Coinbase, America’s largest crypto exchange, is going public. Should you invest?

Coinbase, the largest cryptocurrency exchange in the US by transaction volume, goes public tomorrow, 14 April, listing on the Nasdaq stock exchange, under the ticker COIN. The US crypto giant is hoping to capitalise on the astronomical growth seen in a number of cryptocurrencies over the past several months.

Why should investors care about the listing? And should you buy in?

Why Coinbase’s stockmarket listing is important

Coinbase’s public debut is being touted as the “Amazon moment for crypto,” say analysts at wealth manager D.A. Davidson. Just as Amazon’s listing in 1997 was a key landmark in the dotcom era, so Coinbase’s listing, they say, helps to pave the way for cryptocurrencies to become more mainstream.

The last several months alone have seen a greater institutional embrace of bitcoin, with Wall Street giants including Goldman Sachs and Morgan Stanley becoming more open to crypto, while bitcoin itself has more than doubled in value since the start of the year, hitting a fresh-all time high of around $63,000 today.

Better yet, the cryptocurrency broker “actually generates a profit”, says David Trainer, chief executive of new Constructs, a financial valuation firm. Coinbase’s revenues surged by 139% in 2020 compared to the previous year. And the strong growth has continued – in the first three months of this year alone, revenues of $1.8bn outstripped the $1.3bn seen for the whole of 2020.

Coinbase doesn’t just offer bitcoin –users can also trade other cryptocurrencies including litecoin and ether. It was set up in 2012 and now has 56 million users in more than 100 countries.

The exchange is split into two parts. Coinbase acts as a cryptocurrency wallet and brokerage service, while Coinbase Pro is an exchange for advanced users which enables them to buy and sell cryptocurrencies across trading pairs (in other words you can play the bitcoin/ether exchange rate, say), as well as giving access to more obscure cryptocurrencies.

For example, Coinbase recently added coverage of cardano – a cryptocurrency darling that is seen as the next big thing after ether and has soared more than 600% since the start of the year – but this is only available to Coinbase Pro users.

Coinbase’s listing is a little unusual

Coinbase has opted for a direct listing rather than a traditional initial public offering (IPO). The logic is simple. Companies that choose direct listings over IPOs as a route to go public – as Spotify did in 2018 – avoid having to pay high fees to the investment banks that normally act as underwriters in the standard IPO process.

Unlike an IPO, no new shares are created. Instead, existing shareholders sell their stock direct to the public. Direct listings often are considered the faster and cheaper route to turning a company public.

The risk for the company is that in the absence of underwriters, there is no one to manage the process to try to make sure that the company gets the best price. That said, a direct listing for a fairly well-known consumer brand – and one associated with crypto, which tends to position itself as an alternative to Wall Street – probably makes a lot of sense for a company like Coinbase.

Why Coinbase’s valuation looks... ridiculous

Even though the public debut marks a significant moment in the crypto world, market watchers have questioned the crypto giant’s rumoured eye-watering valuation of $100bn.

David Trainer, chief executive of valuation company New Constructs, says that “the company has little-to-no-chance of meeting the future profit expectations that are baked into its ridiculously high expected valuation.”

He thinks Coinbase’s valuation should be closer to $18.9bn as rivals – including Gemini, Bitstamp, Kraken and Binance – compete for dominance in the sector. “As the cryptocurrency market matures and more firms inevitably pursue Coinbase’s high margins, the firm’s competitive position will inevitably deteriorate”.

Trainer cites the war between share trading platforms in 2019 as an example. Crypto exchanges will “likely offer lower or zero trading fees trading fees as a strategy to take market share, which would start the same ‘race to the bottom’ that we saw with stock trading fees in late 2019.”

To put Coinbase’s valuation into context, Trainer and his team reckon that to justify a valuation of $100bn, Coinbase would have to maintain its hefty 25% profit margins and also grow its revenue 16-fold by 2027. That would imply revenues roughly 1.5 times greater than the combined 2020 revenues of two of the world’s largest exchanges – the Nasdaq and the ICE.

To say that those are ambitious targets is an understatement. Even to achieve Trainer’s valuation of $18.1bn, Coinbase would have to grow revenue at a compound annual growth rate of 21% for the next decade (which matches Nasdaq’s best-ever streak) with margins of 23% (the average for investment bank and brokerage services).

Investors also need to be mindful of general sentiment. Cryptocurrencies are volatile. A crash in bitcoin could easily have a knock-on impact to Coinbase, particularly if such a crash hits trading volumes.

Finally, the wider backdrop may no longer be quite as hospitable to fast-growing tech stocks like Coinbase as it once was. As analyst Kevin Kelly of Delphi points out, “growth stocks are trading at significant premiums relative to historical average.” COIN might well struggle if the “Great Rotation” from growth to value stocks continues apace.

In all, there’s no doubt that crypto is a fast-growing market and that there’s the potential for that to continue. Only 9% of US adults currently invest in cryptocurrencies, according to researcher CivicScience, while 90% of US adults are now on the internet. If crypto reaches similar levels of adoption then Coinbase might well thrive over time. But for now, given the competition in the sector, we’d be inclined to sit and watch rather than buy in right away.