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What’s happening over at Coinbase?

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    With all of the news coming out of Coinbase, it can be hard to know at first glance if this crypto darling is still a solid place to keep your crypto or if it’s time to find a new solution ASAP. As a digital assets hedge fund, Alt-Tab Capital’s top priority is protecting our investors’ funds, so we’ve spent a lot of time looking at the major exchanges in the market.

    In this post, we’ll explain some recent news around Coinbase and discuss how we assess the likely future of the United States’s biggest crypto exchange.  

     

    Coinbase: A Background

    Coinbase was founded in 2012 as a US-based cryptocurrency exchange. They quickly rose to prominence amongst crypto investors due to a user-friendly experience that made buying cryptocurrency far easier than any of the other solutions on the market at that time. Since then, they’ve become a massive force in the crypto space, IPO’ing in April of 2021 with a market value as high as $100B. As of December 2021, Coinbase had custody of $278 billion in user assets, representing over 11% of the total global crypto market cap. Today, Coinbase is available in over 100 countries and has expanded its product offering to include institutional custody solutions, a private-label credit card, an NFT marketplace, a prime brokerage, and other products. 

    However, this goliath of the crypto space is now trading at only an $11.4B market cap, an over 88% decline from its IPO just one year ago. Let’s look at what’s happened along the way and some of the controversies that now have people questioning $COIN’s future.  

     

    Key Metrics

    In understanding the viability of Coinbase, it is essential to realize that nearly all of its revenue comes from its customers’ purchase, sale, and trading of crypto assets. As crypto goes, so does Coinbase, and 2022 has been a horrific year for both. In Q1 2022, Coinbase posted a loss of $429.7M on revenue of $1.2B. This loss represents a year-over-year reduction of 27% in revenue. Perhaps even more concerning is the user attrition, with monthly users falling to 9.2M, down from 11.4M.  

    As bad as these numbers are, it is necessary to consider them in the context of the overall crypto market. Bitcoin is down over 55% year to date; Ethereum down nearly 70%. Still, metrics tell only part of the story, so let’s take a look at some of the other things that have been plaguing Coinbase:  

     

    Failed Products

    Coinbase’s upwards momentum has been stifled by failed product launches, two of the most significant being regulatory troubles in India and its NFT market. Just days after the launch of its exchange service in India, the company had to suspend the service due to issues with India’s central bank. India is an important market for crypto growth, and this setback puts Coinbase even further behind Indian rivals such as WazirX, CoinDCX, and CoinSwitch Kuber.  

    However, even this failed launch in India is a success story compared to the Coinbase NFT marketplace. Coinbase NFT was much hyped and promoted as a likely contender to the current king of the Marketplace, OpenSea. Instead, Coinbase NFT arrived without any compelling features and even lacking some key functionality other NFT exchanges offer. As a result, it is a ghost town. In the first three weeks of launch (and the best three weeks the exchange has had), there were under $700,000 in sales on the platform. The total user pool was 1,287 people. Many of you reading this have had a more successful launch than Coinbase NFT.  

     

    Staff Challenges

    By Coinbase CEO Brian Armstrong’s own admission, Coinbase grew its headcount too quickly. Spurred by IPO success, the company went on a massive hiring spree and was unprepared for this crypto bear market. As a result, the company recently announced layoffs of 18% of the staff, totaling 1100 lost jobs. While those laid off were provided with a severance package, their access to corp resources was cut off immediately, and they received emails to their personal email informing them that they were now unemployed. Further, existing offers were rescinded, leaving those who had accepted a job at Coinbase scrambling.  This created an immediate negative impression of their brand in the market and is likely to cause long-term damage to their ability to attract and retain talent.  

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    It’s also worth noting the headlines around the “Operation Revive COIN” petition in which some employees recently circulated a petition calling for a vote of no-confidence in the company’s executive leadership. While the petition has since been removed, the original petition was archived and can be found here. This petition generated a few days of negative headlines, though this author doesn’t see it as particularly meaningful. While it is possible that this petition does represent the will of Coinbase’s staff, the author has also observed similar petitions at other large tech firms and has yet to see them go anywhere or accomplish much of anything.  

    With that out of the way, let’s look at a couple of the other news items swirling around Coinbase.  

     

    Founders Stock Sales

    The founders and executive team have cashed out over $1.2B of stock since the IPO. The current crypto zeitgeist suggests that this is a sign of a loss of faith in the company and its ability to grow. This author respectfully disagrees. What the headline fails to take into account are three key items:

    1. Most of these stock sales happened at or near the time of IPO.
    2. The founders and executive team still have massive amounts of stock.
    3. If you were in their position, would you not take tens or hundreds of millions of dollars off the table, both to secure your wealth forever and to live a little (ok, a lot)?  

     

    Frankly, this seems more like a story crafted to fit an existing narrative than a useful indicator of anything.  Of course, if we’re going to talk about much ado about (maybe) nothing, then it’s time to talk about Coinbase’s 10Q filing.  

     

    The 10q Filing

    If you follow the crypto space, you likely saw the headlines. “Coinbase says it is going bankrupt and can take all of your money!”. Well, that’s not entirely accurate. Instead, what Coinbase did was file a required quarterly report which read, “Because custodially [sic] held crypto assets may be considered to be the property of a bankruptcy estate, in the event of a bankruptcy, the crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings and such customers could be treated as our general unsecured creditors.”  

    For more on what this means, I’ve asked crypto legal expert Dave Rodman, Founder of The Rodman Law Group, to give his thoughts:  

    “The SEC requires any publicly traded company, such as Coinbase, to file Form 10Q during each of the first three fiscal quarters of the year for the benefit of investors that want to evaluate a quarter-over-quarter comparison of the company’s financial health. Form 10Q is intended to be a comprehensive report of financial performance including financial statements, management discussion, and analysis, as well as disclosures. The part of Coinbase’s recent filing that has Coinbase customers spooked (and therefore investors worried as Coinbase makes its money on customer trades and fewer customers means less revenue), is this new disclosure regarding bankruptcy, specifically that customers who keep their cryptocurrencies in their Coinbase accounts would be treated as unsecured creditors. This means that in the event of bankruptcy, a cryptocurrency exchange would have to pay secured creditors prior to individual customers and could be forced by a court to use customer assets to pay such secured creditors.

    Let’s be perfectly clear about this: Coinbase’s disclosure is not a change in policy or news to anyone who has been paying attention to crypto over the years. In fact, users’ status as unsecured creditors is not specific to Coinbase. Users-as-unsecured-creditors is the status quo for nearly all cryptocurrency exchanges that operate in the United States (Wyoming SPDIs excluded).

    So, if this is, and always has been, the status quo for nearly all cryptocurrency exchanges in the US, why is this only making the news now? The answer is the SEC released a Staff Accounting Bulletin (SAB 121) which requires publicly traded companies that custody user crypto to disclose their status as unsecured creditors publicly. The stated intent of this disclosure is that the SEC wants cryptocurrency exchanges to provide investors more transparency in regards to their assets, but putting on the tinfoil hat for a moment, it is not too far a reach to see this as an underhanded way to throw cold water on a market that Chairman Gensler desperately wants to curtail and control.  

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    The problem here is that regulations have not caught up to the industry, so cryptocurrency investors do not enjoy the same protections that traditional investors do. In nearly all situations, when a TradFi brokerage firm ceases to operate, customer assets are safe and are usually transferred to another registered brokerage firm. There are specific regulations like Rule 15c3-3 the “Customer Protection Rule” that require such firms to segregate their customers’ securities and cash from their own assets. Additionally, TradFi firms are subject to rules that lessen the chance of insolvency in the first place. For example, Rule 15c3-1 the “Net Capital Rule” requires TradFi brokerages to maintain certain levels of their own liquid assets. Add to this the fact that TradFi customers enjoy federally mandated insurance protections from the SIPC and customer accounts are more or less sacrosanct. It is rare for TradFi firms to actually liquidate as troubled institutions are usually acquired by other firms when things get too rough, but if they do liquidate, the SEC, FINRA, and state securities regulators work with the dissolving firm to make sure that customer accounts are protected and that customer assets are transferred to one or more SIPC-protected brokerage firms (see Drexel Burnham Lambert).

    Crypto investors do not currently enjoy any of the above-mentioned protections. Until the laws in this country change to protect crypto investors or bankruptcy precedent is set establishing that CeFi firms’ customers’ assets are superior to the claims of secured creditors (incredibly unlikely without significant changes to the current regulatory framework) the best advice a lawyer can give to a CeFi firm’s customers is to remember the mantra “Not your Keys, Not Your Crypto” and to keep as much of their crypto investments safely self-custodied in cold storage as possible.  

    I do not believe that the SEC is the right regulator for the crypto markets, however, there is certainly something to be said for the establishment of laws and regulations that protect the assets of crypto investors that are similar to those that TradFi investors enjoy and that do require some form of regulatory oversight.”

     

    The Upshot

    With all of this in mind, it is understandable why some are starting to wonder whether Coinbase is viable long-term and whether they should move their crypto out. When considering this, it would be remiss not to bring up the old crypto adage, “Not your keys, not your coins.” If done correctly, there is no safer solution than self-custody. However, while not difficult, doing so is beyond this post’s scope, so let’s focus on exchange options.  

    In this author’s opinion, Coinbase is sufficiently capitalized to survive the crypto winter, is one of the better-regulated exchanges, and while they have had some failed products, none of them have had the questionable economics of failing players like Celsius or Anchor Protocol. In addition to their popularity with the retail investor, they are in an excellent position to benefit when the market reverses and investor interest once again surges.  With the information available now, Coinbase seems among the least likely to fail catastrophically, resulting in a loss of user funds.  So all that to say, while self-custody is a better option if you are capable of it, if you are going to keep crypto on an exchange, Coinbase, along with others like FTX and Binance, are likely among your best options.  

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