Coinbase: how optimists and pessimists quarrelled

Coinbase: how optimists and pessimists quarrelled

In early 2021, Coinbase, the largest cryptocurrency exchange, announced that it plans to enter the stock market. On April 14, its shares were already traded on NASDAQ. Experts’ opinions about this event differed. Some started talking about Coinbase’s significant influence on stock strategies. Others suspected the company of a fraudulent scheme to enrich its owners. Which of them is right, and what are the most likely consequences of converting a cryptocurrency exchange into a public company?

Creation history

One of the founders of the exchange, Brian Armstrong, became interested in cryptocurrency in 2010. One day, the programmer came across a White Paper (a reference document) on bitcoin. After studying it, Armstrong decided to buy the coin for $1,000. The price was miserable – $9 per bit – and even the subsequent fall to $2 did not shake Brian’s faith in the investment’s potential.

While working at Airbnb, Armstrong noticed the high commissions and non-transparent payment system of the company with Latin American countries and decided to create an electronic cryptocurrency wallet in the form of a mobile app. According to the programmer’s idea, his invention would greatly speed up transactions, reduce fees and make the financial flows easily verifiable. But the project was ahead of its time and was not popular.

The failure did not embarrass Armstrong, and he embarked on a new development – a cloud service for buying, selling, exchanging, and storing cryptocurrencies. This idea was the basis for the creation of Coinbase. The young American presented the project in the framework of the startup gas pedal Y Combinator and managed to get an investment of $150,000. At this stage, Brian met the exchange’s second founder, Goldman Sachs trader Frederick Ersam. The latter’s connections enabled Coinbase to secure the support of several banks for currency operations and to raise about $500 million in funding from venture capital firm Andreesen Horowitz.

The third Coinbase co-founder was Armstrong’s friend, programmer Ben Reeves. However, he was soon forced to leave the team because of a disagreement over centralized password storage. Brian was convinced that the exchange should keep copies of users’ passwords on its servers. This would allow them to quickly restore access to their own funds in case of loss of keys. The problem was especially acute for newcomers who often forgot complex 64-digit combinations. Reeves, on the other hand, believed that it was necessary to adhere to the main idea of cryptocurrencies – decentralization. In practice, this meant: a person who lost the password would permanently lose access to his or her coins.

Coinbase now

The listing of the second-largest cryptocurrency exchange by trading volume is the first time ever that a major blockchain company has gone public without using popular go-to-market schemes (IPO or SPAC involving the issuance of new shares). Coinbase opted for direct placement of assets (DPO), without the involvement of intermediaries – underwriters. In this case, the company does not issue securities; those held by the current shareholders go on sale. In the first minutes, the value of Coinbase shares (stock ticker COIN) went up to $428.9 but soon corrected to $328.8. This led to the fact that the company’s capitalization exceeded $100 billion in a moment. For a short time, Coinbase became the largest exchange in the world, overtaking even the NYSE and NASDAQ. True, by the close of trading, its portfolio shrank to $86 billion. But even this amount was 30% higher than what NASDAQ indicated the day before the event.

The company has pleasantly surprised its investors before:

  • In 2020 alone, Coinbase earned about $1.2 billion (net income of $322 million). This is 250% more than the year before ($483 million).
  • In 2017, the exchange became the first unicorn company among bitcoin startups. Its capitalization exceeded $1.6 billion.
  • In 2019, it topped a list of 11 unicorn companies in the cryptocurrency industry with a valuation of $8 billion.

Meanwhile, Coinbase’s financial statistics are already breaking all industry records:

  • Q1 revenue of $1.8 billion and net income of $800 million;
  • Trading volume for the first 3 months exceeded $330 billion;
  • the exchange has a total of $223 billion in customer funds, representing more than 11% of the entire cryptocurrency market (of which more than half – the assets of institutional investors);
  • the number of active visitors of the site – more than 6 million people, and confirmed accounts – more than 55 million;
  • administrative costs and investments in blockchain technology in 2021 are planned at the level of $1.3-1.5 billion.

Today Coinbase is the most transparent cryptocurrency exchange:

  • bank transfers are used for deposits and withdrawals;
  • users’ money is insured by Lloyd’s;
  • has licenses of broker and bank transfer operator;
  • was one of the first to receive permission to work with cryptocurrency;
  • regularly monitors members’ transactions for signs of money laundering, and reports to the U.S. tax authorities.

At the same time, Coinbase strives to preserve the anonymity of its users. The exchange once had to go to court to challenge the US Internal Revenue Service’s orders to provide access to all of its customers’ data, down to their private correspondence. Although Coinbase was forced by the court order to disclose the data of 13,000 people, information about the remaining 500,000 did not go out.

Entering the DPO: details

At the end of 2020, Coinbase decided to offer shares through a DPO, a direct listing. This happened right after the SEC (Securities and Exchange Commission) restriction was lifted.

The benefits of a direct public offering include greater access to investment capital, the ability to raise capital from the company’s own community (including non-wealthy users), and providing liquidity for early investors.

DPOs save money on investment bank commissions, marketing, and presentations to potential participants. But there are certain disadvantages to this type of offering:

  • There is no way to raise additional capital;
  • there is no insurance and guarantees from intermediaries.
  • The latter option is usually chosen by the companies which are confident in their strength and attractiveness to investors.

Coinbase presented two types of shares: class A and class B. The difference between the two is as follows:

  • Class A securities give investors 1 vote;
  • Class B securities – 20 votes at once.
  • B-class shares are allowed to be exchanged for A-class shares. A total of 114,850,769 assets of the first type and 15,850,115 assets of the second type were placed. Thus, holders of B-shares own more than 90% of all votes. Curiously, each of the 1,700 employees of the exchange received 100 securities.

The largest investors in Coinbase were venture capitalists Andreessen Horowitz, Union Square Ventures, Ribbit Capital, founders Brian Armstrong, Fred Ersam, and CEO Surojit Chatterjee.

Coinbase’s entry into the stock market brought solid returns to early investors. Venture capital fund Initialized Capital invested a total of about $300,000 in Coinbase in 2012-2013. An additional $1 million worth of stock was purchased in 2015-2018, with an average purchase price of just $0.15 per unit. After listing on the NASDAQ, these investments brought Initialized Capital a $680 million return.

Slightly less profit for every dollar invested went to:

  • Union Square Ventures and Ribbit Capital, which purchased Coinbase stock for $0.2;
  • ¬†Andreessen Horowitz, with an average purchase price of $1 per paper;
  • DFJ Growth at $2.76; and others.

Coinbase assets are also available as tokens on the blockchain. This allows you to make money from fluctuations in the price of securities without investing fiat money but using crypto to buy.

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