A Deep Dive Into Coinbase’s Stock Before Its Direct Listing

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As one of the largest crypto-asset platforms in the world, Coinbase is gearing up to hit public markets through a direct listing. In this episode of Industry Focus: Consumer Goods, join Motley Fool analyst Asit Sharma and host Emily Flippen as they sift through Coinbase’s business and attempt to demystify an emerging asset class taking the world by storm.

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This video was recorded on March 9, 2021.

Emily Flippen: Welcome to Industry Focus. Today is Tuesday, March 9th, and I am your host, Emily Flippen. Today I’m joined by Motley Fool Analyst Asit Sharma, and we’re going to be talking about CoinBase’s S-1 filing. I have to mention at the offset of the show, CoinBase, for those who are familiar with it, we’re going to make the argument that in long term, this could be a consumer goods business. Asit and I will talk about that in more detail. But I do want to make it clear. I cleared with Jason and I cleared with Dylan in Tech before we talked about CoinBase today. Neither of them had it scheduled. It seems like such an exciting business, such a great opportunity you can talk about it today. We didn’t want to pass up that opportunity.

Asit Sharma: Yeah. Emily, I’m really excited about this one. It’s not the easiest business to wrap your head around. I’ll say that before we dive into it. Nonetheless, it represents one part of the future. I don’t want to say it is the future [laughs] of commerce in investing, but it represents an important slice that I think we should pay attention to.

Flippen: Yeah, I feel like I should say at the offset that crypto is really a new asset class to me. I don’t even own bitcoin, which I think makes me both a bad investor and a bad millennial. I’m excited to hear your thoughts on this, Asit. I know that you’ve spent a bit more time looking at the space. But what I enjoyed about this S-1 filing in particular for CoinBase is that, at the very beginning of their filing, they actually included a glossary of crypto terminology, which made reading through it just that much more enjoyable and understandable for somebody like myself. If you’re interested in this space, I think a great introduction to crypto would actually be reading through CoinBase’s S-1. As far as S-1s go, especially for industries like crypto assets, it was pretty readable.

Sharma: It was. Maybe other companies should consider this, even if they think they’re in an industry that everyone understands. I’ve seen some S-1s from financial institutions that were pretty hard to read because I didn’t get all of the finance terminology, and I had to look at some acronyms. That was pretty neat about this one. You’re right. It’s not a bad introduction. I won’t say it’s picture book easy, but it’s somewhat visual in the middle section. If you’re someone, and we’ll talk about this, who likes to look at the risks of a company, they do a really good job of talking through a bunch of risks that are associated with this investment.

Flippen: Yeah. I’m such a skeptic. My favorite part about reading through filings is reading the risk sections, like many businesses that we’re seeing coming public, but CoinBase especially was not hurting for risks to disclose to investors, that’s for sure.

Sharma: True.

Flippen: Let’s talk a little bit about the transaction details here. We’ve seen a lot of companies choosing to go public via SPACs. I’m going to start calling them SPACquisitions. I just like that better.

Sharma: Yeah, that’s nice.

Flippen: Isn’t that good?

Sharma: Yes, SPACquisition. [laughs] Did you coin that term?

Flippen: I’m not sure if I stole it from somebody, but I will happily take credit for it. We’re seeing a lot of businesses go public via SPACs, through the stock acquisitions, also through traditional IPOs. CoinBase is actually going public through a direct listing. In practical terms, essentially that just means that current shareholders are just selling out their stakes to the public market, so it actually doesn’t generate any capital for the business. Not that CoinBase really needs it, but that’s one differentiator between a direct listing and a traditional IPO that investors should be aware of before coming into this business. We don’t know when it will reach public markets, but when it does, it will be trading on the Nasdaq under the ticker symbol COIN, which I feel like was a pretty nice snag.

Sharma: I’m surprised that some small businesses collect coins from people and turn them into receipts working cash out at the grocery counter. I’m surprised that some businesses like that didn’t already have that symbol, C-O-I-N, so good for them. [laughs]

Flippen: I think the thing that blows my mind here is that while we don’t know what CoinBase will be trading at once it reaches public markets in terms of valuation, Axios, alongside some private market information, has found that CoinBase was valued at over $100 billion on the private market. That would be incredibly large for people who don’t have quite a sense about what a $100 billion business looks like. We’re talking about a market capitalization that would be larger than businesses like Zoom or Uber. This would be and likely will be by no means a small direct listing.

Sharma: Emily, I just found that an incredible piece of news. I expected this to be big, but I was thinking more like $10 billion. I think that one of their funding rounds just from a year or two ago placed them under $10 billion, like $8 billion or something, so I was thinking there will be a premium on that 10%-20%. It’s difficult to conceive of investing in a company that’s already valued at $100 billion, that’s relatively small, we’ll talk about finances as we go. But you can start thinking about what’s the potential of this company if it goes 10 times, [laughs] if it 10X’s, it’s going to be a trillion-dollar company. How much larger can it get? What’s the investment potential here for investors? But when we talk about valuation, I’ve got some thoughts on that. Maybe there’s a way you can be comfortable with us, but it is nuts; $100 billion, that is big. [laughs]

Flippen: It’s just so large, I can’t imagine another $100 billion company out there that investors haven’t heard of as much as they would have not heard of CoinBase, if that sentence makes sense. I think generally speaking, once you hit the triple-digit and billions valuations, namesake brands are what becomes the largest. Consumer facing businesses, business like CoinBase at that level valuation, while it has a handful of million users, it by no means has the breadth in the scale of household names like Zoom, Uber, Lyft, all these businesses that are much smaller, that would be much smaller than CoinBase. That within itself, I think it’s just so interesting. Perhaps what I should have done at the offset of the show was tell our listeners what CoinBase is. Clearly, if you came into this podcast having never heard this name before, which as I’m speaking, I’m realizing a lot of people may not have, it is a platform that claims to power the crypto economy. Crypto assets are the currencies like Bitcoin, Ethereum, LiteCoin, you may have heard of these.

 Before we get into the business itself it’s maybe worth explaining what the crypto economy is. This is, again, like I said at the offset of the show, not something that I’ve had a ton of experience with personally. I’m not even an owner of Bitcoin. But defined by CoinBase, the crypto economy is essentially describing a new financial system that’s built on the back of crypto assets like Bitcoin. These currencies operate on blockchain technology that maintains distributed records and ledgers of transactions that’s supposed to be anonymous and secure. The argument is that this financial system will be more cost efficient and more transparent, easier-to-use than the legacy systems that we’ve built out, and CoinBase spent a lot of time in their S-1 just pointing out why users of CoinBase, these are individual retail users, institutions, why they would even want to access the crypto market. They spent a lot of time just justifying the existence of their business. I can’t remember the last time I read an S-1 that had to spend so long explaining what they do and why they do it.

Sharma: So true, Emily, and I wonder if part of this is CoinBase having to get over customers’ or potential investors’ hesitations around this big idea, which is Bitcoin. Bitcoin is responsible for the bulk of CoinBase’s success because it’s the most heavily traded digital asset or cryptocurrency, if you will, based on the blockchain, a sort of ledger-like repository of information. Here we have a company which has the biggest platform and the biggest brand extension in the world, having to tell customers, well, this is about a lot of different functionalities that exist with blockchain. It’s simultaneously having to persuade investors that we are here to promote Bitcoin usage and to make money off of Bitcoin transactions. At the same time, there’s a lot of potential in all types of alternative transactions that can happen. Just to give you one example, they talk about the market for crypto arts. You can digitize almost everything, you can digitize art into digital tokens. Those can be bought and sold and their value can appreciate. There’s so many other examples that they cite.

It’s simultaneously focused on this idea that everyone is somewhat familiar with. I checked the price of Bitcoin before we went on, and it was $53,000 per Bitcoin, approaching an all-time high. I think the all-time high was like $57,500 simultaneously, plus all this potential that exists out there in the blockchain. There you have it. They had to spend some time helping people to get the concept of where they see all this potential.

Flippen: Maybe I’ll anger both CoinBase and some of our listeners by making this analogy. But in a lot of respects, CoinBase’s business can be related to that of a financial institution. If you were to take out some of the heavy regulations that banks have dealt with by being located and then being held accountable to the central government, let’s just say that they make a majority of their revenue just from transactions that happen on the platform, not dissimilar to the way that many banks do by providing services to consumers. CoinBase really is looking to disrupt this traditional method of banking. I suspect at some point in the future, Jason will probably revisit the topic of CoinBase and crypto assets and decentralized finance on the Financials podcast and provide some more light there because I think that aspect alone is compelling and something that is probably far above my own head. But the point being that when you look at the revenue coming into CoinBase as CoinBase exists today, essentially what they’re doing is taking a fee out of transfers and purchases or sales of crypto assets. Currently they trade more than 90 crypto assets. We talk about Bitcoin a lot because it’s the most common crypto asset, most common cryptocurrency, one that probably resonates the most with the listeners. But you mentioned art and other tokens. These are assets that are traded digitally and CoinBase facilitates those transactions.

Sharma: Emily, they’ve got this portion of revenue that comes from the trading of these smaller assets. They’ve got the fees. They also have subscription and services revenue. In these they’ve got four main products: Store, stake, distribute, and build. Each of these being a value-add to their base level of service. They have assets that they put in custody, which I believe they have on their platform at the end of December 2020, about $90 billion of assets in custody. That made up about 11% of the total market capitalization in the entire cryptocurrency world as of the end of last year. This is just to give you a sense of how big this company is in terms of market share for trading of these. Yeah, store, stake, distribute, and build. For those of you who aren’t familiar with the idea of stake, that’s the one term that might throw some of us here. We can get the rest of this. Staking is interesting, it’s a way to lock up your coins, if you own cryptocurrency, to help to participate in validating the blockchain. Validating the blockchain simply means validating transactions that occur on the blockchain. Right now, it’s a very energy-intensive business because it takes energy for computers to perform these very complex calculations that serve as validation.

Every time, Emily, you or I have a transaction over this platform or any other platform, someone has to validate that, machines have to validate it. That’s how this whole concept of decentralization works on the blockchain. But there’s an alternate form for validation called staking. That just means if you’ve got a number of coins, you can offer them to be locked up for a certain amount of time. It helps validate the transaction more efficiently, not using quite as much energy versus this traditional method where computers are performing calculations. They participate in this, and this is another great way for CoinBase to make money. Because not only are they offering an alternative form of validation and participating in this, it’s more energy efficient for those of you who have concerns about the environmental impact of the growth of Bitcoin and other currencies, and they make money off of staking. They take a small fee every time you or I stake coins to help transactions get validated in this blockchain. They’ve got these other revenue streams, as you pointed out, they’re smaller. They also have an even smaller portion of revenue from holding crypto assets themselves. They act almost just like a market maker, they help fill smaller orders from small customers.

Flippen: Yeah, This is something you know well with your accounting background, Asit. But because they act as a market maker, the way they recognize revenue for some of their transfers is interesting. CoinBase did over $1.2 billion in revenue last year, which for the most part was done by taking this fee from being a middleman as part of the transaction. However, four people who are trading in crypto assets that are less frequently traded, that are much smaller in order size, can’t just go to the market and fill that without having some stake in their own hands, in their own inventory. It would cost them too much time, too much money. To your point, they said they have a pretty large portion of crypto assets held on their balance sheet to facilitate the sales and the orders demanded by these smaller traders on the platform. When those flow through to the income statement, it’s recognized on a gross basis, so that $1.2 billion is not all this high margin fee. A lot of it’s actually really low margin crypto assets because they recognize the full value of the crypto asset that they transfer and an operating expense, which is the full cost that it took to buy that crypto asset and hold it in their inventory. Now that the sales were around 10% or so of their total revenue, it’s still a large portion, I think 10% of $1.2 billion is still pretty notable, but it’s not like that $1.2 billion is being horribly propped up by acting as these middlemen. But it is interesting and something that you’d probably want to keep an eye on, the growth of their own ownership of these assets and the gross versus net reporting, if you’re interested in investing in this company.

Sharma: Absolutely. Because a trend could affect their profitability. Now they’ve got some other puts and takes on their income statement. When we get to that section, that will just point out that it helps offset a little bit of this effect of a lower margin type of revenue. But as they grow, you want to keep your eye on exactly what margin is tied to each type of transaction, so it’s great of you to point out.

Flippen: Yeah. That’s something I never really thought about, actually when I headed into this report, it was just the middleman aspect of needing to fulfill small orders. Again, it goes back to their relationship that a lot of banks have had and highlights one of the fears that I’d have with this business is we’ve seen a rush to the bottom in terms of fees on the traditional finance side. Right now there isn’t a lot of competition in terms of trading and holding storage for crypto assets. If competition heats up, I’d wonder a little bit about CoinBase’s take rates. They don’t explicitly break out a take rate like the percentage of the fee they take on every single transaction because the fee really heavily depends on how big the order is and what crypto asset it’s being put into. That lack of transparency, well, not something that — I’m not going to dark points for not laying that out, but it is something that I’d want to watch over a longer period of time.

Sharma: I just want to quickly point out here that they may have a bit of pricing power as this trading becomes more common and some of their competitors grow a little bit larger. They’ve got several different competing exchanges. CoinBase was one of the first exchanges to come about. The company was formed in 2012. From the beginning, they actually had what I think is an admirable focus on working with regulators and making sure that their environment was secure. They pioneered ideas like cold storage, where they’re actually storing keys for wallets. Wallets are basically the receptacles of your own cryptocurrencies. It’s all numerical. But they pioneered the storage of these offline, so just completely away from the Internet, that’s called cold storage, and then secure hot storage, where they’re securing this data and it is connected to the Internet, but they have a lot of security protocols. This has really helped them grow to the customer base they have today. I think it’s something in the back of my mind when I chose an exchange. I started my CoinBase account in 2017, and I’m a dabbler. I just dabbled really, really lightly in this stuff. I want to come across as any crypto expert, I’m not. But that was something that was important to me when I was choosing between different exchanges.

Nearly every major exchange that you can name has had some kind of security incident over the years, except for CoinBase. This is something that maybe, again, that take rate isn’t as transparent, but am I willing to pay what seems like a little bit of owner’s fee when I fund my account each time? I think I am for now. It’s such a new industry. The reality of it is that buying and holding cryptocurrency is complicated. If you really want to have the coins you buy in a secure environment, you are going to take them off an exchange, and you’re going to create a digital wallet that may be stored right on your laptop, or you transfer that even to paper and put it in a safe deposit box. It’s not an easy process. CoinBase makes it feel really super simple. They’ve got an easy to use interface. It’s extremely intuitive if you’ve ever used a modern brokerage account, it looks very similar. I think maybe they have some built-in pricing power there, but time is going to tell as other platforms become more robust with their own security vis-a-vis their platforms.

Flippen: I am going to make a weird connection here. Last year, two years ago I guess at this point, I went skydiving. I went with a friend, we had a couple of skydiving instructors. My friend’s skydiving instructor had been doing it for a year or two years now, and I asked my instructor, “How long have you been skydiving?” He says, 17 years. At first, I was like, that’s great. I have a very experienced person on my back who’s not going to let me die. But then I thought to myself, well, “Aren’t you overdue? Isn’t it only a [laughs] certain amount of time?” At some point, the other hand is going to drop. It feels like you’re just overdue for some incidents. I’m happy to say, clearly, I survived [laughs] my skydiving trip. But when I hear you say that CoinBase hasn’t had a security incident, which is obviously great for them when all of their competitors already have, I come back to that mentality where I think to myself, well, “Aren’t you overdue [laughs] for some security incident?”

It feels like in today’s day and age that there is never something that is 100% secure. You’re never going to be 100% protected by outside threats. I think if CoinBase did have an incident like that, especially when they’re charging higher fees than some of their other competitors, it could really devastate their business in a way that you wouldn’t quite get that you did when, say, Target got hacked. People still went to Target. CoinBase gets hacked, I could see them losing a lot of their digital assets, not only because they lost trust, but because these assets they’re not regulated, they’re not transferable. There’s really no recourse for the people who would’ve been violated in this incident.

Sharma: It’s so true. But there is no recovery if you lose your bitcoin, either through a fraudulent transaction or you lose your keys [laughs] to your bitcoin, you can’t get it back. This is something that the company has spent a lot of time and money on, trying to insure accounts, but on the other hand, I think that bad actors want to go after a platform like this just because of the amount of assets that are on it. It’s almost like, “Hey, management if you’re listening, better double down. No kudos for being good so far, double down and make sure you keep this platform secure.” Good analogy, Emily. [laughs]

Flippen: I want to give the opportunity, I realize that we’re probably now, what, 20-25 minutes into this podcast. I want to get to you make an interesting argument about that decentralized finance. I’m going to throw some numbers out there just to cover our basis, so people get a sense about scale and the breadth of CoinBase’s business. You mentioned that yourself, you have a CoinBase account. There are essentially two tiers of users for CoinBase. There are those that have verified users, and right now they’re 43 million verified users, people who have made an account, verified their accounts on CoinBase, and then they also have monthly transacting users. These are the monetizable users or they’re more easily monetizable users, because they’re actively trading, buying, selling crypto assets. As of the fourth quarter in 2020, there are 2.8 million transacting users. That dropped from 43 million, presumably a whole […], if you will, as CoinBase so kindly defines in their S-1, all the way to 2.8 million monthly transaction users. Growing their user base and the monthly transaction users, which pretty strongly correlates to the price of crypto assets, including Bitcoin as you might expect, is going to be critical for them to continue to monetize and grow their business over time. Their verified users were up 34% year-over-year. It’ll be really interesting to see where that number goes in the next year, so when crypto assets may fall out of favor, as they sometimes do.

Sharma: Yeah, the interest in crypto assets seems to be really cyclical, and I’m keeping an eye also on 115,000 ecosystem partners they have, that sounds like a lot of ecosystem partners. For those of you who follow Software-as-a-Service companies who build ecosystems or marketplace platforms, you often hear we’ve got hundreds of partners or thousands of partners, but well over 100,000 partners, they’re developing so many different types of products with their partners. That number, probably the utility of that, who knows? It could be a handful [laughs] of true robust partners that are going to help them get assets and new types of currencies on the exchanges that will be positive to trading volumes. It’s something just to watch, but it’s impressive as a number to begin, and I think all these stats that you called out are very impressive.

But again, this last thing you said, Emily, and they note this as a risk in their S-1 statement. — every year depends on a lot of volume and interest. I mean, start with Bitcoin and go down to the next most highly traded asset, which is Ethereum. If you have one of these off years, it’s really hard for this company to generate profit. They made really high operating profit last year in 2020. You mentioned the $1.2 billion in revenue, and I think that the operating income was over $300 million. But the year before that, they lost $30 million because that was a year, 2019, where we had a slump [laughs] in Bitcoin. This is something, again, it gets back to valuation. It’s hard to understand and to grasp this $100 billion valuation, if that’s what it ends up being, in the context of unpredictable revenue and earnings streams year after year. You almost have to be something of a super long term holder if you want to own CoinBase and a true believer in the potential of not just the platform, but the crypto industry in general.

Flippen: Completely agreed, and before we move on to talk a little bit about management and your perceptions of the decentralized finance opportunity, it’s worth noting that more business than you may expect comes from institutional owners of crypto assets. You mentioned at the offset that $90 billion of crypto assets were being held by CoinBase on the CoinBase platform, $57 billion of that $90 billion were actually being held by institutional traders, so non-retail traders. Only $32 billion of that were retail traders. These are presumably institutions that either are long term holders of crypto assets or have some business reason to be holding the crypto assets on the CoinBase platform. That will be interesting to watch as well. That’s changed pretty dramatically just going back to the first quarter of 2018 when you looked at the $56 billion that were on the platform, $45 billion of that were from retail traders. The institutional players are definitely coming into the game a little bit more on the CoinBase platform.

Sharma: Right, and one thing I wanted to call out was an example that they used in their S-1 of an institutional investor that supposedly conducted one of the largest digital trades ever. I think this was in 2020, and they used CoinBase over a period of I think seven days, maybe it was five business days or seven full days because crypto assets trade over the weekends too, to actually make this huge transaction without moving the market and CoinBase used not just its own ability to time trades, but use these proprietary algorithms to make sure that they didn’t push the market too much with all this order flow; that’s really attractive to institutions who are looking at Bitcoin as a potential asset to hold on their balance sheets, which to me, I am going to be honest, is nuts. [laughs] I don’t know, Emily, I’d never heard of MicroStrategy ’till you told me about it. This is the company that has most of its balance sheet in Bitcoin and actually borrowed, was it another half $1 billion a few months ago to add even more [laughs] or something like? However, if you’re an institution, you want to work with a platform that can do just this for you, and can help you move hundreds of millions of dollars without moving the market and pushing asset prices up too high.

Flippen: Definitely, and a quick note on management there. Their CEO is a man named Brian Armstrong. He’s pretty young, he co-founded the company in 2012, he’s only 38 years old. It’s still pretty green. I’m not jealous. In 12 years, I’m probably not going to be the CEO of a $100 billion company, [laughs] I’m still coming to terms with that. But he was formerly a software engineer at Airbnb. Interesting background on part of the CEO and as you noted, the remainder of the management team came into the company as relatively new, between 2018 and 2020, so the new management team will be interesting to see if they change the CoinBase strategy at all in terms of institutional versus retail traders.

Sharma: Well, we’ll see. These are people I think broaden because the company was going to go public and they are heavy hitters. Just to mention a couple here: Surojit Chatterjee is the Chief Product Officer who came on board last year in 2020 February. Surojit was hired away from Google [Alphabet]. He was Vice President of Product Management for Google Shopping platform. Then their Chief Operating Officer, Emilie Choi, joined in June 2019, and she was hired from Microsoft, where she was the Vice President and Head of Corporate Development at LinkedIn. They’re picking up some heavy hitters. They are relatively new, but they’re people with deep experience on the product side, in e-commerce, and also on social networks, which the social aspect here isn’t quite as big, but you can understand where the company wants to go in terms of brand building. I’m wondering that too, and we will be able to see, as investors who can read these quarterly reports, the revenue mix each quarter, and that’s going to have a lot to do with how successful this company can be in making its revenue streams a little bit more stable. I was talking about volatility with those revenue streams. But the more institutional traders that come on board that usually points to some stability and we’ve seen that happen with platforms like the Chicago Board of Options Exchange Risks now called CBOE, but it’s a publicly traded exchange platform and they cater toward institutional investors who are using options and sophisticated strategies. Their revenue actually looks fairly smooth, even though it’s based on real-world trading, just like CoinBase.

Flippen: Before we get onto the risks here, and we could probably do an entire podcast just over the risks. As I mentioned, they certainly take a lot of time in CoinBase’s S-1 talking over the risks. If you want to get the full run down, I again encourage all the investors and listeners to read through it yourself. But I don’t know if you want to talk about optionality and the opportunity that exists with decentralized finance, a concept, DeFi as you Slacked me this morning, I had never heard of before your Slack message. What can you tell us about that?

Sharma: DeFi is actually less complicated than it sounds. It’s attractive to me because I think it’s got some utility, and also because it sounds fun and fancy. DeFi — I’m interested in DeFi [laughs] on these networks. What it is, it’s a series of applications and they’re built on peer-to-peer protocols that utilize smart contracts to basically mimic real world finance functions, so think lending, borrowing, insurance. Peer-to-peer, meaning that it goes between people and smart contracts, meaning that these are contracts that are pretty much automated and the contracts themselves, at least the ones that are most prominent are built on the Ethereum blockchain. For those of you who are familiar with CoinBase, you’ve probably already seen something called compound. Compound is an interest rate protocol that let’s users earn interest on their crypto assets. In their S-1, CoinBase said that hundreds of thousands of users leverage compound to earn interest on billions in digital assets. Now, compound just came onto CoinBase’s platform at the end of last year, but they already have tons of people that are using compound to earn interest on cryptocurrency. It’s no different, Emily. This whole concept of decentralized finance is no different than stuff that happens in the real world.

If you buy a foreign currency through a traditional Forex exchange with your U.S. dollars, you will often earn interest on the other currency. The same with insurance, these smart contracts are going to be utilized to provide things like insurance where you’ve got transparency, you’ve got automation, you’ve got this trustless contract because it’s ultimately secure. You don’t have to worry about the trust element. But I’d like this because it speaks to utility versus what really worries me about Bitcoin. Is Bitcoin a currency that’s just fluctuating wildly every day, is it truly, as you said at the beginning, Emily, a store of value potentially that can cut out middlemen? We don’t know. I think that’s above both of our pay grades to understand that, and frankly, I think it’s impossible for anybody to predict ultimately what Bitcoin will be. Will it be a dominant currency that is here forever and gobbles up capital from the U.S. dollar and the euro, etc.? Or is it just a precursor to something better that’s more energy efficient, that actually has better utility for transactions?

I don’t know about those things, but what I do know is that there will be a market for contracts that facilitate very simple finance functions. They’re already doing this right here on this platform. As they said, there’s billions in assets that people are already earning interest on just through the use of this one interest rate protocol called compound and there’s so many others. I’m fascinated by this, and I think if you’re looking for optionality in the CoinBase platform, if you’re looking for some type of future equation to justify a $100 billion valuation, it’s more here in decentralized finance to me than it is in people bidding up Bitcoin because they think it might go up, or potentially it’s going to replace other currencies. That just seems like a sketchy proposition and that can only be proven out over a really long period of time, whereas you could see for DeFi protocols and tokens how they can be used literally today and in the near future. I’m excited about that for this platform. Am I going to go out and buy CoinBase right after the IPO? Let’s talk about risks. [laughs]

Flippen: It’s really funny, because I didn’t expect for your conversation about decentralized finance to actually answer probably two of my biggest risks for this business. The first one that was in the back of my head, as I read this S-1, was just, it was why would I buy CoinBase as opposed to buying Bitcoin? The only answer I could come up with was, it was less of a pure-play bet on any one Crypto assets. But then I was thinking to myself, so I can buy CoinBase or I can buy a little basket of other crypto assets because it seems like CoinBase’s business moves directly in line with the value of crypto assets. When they go down, CoinBase loses value, they lose money. When they go up, CoinBase looks like an amazingly profitable business. In my mind, I was thinking to myself, is there really any diversity value in owning CoinBase over crypto assets if you’re already invested in the space?

Then the second question I had was on valuation. In my mind, the best case scenario for CoinBase is that crypto assets become this universal truth when it comes to especially cross border transactions. That’s easier, safer, more efficient than other traditional legacy finance tools. In which case you are looking at a business that has very predictable growth but very low margins. I’m actually an investor in CBOE. I understand the business, it’s not a particularly high-flying, high growing business. But it is very predictable, despite the fact that it gets the majority of its value from trades, individual and retail or institutional investors trading on the platform. In my mind, there was nothing in this business that would justify earnings of less than $500,000 translating into a $100+ billion valuation. But both of those concerns my two biggest risks which I outlined there I think can be answered if your notes on decentralized finance come to fruition.

Sharma: Potentially, all these other types of digital opportunities that CoinBase mentions, they don’t spend a ton of time on this, but they clearly see it as an opportunity. I mentioned digital artwork. Some viewers may have heard this term, NFT, before, non-fungible token. A non-fungible token is a crypto asset that represents something that’s completely unique, like a piece of art. It’s a way to trade something that’s done out of any other origin but for this one specific purpose; for example, there’s crypto art that is then traded via NFTs. I can’t remember the name of the band, I’m sure someone can tell me, but it’s a pretty well known band. There is a band that’s releasing their next album as an NFT, as this non-fungible token.

There’s use cases that are still being worked out in real time. The optimist in me says, “Man, it’s important to pay attention to CoinBase because what they’re trying to do is to integrate with a lot of protocols. Not just the one that powers Bitcoin, but the one that powers these smart contracts, the ones that power DeFi, the ones that will work with non-fungible tokens.” I think it’s important just for that. But again, as you point out, Emily, the valuation risk clearly is there. How much can this company go? I will say this on valuation: I have a feeling that the valuation is going to jump around quite a bit. Because I believe that retail investors in their excitement are going to lose track of what CoinBase is pointing out in the S-1, that income can really vary from year to year based on Bitcoin activity and Ethereum activity, as you’ve been saying, Emily. I think there will be a lot of investors, not just retail investors who are excited again, but also institutional investors into CoinBase who will see a bad earnings quarter or year and want to sell out. Maybe that $100 billion valuation, if that’s where it ends up becoming, could get hacked in half, [laughs] within a couple of years time. Let’s say activity subsides as it does periodically with these coins, that could be a buying opportunity. I would be paying attention at that point if I saw a […] in crypto assets and suddenly this was worth half what it was. I would be a little more willing to buy it.

Flippen: I feel like having this conversation with you is just highlighting to me how little I know about the use cases in the future for crypto assets and there are certainly people out there, yourself included, who have a much better sense about what this could evolve into, in a way that I think my laggard viewpoint can’t quite visualize at this point. It was the same reason why I was never interested in buying crypto assets at any other point in my career, to this point, despite being a relatively young person, despite being around people who are interested in this space and had purchased at least some portion of Bitcoin or […] Bitcoins at different points in time.

Sharma: There is a part of me that’s really with you there because I don’t know, it’s weird. I don’t have that great component that I used to have when I was younger then I got to get in on this because these assets are going up 10 and 20 times. The skeptic in me doesn’t even want to participate on some level. I’ve never owned Bitcoin, and I’ve passed by other coins which I’ve seen just shoot up in value. I’m more interested on an intellectual level and part of me is just — I have this hype-meter. Once my hype-meter gets going, I’m reluctant to participate in something that could be great opportunities just because they got hyped. It’s something that I have to overcome long term and really like out of proposition. I don’t know, hype turns me off, Emily. [laughs]

Flippen: I’m right there with you, and maybe that’s a good place to leave out this episode. I think if investors are passionate and interested in crypto assets, if they are owners of different types of assets and if they are interested in CoinBase, I’m not going to say it is a bad company to invest in. It’s definitely interesting. I would just argue that you should have a thesis for making that investment beyond just the fear of missing out. We talk a lot about how fear in particular can cause investors to make bad investing decisions. Selling their assets when the market tanks. But I’d argue that alongside fear, greed is also probably one of the worst investor emotions that people can feel. It causes them to make emotional investing decisions, largely purchase decisions, without really knowing why they’re doing it, just because they are afraid of missing out. It’s an interesting business but if you are listening to this podcast and you’re thinking to yourself, I missed the train on Bitcoin. I want to get involved in this space, I don’t want to miss the next Bitcoin, so I am going to buy myself some CoinBase because everybody is doing it. If and when people are doing it, I would just encourage you to develop a better reason to buy other than just the fear of missing out.

Sharma: Absolutely. FOMO, it’s a strong pull. You get it, but something you’ll often regret later on. [laughs]

Flippen: Asit, as always, thank you so much for joining and providing your extremely valuable insight onto a business that I’m still not sure I quite understand.

Sharma: Well, Emily, I’m going to remind you of something as we sign off. We actually talked about Bitcoin at the end of last year, and we were both way off in our predictions. We’ll have to revisit this. I’m not going to say what we said would happen with Bitcoin, but we have to revisit CoinBase and Bitcoin at the end of this year and give some additional thoughts. [laughs]

Flippen: I’d love that. I love publicly embarrassing myself. [laughs]

Sharma: Same here, I’m going to be in that boat with you.

Flippen: [laughs] Listeners, that does it for this episode of Industry Focus. If you have any questions or just want to reach out to say “Hi,” feel free to shoot us an email at [email protected] or tweet at us @MFIndustryFocus. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against any stocks or cryptocurrencies mentioned, so don’t buy or sell anything based solely on what you hear. Thanks to Tim Sparks for his work behind the screen today. For Asit Sharma, I’m Emily Flippen. Thanks for listening, and Fool on!

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis — even one of our own — helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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