The Breakdown - The Definitive Guide to Coinbase Going Public

Episode Date: April 14, 2021

On the day of Coinbase’s historic direct listing on NASDAQ, NLW answers your most important questions about the company and its place in the industry.  How did Coinbase become successful? What is the crypto public's perception of Coinbase? What is Coinbase's business model and how has that model been shifting? What is Coinbase's role in the recent institutional shift in bitcoin? Does Coinbase have any controversy in its past? Why did Coinbase choose a direct listing? What are people expecting, price wise? Why did BTC and ETH hit all-time highs in advance of the listing? How might Coinbase impact the crypto markets? -- Earn up to 12% APY on Bitcoin, Ethereum, USD, EUR, GBP, Stablecoins & more. Get started at nexo.io -- Enjoying this content?   SUBSCRIBE to the Podcast Apple:  https://podcasts.apple.com/podcast/id1438693620?at=1000lSDb Spotify: https://open.spotify.com/show/538vuul1PuorUDwgkC8JWF?si=ddSvD-HST2e_E7wgxcjtfQ Google: https://podcasts.google.com/feed/aHR0cHM6Ly9ubHdjcnlwdG8ubGlic3luLmNvbS9yc3M=   Follow on Twitter: NLW: https://twitter.com/nlw Breakdown: https://twitter.com/BreakdownNLW   The Breakdown is produced and distributed by CoinDesk.com

People who have been in this industry for a long time have seen so many years of incremental nudging and bumping and pushing into mainstream traditional finance. And this Coinbase listing shows that the barbarians aren't just at the gate, we're in the city. Welcome back to The Breakdown with me, NLW. It's a daily podcast on macro, Bitcoin, and the big picture power shifts remaking our world. The breakdown is sponsored by nexus.io and produced and distributed by Gnxo. coin desk. What's going on, guys? It is Wednesday, April 14th, and today we are talking the definitive guide to Coinbase going public. So I have obviously spent a lot of time in the last couple weeks on Coinbase. I explained on Monday why I think this is the first big test of this

Bitcoin bull market. There are a bunch of bigger picture, longer term shows that I want to get to very soon. For example, why the Biden administration is getting nervous about the Chinese digital yuan. However, this is a seminal day in the history of this industry. So what I wanted to do is just give a quick primer show, particularly for new folks who might just be coming in the door of the Bitcoin space via Coinbase being listed on the NASDAQ. For those of you who have been hanging out with me and have heard a lot of this before, I apologize.

I promise we're going to get to some new stuff soon, but it's a big day. Remember, the anticipation and hope of many in this space is that this blue chip Silicon Valley Tech Company listing provides a gateway for learning more about Bitcoin and the crypto space as a whole. Assuming that some of those folks are Googling and discovering this today, hopefully this episode will give you a good base of understanding not only Coinbase, but the Bitcoin industry as a whole. First up, let's talk how Coinbase became successful, and let's start with its origins. Coinbase was founded in 2012 when Brian Armstrong left Airbnb to started. He would later have Fred Ersum join after meeting him in an online Bitcoin forum.

They went through Y Combinator summer of 2012 class, and I actually have a personal anecdote about that. I was advising another company who went through that class, and I remember distinctly when they handed out a little thumb drive that had one Bitcoin each to each of the other people who are going through Y Combinator. Unfortunately, being an advisor didn't get me to that because it was a pretty good door prize. I think it's also important, though, to understand that Silicon Valley really has never been at the forefront of understanding Bitcoin, as weird as that sounds. For a very long time, the story of Bitcoin was entirely the payments narrative in Silicon Valley. It was looked at as, ironically now, given what we've seen, another competitor to Square. I was there and I remember

that sort of narrative. In many ways, Coinbase was where Silicon Valley's user experience sort of mindset and the Bitcoin industry met. Coinbase in many ways filled the gap. Still, though, not everyone got it. It took folks who were kind of renegades, like the investors that initialized, including Gary Tan and Alexis O'Hanian, to really advocate for this initially with their more reluctant venture capitalist peers. By the end of 2013, however, Coinbase was outsetting records for funds raised. It raised a Series A of $5 million early in the year, and by the end of the year it had raised a $25 million Series B from Andrews and Horowitz. And already in that first year, we saw the thing that was going to really matter about Coinbase. It had 650,000 retail users.

2013 was one of those big years for Bitcoin, so it happened at the right time. Still, back in the day, as I mentioned, there was a lot of focus on accepting Bitcoin for payments. In December of 2013, Coinbase launched a point-of-sale app that allowed retail users to accept Bitcoin. In 2015, Coinbase raised the $75 million Series C from investors, including the Intercontinental Exchange, the parent company of the New York Stock Exchange, as well as Spanish Bank, BBVA. In 2017, they raised a $100 million series D with companies like Dropbox, GitHub, and even Netflix participating. Also in December of 2017, they listed Bitcoin cash. This created a schism with many bitcoins who saw it as a betrayal of Bitcoin.

2018, 2019, and 2020 were largely building years. They launched a custody service for institutional investors. They formed the Center Consortium with Circle to launch USC. And so I think here there are really two important threads going on. The first is the strong emphasis on retail all the way throughout. If Coinbase was to place one big stamp on this industry, it was all about being the easiest place to do your first buys. That was and still remains the biggest draw to this app versus other exchanges. The second piece, however, which you see more in the latter years, is the shifting focus to the institutional use case, which we'll get to in just a minute. Next up, what is the opinion of Coinbase among those who are deeply enfranchised in this space. There are positives and

negatives. On the positive end, I think many people are appreciative of the user experience improvements that they brought to the space. While many, many applications have really kind of left aside standard U.X thinking, Coinbase super simplified the experience in a way that made it hyper-accessible to retail investors. I think along those lines, many are appreciative of the mainstreaming impact, the mainstream facilitation of people getting into the space. On the negative side, Coinbase historically has a lot of downtime. When markets are really moving, Coinbase has previously gone down. Now, of course, that's to some extent being a victim of their own success, but it's still nearly a meme in the crypto space. A second, sometimes negative view depending on your perspective, is which assets

Coinbase has listed. This is particularly for bitcoins who think that it's irresponsible for an exchange to push retail investors to what they consider second-tier assets or meme assets rather than Bitcoin to start, especially when there's a psychological impact, particularly of people who are coming from the traditional equity space, of not realizing that you can buy part of a Bitcoin. This isn't a coin-based specific critique. It's a critique of almost all exchanges in the space for those who hold it. Finally, one more negative view for people who are in the space is that the fees, especially paid by retail, are particularly high. This has some wondering how sustainable Coinbase's business model is, but we'll get to that in a minute. In general, I think,

those who are enfranchised in the crypto space often have moved on beyond Coinbase. They have different exchanges that suits their needs. The Bitcoiners have platforms that are Bitcoin-specific, like River or Swan now, while those who are interested in Defy have a variety of different protocols and decentralized exchanges that they can use. Next, let's actually talk about business model. What is Coinbase's business model and how has it been shifting? As I mentioned, it's largely historically been focused on retail. And importantly, fees are much higher for their retail offering than for their institutional or pro customers. As I said, this has many questioning how durable or sustainable their business model is.

Last year, trading fees accounted for 86% of Coinbase's revenue. If you think that their fees are particularly high, which they are relative to the rest of the industry, you have to wonder how long they'll be able to defend the sort of margins that they're making from those fees. However, there has been a shift recently. In an interview with CNBC this morning, Brian Armstrong said that non-trading revenue is expected to account for more than 50% of the company's revenue in the next 5 to 10 years. Non-trading revenue includes revenue from things like institutional custody, debit cards, and staking.

So in effect, Coinbase is out trying to argue that yes, fees have accounted for a significant majority of their revenue so far. yes, there may be downward pressure on fees based on future competition, but no investors shouldn't be worried because they have all of these new lines of business that are going to account for a big chunk of revenue going forward that are going to supplement and expand their durability. Now, this also might be a pitch for why investors who are worried about cyclicality should feel more comfortable. In other words, if you're worried that Coinbase is only successful when Bitcoin is successful, maybe these other business lines make you.

it feel a little less tied to that market cycle. This, I think, is the perfect segue to our next question, which is what is Coinbase's role in the recent institutional shift in the Bitcoin industry? Obviously, if you've ever listened to this podcast before, or if this is your first one, the biggest story and theme of the last 12 months has been that the institutions, after many years of anticipation, are actually coming into Bitcoin. This is being driven by a larger macro narrative around a potential secular shift to inflation and Bitcoin as a hard-capped asset being a very interesting hedge in that context. Whatever you think of them, Coinbase has been a huge enabler of that. Michael Saylor has praised them and has done his Bitcoin buying for micro-strategy

through Coinbase. What's also clear is that it's not just Michael Saylor. When Coinbase released its Q1 numbers, it was revealed that of the $223 billion in assets, custody done on their platform, 122 billion of those were from institutions, something like 54%. It turns out that despite Coinbase's historic brand as the retail-focused, US-based regulated crypto exchange, when all those big institutions decided to start coming into Bitcoin, they just looked over to the company that had the biggest brand as well. As I mentioned, Coinbase started its institutional custody offerings a few years ago, so they were ready to accommodate this shift as it happened.

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to the exchange. In short, when you see a lot of Bitcoin coming on to Coinbase or any other exchange for that matter, it means that the holders of that Bitcoin are potentially getting ready to sell. On the other hand, when you see Bitcoin flowing out of exchanges, especially in big chunks, that often means that people are moving their Bitcoin from the exchange where they bought it to cold storage where they intend to hold it for the long term. Over the last few months, we have seen massive, consistent outflows from Coinbase and other exchanges, suggesting that big institutional buyers are putting their Bitcoin into cold storage and keeping it away from exchanges. This is one of the reasons that despite such aggressive price action over the past

few months, most people don't feel like we're at the cycle top. Just yesterday, some 12,677 Bitcoin worth approximately 770 million left Coinbase Pro. As we get deeper and deeper into this market cycle, you can bet that people are going to keep watching the flows in and out of Coinbase to understand where the institutional mindset is and when we've likely reached a top where those institutions feel like they have to take some profit. Or get out more. entirely. Next on this definitive guide, let's talk about Coinbase and controversy. Does Coinbase have any controversy in its past? So there are two large ones and one little tiny one that I'm going to mention here. The one little tiny one really isn't a controversy. It's more just a question that some have.

Obviously, over the course of the last six months, it has become a major trend for corporations to put Bitcoin in their treasury. We've seen micro strategy most famously. We've seen Square, now Time magazine, Tesla, all these companies are putting Bitcoin on the books. Coinbase does have some Bitcoin on the books, but it's a very small amount. And this has led many to wonder why aren't they leaders in the Bitcoin Treasury space? I don't have any answers. I think it's a fine question. My guess, seeing the profile of this company, knowing that their intention was to go public this year, I wouldn't be surprised if their logic was that they're already so exposed to the cyclical risk of the Bitcoin price falling in their core business, that they thought that to also have their cash reserves in Bitcoin

would be a bridge too far for the average Wall Street investor. Now, one can disagree or agree with that approach, but if I had to place a guess on why they don't have more Bitcoin in the books, that would be it. Now, two real controversies that are distinct from the past that I did want to mention. The first is the best known and came last year when in the wake of the Black Lives Matter movement, many Coinbase employees got frustrated with CEO Brian Armstrong's response. They wanted a more vigorous vociferous affirmation of the Black Lives Matter movement, which they didn't get from Brian Armstrong.

Instead, what they got was a pretty radical approach, at least according to some, of him deciding that Coinbase was going to be apolitical. As in, employees simply wouldn't be able to talk about this type of issue in the context of work. There were huge debates about this with many, especially in Silicon Valley, saying that it was a model for the future, that the rancor of political discourse was ruining company cultures. There was also the reverse response that basically said that it was impossible for people to leave these sort of things that were so tied to their identity at the door. Coinbase, for their part, offered anyone who was uncomfortable with the new policy a severance package, which some 5% of people took. Now, another important controversy that was a little bit farther in the past was when in 2019 Coinbase acquired Neutrino. They paid $6.4 million in cash with another $7.4 million in escrow.

The problem with Neutrino is that its founders were directly affiliated with a company called Hacking Team, which, to make a long story short, was effectively the chosen team for technical surveillance missions from despots and authoritarians the world over. There were many of us screaming back then that there could be nothing less Bitcoin than partnering and allying with people who are used by authoritarian to deny the financial, social, and human rights of their citizens. The pressure eventually became so immense that the neutrino acquisition was sort of unwound. And in their SEC filings, Coinbase acknowledged the damage that it did to their brand. But with that, let's move back to the market. Why did Coinbase choose a direct listing?

First, let's hear what Brian Armstrong had to say about it on CNBC. this morning. For me personally, I was excited about the direct listing because, you know, number one, I wanted there to be just a true market on day one that set the price, not something that was set behind closed doors and a small number of participants got to buy in early or something like that. And I felt like it was more true to the ethos of crypto. I thought it might more truly give us a price that the market had decided versus, you know, kind of a guess that we all had come up with. We'll see how it goes, but I'm excited so far about the direct listing approach. And we have, of course, had a strong balance sheet as well. So it wasn't like we were trying

to raise a bunch of money right in the direct listing itself. But, of course, there's opportunities to do that as a public company if companies knew it as well. Now, why does a direct listing matter instead of an IPO? Well, it could have pretty different impacts on the market action. IPOs have shares preallocated and a price preset by investment bankers. Direct listings do not. This means that the market. market will have even more power to set the price. What else is different about a direct listing from an IPO? IPOs raise new capital, direct listings do not. That means that direct listings are liquidity events, but not capital raising events. IPOs are theoretically less volatile for a couple of

reasons. IPOs usually have commitments of big tranches that are being bought by institutions, and those institutions in order to save face often have an incentive to defend the price at which they bought. This limits the downside potential of early trading action. IPOs also tend to have market lockups where existing shareholders can't dump their shares onto the market right away. Direct listings have no such provision, which means that theoretically, every Coinbase shareholder could just dump their stock on the market and potentially crash the price. The flip side and another piece of why IPOs can be less volatile is that we don't have any idea how many of Coinbase's shareholders actually want to sell right now. Is everyone trying to get out at the market top to buy

houses, or is everyone else convicted that we're still just at the beginning of a big bull run and want to keep their shares tightly held? Either of those could create their own self-fulfilling prophecies. Finally, IPOs involve expensive, laborious, burdensome roadshows that generate demand, and some are saying that we don't know if investors will even care about Coinbase because they had no IPO roadshow to bring awareness. Coinbase, I think along with the rest of us, are betting that that's total bullshit, that the whole IPO roadshow thing is an artifact of the past, that there are plenty of different ways to advertise your company, and that Bitcoin hitting all-time highs right as this happens, 3x what Bitcoin's all-time high was for three years,

is a pretty good advertisement for the most accessible, low-risk public exposure to that asset class that has yet existed. So what are people expecting price-wise? Estimates of share price have been anywhere from 195 a few weeks ago to 440, and just recently it's been trading closer to 600 on FTX, pre-IPO markets. The starting reference rate was set at 250, and the last text alert that I got said that trading would start at 350. This is another thing about direct listings is that we actually don't know exactly when the trading will begin. Given that, I'll just do a couple more little bullets before sending you off to frantically refresh your blockfolios and trading views like

everyone else. Why did Bitcoin and Ethereum hit all-time highs in advance of the listing? Simply put, this comes down to the idea that Coinbase is a gateway drug, that some number of people are going to get into Coinbase because it's such an easy, accessible equity, and then want to fall farther down the rabbit hole to explore Bitcoin, to explore other aspects of this industry. This is the most pure play market exposure we've seen, and so there is a lot of anticipation. Bitcoin got above 64,000 and is currently trading around 63500. ETH for its part is at 2340. should also note that this has had a major knock-on effect on other exchange tokens. Binance's B&B is up 100% in the last month. And all of this gets, I think, to perhaps the biggest question for those

of us who are inside this industry. How might the Coinbase listing impact the crypto markets? Broadly speaking, there are two views. The first is that this is the next leg up of the bull market. This is the view of Coinbase as a gateway drug. This is the view that sees new, people, new institutional investors, new retail investors, discovering Coinbase and then pouring into the underlying, getting some exposure to the things that make Coinbase all its money. I think there is especially a strong emphasis on the idea that there are many institutions who are on the border for whom this will tip them over into crypto market exposure and give the people who are inside those organizations who are advocates for deeper plays within the crypto

industry itself leverage to get their companies and institutions on board. There is, however, an opposite view that Coinbase drives the market in the other direction. There are two possible reasons for this. The first is simple underperformance. If Coinbase pops and then craters, maybe it takes the patina off the rest of the crypto industry. Maybe it makes people start to think that we're at a local cycle high, and maybe that convinces institutions who have made a pretty penny over the last few months that now would be a good time to close at least part of their positions.

The second possible reason that some think a Coinbase listing could cause the crypto markets to go in a negative direction is that it would actually suck liquidity out of the underlying assets directly. In this argument, effectively, Coinbase isn't the gateway drug, it's just the drug of choice. Companies that are more conservative, more hesitant to jump into the Bitcoin pond entirely say owning coin is enough. We don't have to own the underlying because we believe that coin as an equity is so exposed to the Bitcoin price. I think these are reasonable positions to at least explore, but I've said before and I'll say again, I think it's far more likely that this brings new people in, that this serves as a starting point rather than an ending point than the other way around. For now, however, I'll close my Coinbase coverage for at least a little while with this note. Regardless of what you think of

this company, it is a seminal moment in the history of the Bitcoin industry for one of the most anticipated public listings of the year in the biggest markets anywhere in the world to be squarely focused on the cryptocurrency industry. People who have been in this industry for a long time have seen so many years of incremental nudging and bumping and pushing into mainstream traditional finance and this coin-based listing shows that the barbarians aren't just at the gate we're in the city. Watch what happens next. With that guys, I appreciate you listening. I hope you're having a great Coinbase day. Until tomorrow, be safe and take care of each other. Peace. We're witnessing the greatest paradigm shift in finance in modern history.

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