in the lending business. That being said, the extension of credit is a core part of the economy and when done correctly, has the potential to facilitate true commerce in the space and intermediate borrowers and savers, an activity we think has the potential to emerge in the space over time. We note in Exhibit 49 that the US banking system is >60% loan/deposit ratio, which in our view is indicative of the longer-term lending potential for a crypto ecosystem. '''Other opportunities''' Payments likely multiple enhancing opportunity over time: Crypto payments has yet to see mass adoption as a result of technological barriers, price volatility, long transaction confirmation times, and low transaction throughput of the highest profile blockchain networks. We showed in Exhibit 16 that means of exchange activities tend to have both large TAMs while also benefiting from higher/more stable take rates over time, with less volatility than store of value activities, which can be buffeted by a number of cyclical factors. We believe payments is the most multiple-enhancing activity COIN could pursue, as the valuations for payment companies tend to be much higher than that of capital markets businesses. COIN is currently experimenting with a Visa debit card that links to a Coinbase account funded with cryptocurrencies. While this particular activity is largely immaterial today, we believe it represents progress in the means of exchange direction and demonstrates progress on the acceptance front by normalizing using crypto for transactions. Non-fungible Tokens (NFTs): Digitized and fractionalized ownership: The recent proliferation of NFTs or non-fungible tokens demonstrates the ease with which unique, scarce assets can be created and transferred on the blockchain. While much of the NFT space revolves around digital artwork, we believe NFTs have the potential to expand to include digital representations of physical objects such as real estate and artwork as well as intangible assets such intellectual property. Given the crypto infrastructure that NFTs are built upon, we would expect Coinbase to expand support for NFT custody over time, with the potential to provide access or support for NFT exchanges as well as the issuance of NFTs. This also seems to us like a logical space for a bolt-on acquisition.
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