Coinbase Strategy
Teardown
How Coinbase Grew Into The King Midas Of Crypto Doing $1B In Revenue
1
To sustain the cryptocraze, Coinbase will need
to foster real applications of cryptoassets —
and not just speculation.
Coinbase is the most popular consumer-facing cryptoasset exchange
in the United States. Operating since 2011, the company allows users
to buy, sell, and store cryptoassets, like bitcoin and ethereum.
The company already has significant visibility with consumers in
a sector that was once exclusively the province of cryptocurrency
enthusiasts. In mid-December, the company’s mobile app reached the
top spot on Apple’s App Store.
Coinbase has soared in popularity and turned itself into the on-ramp
for mainstream crypto investors by positioning itself as a safe harbor
among cryptoasset exchanges. The company has never been hacked,
unlike many of its competitors. Coinbase has also maniacally pursued
compliance with existing regulations and law enforcement, putting it
on the right side of the law — another huge asset in a sector that is still
in desperate need of regulatory guidance.
This has helped Coinbase secure $217M in equity financing from some
of the biggest-name VCs, and vaulted the company into the unicorn
club.
However, while Coinbase is best known for its cryptoasset exchange,
it has bigger aspirations than helping people buy and sell crypto. The
company’s stated goal echoes cryptoasset enthusiasts’ ultimate
vision: to create a new, “open financial system.”
For the time being, though, Coinbase looks a lot like a traditional
financial services player. Coinbase makes money by charging fees for
its brokerage and exchange. It also custodians user funds, like a bank,
and decides which cryptoassets to list, like the NASDAQ or NYSE.
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Coinbase thus finds itself caught between worlds: it’s the most
well-funded blockchain company in the United States, but it’s a
centralized company, not a decentralized ledger. The company once
advertised cryptoassets as the “future of money,” but now positions
itself as a way to “buy and sell digital currency.” In many ways,
Coinbase is a centralized on-ramp to a decentralized ecosystem.
This begs the question: how does Coinbase view the assets
that it enables customers to buy and sell? Is it still interested in
encouraging crypto adoption to build a new financial system, or
primarily occupied with encouraging the speculation that fuels its
core lines of business?
In this report, we examine Coinbase’s strategy, financing history,
product offerings, business initiatives, threats and future oppor-
tunities. We dig into how Coinbase operates, how it’s capitalizing
on cryptoasset speculation, and what it’s doing to push forward
blockchain technology.
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» EXCHANGES 101
» WHAT IS COINBASE?
·
· Coinbase & GDAX
·
· Hosted wallets
·
· Custody
·
· Toshi
» COINBASE AS KINGMAKER
·
· From currency to investment
·
· User metrics
·
· Security
·
· Regulatory compliance
·
· Ease-of-use
·
· The Coinbase effect
» VALUATION & INVESTORS
» THE ROAD AHEAD: AN OPEN FINANCIAL SYSTEM
·
· Challenges & Risks
» CLOSING THOUGHTS
Style notes: “Cryptoassets” includes all coins, tokens,
and digital assets traded on cryptoasset exchanges.
“Bitcoin” refers to the Bitcoin ledger, or protocol, while
“bitcoin” refers to the asset or a unit of account on the
Bitcoin ledger. This is reflected for all cryptoassets in
this report.
Table of
contents
4
Cryptoassets like bitcoin, ethereum, and litecoin are primarily
obtained in one of two ways: through mining or through an
exchange.
Mining has high barriers to entry. Participating in a mining pool
or operating mining “rigs” can be expensive and complicated.
For the more novice consumer, fiat-cryptoasset exchanges
and brokerages – like Coinbase, Kraken, and Bitstamp – have
established themselves as the primary on-ramps to this asset
class. These allow consumers to trade fiat (e.g. USD, GBP) for
cryptoassets (e.g. BTC, ETH, LTC).
There are a couple of important terms to understand when
discussing exchanges.
1. First, the “trading pair” (or, “currency pair”) is the product being
traded. In the above screenshot the product is ETH, and the
“quote currency” is USD. This means that traders are buying
and selling the cryptoasset ethereum, priced in dollars.
2. The order book shows all the bids and asks at a given time. A
“bid” is the price at which a buyer will buy, and an “ask” is the
price at which a seller will sell. The order book also shows the
aggregate amount of asks and bids (supply and demand) at a
given price, called the “market size.”
Exchanges 101
An annotated screenshot of
Coinbase’s exchange, GDAX.
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3. The “depth chart” is another way to visualize the order book,
showing cumulative bid and ask orders over a range of prices.
Coupled with volume — or, the total amount traded over a given
time period — the depth chart provides a good way to measure
“liquidity.” Liquidity describes how easy it is to turn an asset
into cash. For instance, if ethereum suddenly saw a massive
sell-off, there might not be enough buyers, or enough “liquidity,”
for sellers to sell to.
4. Lastly, the “mid-market price” is the price between the best
“ask” price and the best “bid” price. It can also be defined as
the average of the current bid and ask prices. The “price” of
an asset (as quoted on Yahoo Finance or Bloomberg, etc.) is a
direct function of the bids and asks in the market, which in turn
reflect supply and demand.
6
Coinbase was founded in July 2011 by
former Airbnb engineer Brian Armstrong and
was first funded by Y Combinator. In 2012,
co-founder Fred Ehrsam, a former Goldman
Sachs trader, joined the company, after which
Coinbase launched services to buy, sell, and
store bitcoin.
Today, Coinbase operates in 32 countries and can be divided into
four primary lines of business:
» Coinbase
» GDAX
» Custody
» Toshi
COINBASE & GDAX
Coinbase operates both an order book exchange, called the
Global Digital Asset Exchange (GDAX), and a brokerage, called
Coinbase.
More advanced traders (including small institutional players,
like cryptoasset hedge funds and family offices) buy and sell
cryptoassets on GDAX and determine the mid-market price.
Coinbase (the brokerage) then allows retail investors to buy and
sell cryptoassets at these mid-market prices, and charges a fee
on top.
In practice, retail investors can buy and sell directly from
Coinbase’s brokerage, like they might buy a stock from Scottrade
or Charles Schwab. Coinbase’s brokerage fees range from roughly
1.5% to 4.0% depending on the user’s payment method; due to
increased risk, credit cards come with higher fees than bank
transfers. Traders on GDAX pay significantly lower fees.
Of note, Coinbase’s brokerage buys cryptoassets from GDAX,
instead of from an outside exchange. This gives the company a
secure in-house source of liquidity. Given how often exchanges
are hacked or otherwise compromised, this is quite important;
Coinbase’s brokerage doesn’t have to rely on anyone else for
liquidity.
What is
Coinbase?
7
A screenshot of Coinbase’s brokerage.
HOSTED WALLETS
A common mantra found in the cryptoasset community is “be
your own bank.” Accordingly, Bitcoin enthusiasts promote what
they call “private key management solutions,” which means
storing a long string of random numbers or letters offline, either
on a piece of paper or on a dedicated storage device (a “hardware
wallet”). Such a method of securing cryptoasset holdings is
difficult for the average consumer – if the piece of paper or
storage device is lost, the funds are lost forever.
Flaunting this mantra, Coinbase offers hosted wallets alongside
its exchange and brokerage. These allow users to safely store
cryptoassets on Coinbase, which custodians the assets. As of
Coinbase’s last reporting, in late November 2017, the company
had 13.3M users and 45.2M wallets (users generally have more
than one wallet, each for a different cryptoasset).
Coinbase’s customers typically fall into one of two groups:
(1) investors, and (2) those transacting with cryptoassets. For
investors, Coinbase encourages transferring funds into its “cold
storage” vaults, which it guarantees against Coinbase hacking.
These vaults are disconnected from the internet and offer
increased security. For those transacting (or trading on other
exchanges), Coinbase allows users to send funds from Coinbase
to other wallets.
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CUSTODY
Institutional investors — hedge funds, asset managers, and
pension funds among them — have expressed interest in
cryptoassets as their overall value climbed this past year. In
order to capitalize on this sidelined institutional money, Coinbase
announced “Custody” in November.
Custody provides financial controls and storage solutions for
institutional investors to trade cryptoassets. The service is geared
toward larger players on Wall Street and costs $100,000 in initial
setup fees, a management fee of 10 basis points monthly on
AUM, and a minimum balance of $10M. Coinbase plans to launch
Custody early this year.
Custody is not the first mover in the space. Digital Currency
Group’s Genesis Trading has offered institutional players OTC
(“over the counter”) trading in cryptoasset markets since 2013,
while the Winklevoss Capital-backed Gemini was founded in
2015. Other major OTC providers catering to institutions include
Circle, which has raised $136M in venture financing, and DRW’s
Cumberland.
Additionally, traditional exchanges like the Chicago Board
Options Exchange (CBOE) and CME now offer futures trading
for cryptoassets, with the CBOE also recently filing for a bitcoin
ETF. Lastly, investment trusts – like Grayscale – offer tradable
securities on top of cryptoassets. These often trade at a premium
to exchange prices, but are operationally easier for institutional
investors to hold.
TOSHI
While Coinbase remains focused on its core brokerage and
exchange businesses, one of the company’s longer-term projects
is Toshi. Toshi is a mobile app for browsing decentralized
applications, an ethereum wallet, and an identity and reputation
management system. At a high level, the aim with Toshi is to give
users broader access to decentralized applications built on top of
the Ethereum blockchain. In this way, Coinbase hopes that Toshi
could allow for the building of viable crypto use cases, beyond
speculation.
Some current examples include Leeroy, a decentralized social
media platform where users earn money for likes, and Cent, where
users can ask questions and offer bounties for the best answers.
Toshi launched in April 2017, and early traction has been limited;
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the app counts under 10,000 installs in the Google Play Store.
Critics of Toshi point to the app’s centralization. Toshi is built,
maintained, and effectively controlled by Coinbase, which might
discourage developers from building on top of it.
To use an analogy that illustrates the downsides of centralization,
consider an Amazon merchant. If Amazon were to change
its search algorithm or fee structure, that merchant might be
adversely affected. Decentralization, according to proponents,
presents an alternative that makes developers less subject to the
whims of the platform they build on.
On the flipside, and as a function of centralization, Coinbase can
make quick changes to Toshi without community consensus.
Coinbase also has a significant number of existing users, brand
recognition, and money to spend, which could bode well for
Toshi’s future adoption.
A screenshot of Toshi’s page in the Google Play Store
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Coinbase has emerged as something of
a cryptoasset kingmaker for investors, as
assets listed on its exchange have seen
substantial price appreciation.
This development is largely a result of cryptoassets evolving
into an investment vehicle. Coinbase’s excellence in security,
regulatory compliance, and ease-of-use has helped drive up user
numbers. When Coinbase give its “stamp of approval” to a given
cryptoasset, millions of users can then trade it, which often drives
up prices.
FROM CURRENCY TO INVESTMENT
Where bitcoin and other cryptoassets were once considered a
“means of exchange” and an alternative payments system, they
are now more often called a “store of value” and an investment
opportunity.
Google trends highlight focus on ‘investment’
2017 – 2018 YTD (01/09/2018)
Coinbase as
kingmaker
Google trends highlight focus on ‘investment’
2017 – 2018 YTD (01/09/2018)
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Scaling issues have contributed to this shift, as core developers
remain locked in debate over how best to scale Bitcoin into an
effective payments network. Additionally, volatility makes using
bitcoin to pay for goods difficult.
Fred Wilson of Union Square Ventures pointed to this volatility in a
recent blog post, writing: “This was a Bitcoin t-shirt I bought in the
summer of 2013 [for .18 BTC]. At today’s prices, that t-shirt cost
me $830 […] You can’t keep spending something that goes up as
much as Bitcoin has.” That number is considerably higher today.
Thus, while Coinbase initially promised “instant payments [and]
widespread [bitcoin] adoption,” bitcoin has seen limited adoption
among merchants and consumers; users haven’t meaningfully
transacted with bitcoin like they might with dollars or euros.
Coinbase has overhauled its messaging and user experience
to capitalize on this trend, with the company’s homepage now
encouraging users to “buy and sell digital currency,” where it once
welcomed users to “the future of money.” This makes a lot of
sense as a brokerage: Coinbase brings in revenue on every trade
(based on volume), and is therefore incentivized to encourage
frequent trading and investment.
Coinbase UX capitalizes on ‘investment’
thesis
January 2013 vs. January 2017
Coinbase UX capitalizes on ‘investment’ thesis
January 2013 vs. January 2017
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USER METRICS
Astounding user growth validates Coinbase’s messaging shift.
According to data aggregated by Alistair Milne of Altana Digital
Currency Fund, Coinbase was adding users in November at a rate
of 100,000 per day. Although Coinbase has stopped publishing
real-time user metrics, its site claims over 10M customers served
and over $50B in cryptoassets exchanged.
Coinbase’s meteoric user growth
January 2013 – November 2017
Assuming an average 3% fee for Coinbase transactions and $50B
exchanged, total revenue of the company (since inception) would
be $1.5B. Of course, that number could be much higher or lower
depending on the company’s true fees and total volume.
According to recent reports, Coinbase made $1B+ in revenue in
2017 alone. At the end of Q3’17, the company was projecting a
2017 total of just $600M, well under its actual.
SECURITY
Although cryptoassets themselves are quite secure, exchanges
have a long history of hacks, exit scams, and lost funds. The most
Coinbase’s meteoric usr growth
January 2013 – November 2017
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well-known hacked exchange was Mt. Gox, which lost 850,000
bitcoins to hackers in early 2014, worth $450M at the time. Today
(in early January 2018), those coins would be worth close to
$10B. Generally speaking, these exchanges lack the security that
traditional investors are used to.
Coinbase is the exception to this rule. Coinbase has continued to
make security a top priority, and it’s paid off. The company has
operated since 2012 and has never been hacked, establishing
significant trust with consumers.
Investments and funds are held and insured by Coinbase, with the
majority of cryptoassets stored offline in cold storage vaults, and
the remainder insured by Lloyd’s of London. Funds held in USD
wallets on Coinbase are covered by the FDIC and insured up to
$250,000.
Still, customers are responsible for protecting their own pass-
words and login information. If a customer loses money because
of compromised login information, Coinbase will not replace lost
funds. Coinbase recommends that customers turn on two-factor
authentication and place funds into cold storage in order to thwart
would-be hackers.
REGULATORY COMPLIANCE
As mentioned, exchanges that handle fiat-cryptoasset trading
pairs (e.g. BTC/USD, BTC/GBP) are the primary consumer
on-ramps to cryptoassets. Cryptoassets have a history of use in
the black market, first with bitcoin, and now with privacy-focused
coins, like monero and zcash. Coupled with the sector’s nascency,
regulatory bodies have struggled to define, legislate, and tax
cryptoassets.
In this regard, Coinbase has differentiated itself from other
exchanges by spending substantially on licenses and compliance.
Coinbase has made a point of complying with state-by-state
money transmission laws, and is one of a few companies to
hold a New York Virtual Currency License, or “BitLicense.” A
common critique of the BitLicense is its prohibitive cost; over ten
companies moved their headquarters from New York to other
locales in 2015 after the license was announced.
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Coinbase’s “BitLicense”
(source: Coinbase)
Other regulations that Coinbase complies with include registration
as a Money Services Business with FinCEN, and the Bank
Secrecy Act and Patriot Act. Coinbase operates its exchange in
32 countries, including the UK and Switzerland, as mentioned.
According to the company, “no license is required to operate a
digital currency business in any other country [outside of the US]
where Coinbase operates.”
Taken as a whole, Coinbase’s focus on compliance offers safety
and assurance for consumers and regulators alike.
Relationship with law enforcement
Similarly, Coinbase has cooperated heavily with law enforcement.
Coinbase follows strict identity verification procedures to comply
with regulations like KYC (Know Your Customer) and AML (anti-
money laundering), and to track and monitor cryptoassets sent to
and from its site.
As touched upon earlier, the company complies with the Bank
Secrecy Act, which the company says “requires Coinbase to verify
customer identities, maintain records of currency transactions for
up to 5 years, and report certain transactions,” and the Patriot Act,
which has famously been criticized for making it easier for the US
government to intercept people’s phone conversations.
Coinbase is therefore a boon for regulators and law enforcement
15
in deciphering decentralized black market activity. Blockchain
tracking companies, like Chainalysis, work with Coinbase (and
other exchanges) to assist in AML enforcement. As US Treasury
Secretary Steve Mnuchin put it in a recent interview: “If you have
a wallet to own bitcoins, that company has the same obligation
as a bank to know [you as a customer, and] we can track those
activities.”
At the same time, Coinbase has pushed back against what it
sees as government overreach. In one public instance, the IRS
requested customers’ records for the period between 2013-2015.
November 2017 court documents from the case nicely summa-
rize the dispute: “That only 800 to 900 taxpayers reported gains
related to bitcoin in each of the relevant years and that more than
14,000 Coinbase users have either bought, sold, sent, or received
at least $20,000 worth of bitcoin in a given year suggests that
many Coinbase users may not be reporting their bitcoin gains.”
Coinbase refused to hand over records, and ultimately won a
partial victory in court by reducing the number of customers and
scope of data provided. The company has since agreed to give
the IRS records on 14,000 users, a somewhat unsatisfactory
outcome for Coinbase users with strong privacy concerns.
Accusations of insider trading
Cryptoasset trading remains largely unregulated and is something
of a “wild west” for speculators. Pump-and-dump schemes and
fraudulent initial coin offerings are rampant. Additionally, and
as we’ve explored in prior reports, large initial coin offerings run
the risk of overcapitalization; raising too much money could
disincentivize founders from building the product in question,
turning founders building companies into money managers.
Although Coinbase has generally kept its brand reputation
clean, recent events have spurred rumors of insider trading and
“front-running.” According to numerous reports, the price of
bitcoin cash on global exchanges spiked in the hours leading
up to Coinbase’s launch of bitcoin cash trading. Such a price
movement is certainly suspect.
Armstrong released a strongly worded statement after the event,
pointing to Coinbase’s employee guidelines: “We’ve had a trading
policy in place for some time at Coinbase. The policy prohibits
employees and contractors from trading on ‘material non-public
information,’ such as when a new asset will be added to our
platform.”
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Of concern, the statement did not reference any federal or state
regulations enforcing said employee policies, underscoring the
sector’s nascency in regulatory and legislative circles.
EASE-OF-USE
In addition to its security and regulatory compliance, Coinbase’s
user interface and mobile application have helped the company
position itself as the de-facto US cryptoasset brokerage. In com-
parison to earlier iterations, Coinbase’s current user experience is
simple, clean, and well-suited for cryptoasset retail investors.
Most notable is Coinbase’s mobile app. A testament to the
company’s brand, it was the most downloaded app on Apple’s App
Store in early December 2017. Coinbase also currently sits at No.
5 for most downloaded US “Finance” apps. No other cryptoasset
exchange comes close, and few legitimate cryptoasset exchange
apps are even deployed.
It’s unlikely that bitcoin would ever have hit the mainstream
without a company like Coinbase, which provides an easy-to-use,
trusted means of buying and selling cryptoassets.
Bitcoin mania propels Coinbase to #1 on App
Store
Bitcoin mania propels Coinbse to #1 on App Store
Apple App Store. 2017 – 2018 YTD (01/08/2017)
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As mentioned, Coinbase’s KYC and AML requirements require
users to strictly verify their identities, which has proven difficult
for users to do via Coinbase’s mobile app. In many cases, users
have reported long wait times for verification.
Coinbase has also struggled with general customer support.
These issues have expressed themselves in Coinbase’s app
reviews; the app is currently rated an average of 3.6 stars based
on 16,107 reviews (as of January 8th, 2017), and has been
garnering a larger percentage of 1-star ratings in recent months.
Coinbase faces growing pains amid record
app downloads
Apple App Store, star ratings. April 2017 – December 2017
THE COINBASE EFFECT
All of these factors — strong security, regulatory compliance,
ease-of-use, and a focus on investment — have enabled Coinbase
to emerge as something of a cryptoasset kingmaker for investors.
One example of this was its recent addition of bitcoin cash. At
around 7pm EST on December 19th, 2017, Coinbase surprised
Coinbase faces growing pains amid record app downloads
Apple App Store, star ratings. April 2017 – December 2017
18
users by listing a fourth asset: bitcoin cash. Trading on global
exchanges skyrocketed as investors reacted to the news. A day
after the announcement, bitcoin cash closed at $4,000 on some
exchanges, up from around $2,200 two days earlier. Volume
soared as well, from $2.5B on December 18th, to almost $12B on
December 20th, an increase of 380%.
However, almost none of this trading was happening on Coinbase.
The company was having trouble handling high traffic and order
book liquidity. Four minutes after listing bitcoin cash, with the
price swinging from $3,500 to near $9,000 on its exchange,
Coinbase paused its bitcoin cash order book.
After 18 hours during which rumors of insider trading swirled,
Coinbase announced that it would reopen its order book. The
company cautioned in a blog post that “if significant volatility
[was] observed, GDAX [would] pause trading.”
‘Coinbase effect’ sends traders into bitcoin
cash frenzy
‘Coinbase effect’ sends traders into bitcoin cash frenzy
Overall BCH/USD price and volume. November 21, 2017 – December 26, 2017
19
Overall BCH/USD price and volume. November 21, 2017 –
December 26, 2017
While just one instance, this event speaks volumes. Cryptoassets
are difficult to obtain (especially in current market conditions), so
an “accessibility premium” is often at play: when a cryptoasset is
more accessible, it tends to rise in price.
The bitcoin cash listing is one example of this “Coinbase effect,”
but there are others: Ari Paul of Blocktower Capital cited a 30%
rally for litecoin the day of its listing, as well as a 14% rally for
ethereum when it was first listed on Coinbase in July 2016.
In recent weeks, rumors of Coinbase listing ripple (XRP) contrib-
uted to a substantial run-up in the asset’s price. However, the
price slid after Armstrong released a statement that the company
“[had] made no decision to add additional assets to either GDAX
or Coinbase.”
Such data highlights the company’s central role in the sector:
Coinbase is best at making cryptoassets easy to buy, store, and
ultimately, access. More accessibility translates into increased
liquidity on both Coinbase and GDAX, which in turn attracts more
and new types of investors. While just one instance, this event
speaks volumes. Cryptoassets are difficult to obtain (especially in
current market conditions), so an “accessibility premium” is often
at play: when a cryptoasset is more accessible, it tends to rise in
price.
The bitcoin cash listing is one example of this “Coinbase effect,”
but there are others: Ari Paul of Blocktower Capital cited a 30%
rally for litecoin the day of its listing, as well as a 14% rally for
ethereum when it was first listed on Coinbase in July 2016.
In recent weeks, rumors of Coinbase listing ripple (XRP) contrib-
uted to a substantial run-up in the asset’s price. However, the
price slid after Armstrong released a statement that the company
“[had] made no decision to add additional assets to either GDAX
or Coinbase.”
Such data highlights the company’s central role in the sector:
Coinbase is best at making cryptoassets easy to buy, store, and
ultimately, access. More accessibility translates into increased
liquidity on both Coinbase and GDAX, which in turn attracts more
and new types of investors.
20
Coinbase’s top spot in App Store coincided
with bitcoin run-up on GDAX
BTC/USD GDAX price and volume. January 2016 – December
2017
Although the company achieved unicorn status at a valuation
of $1.57B in its $100M Series D in August 2017, recent
disclosed revenue numbers ($1B in 2017) suggest it might
fetch higher offers today.
Coinbase’s top spot in App Store coincided with bitcoin run-up on GDAX
BTC/USD GDAX price and volume. January 2016 – December 2017
21
Although the company achieved unicorn
status at a valuation of $1.57B in its $100M
Series D in August 2017, recent disclosed
revenue numbers ($1B in 2017) suggest it
might fetch higher offers today.
Series D pushes Coinbase to a valuation of
$1.6B
Equity financing. June 2012 – August 2017
Looking at investors, Coinbase has attracted a mix of venture and
corporate investment. In total, Coinbase has raised $217M in six
equity financings since 2012 (including its seed round, not shown
on the above graphic). Brand-name venture investors — Union
Square Ventures and Andreessen Horowitz chief among them —
got in early, and have continued to participate in funding rounds to
the company.
Large financial institutions, like the NYSE and USAA, were part of
Series D pushes Coinbase to a valuation of $1.6B
Equity financing. June 2012 – August 2017
Current
valuation and
investors
22
the company’s $75M Series C in January 2015. According to an
NYSE press release, the Series C investment helped “[support]
Coinbase’s growth utilizing [NYSE’s] global distribution capabil-
ities and market expertise.” Indeed, Coinbase would launch the
“Coinbase Exchange” geared toward professional investors in the
same month. This would later rebrand to the “Global Digital Asset
Exchange,” or GDAX. In November 2015, USAA partnered with
Coinbase to allow their customers to monitor their cryptoasset
wallet balances when they log into their USAA accounts.
Coinbase investors are diverse and smart
As of 08/10/2017
Also of note, Japanese players Bank of Tokyo Mitsubishi UFJ
and NTT DoCoMo contributed to Coinbase’s Series C-III in July
2016. At the time, Coinbase said it would look to expand into the
Japanese market, however this expansion has yet to happen.
Coinbase investors are diverse and smart
As of 08/10/2017
23
With all this, the question remains: is
Coinbase simply profiting off of Bitcoin
mania, or building upon the asset’s original
vision for a new, open, and global financial
system?
The answer is most likely a bit of both. Coinbase’s user growth
and revenue numbers imply a higher valuation than its most
recent valuation of $1.57B. At the same time, Coinbase is hedging
its core business against increased competition, execution
risk, and an uncertain cryptoasset market by adding more
cryptoassets and exploring possible use cases for blockchain
technology with Toshi.
CHALLENGES AND RISKS
Coinbase faces increased competition from a number of existing
players as well as upstart decentralized exchanges. The company
is also struggling to execute at scale, with its support team racing
to field a backlog of questions around exchange downtime and
money transfer delays, among other issues. Lastly, Coinbase is
directly exposed to cryptoasset prices, and must remain vigilant in
the event of a sustained downward trend in the market.
Competition
Coinbase and GDAX face direct competition from a number of
fiat-cryptoasset exchanges. Bitfinex, Bitstamp, Kraken, and recent
entrant to the US market bitFlyer are Coinbase’s main competitors,
although there are others, including traditional brokerages like
Robinhood (which just announced support for cryptoasset trading
in five states).
It’s important to note that Coinbase does not support cryp-
to-crypto pairs (e.g. BTC/ETH) and only supports fiat-crypto pairs
(e.g. BTC/USD). As a result, the company’s pool of competitors is
more limited, as there are hundreds of crypto-crypto exchanges.
Binance is the largest cryptoasset exchange by volume (with
nearly $6B worth of cryptoassets exchanged on January 11), but
only supports crypto-crypto trading pairs.
The road
ahead: an open
financial system
24
Coinbase faces fiat exchange competition
24hr trading volume ($B). January 8, 2017
Additionally, and as noted above, none of the
exchanges mentioned here have strong mobile presences, and
only a couple offer brokerage services. Coinbase’s competitors for
the most part operate order book exchanges and cater to more
experienced traders. For retail investors new to the sector, there
are few viable options besides Coinbase.
Another angle of competition comes in the form of decentralized
exchanges, like 0x. 0x is a tokenized exchange initially launched
via a $24M ICO, and is gaining steam. While more technical and
more difficult to use, decentralized exchanges have no central
point of attack and therefore offer increased security. Still, activity
is limited when compared to major centralized exchanges, and
this threat should be considered on a longer time horizon.
Scaling
Coinbase has faced internal challenges from poor execution. As
evidenced by recent events around the listing of bitcoin cash,
Coinbase has struggled to scale amid a massive increase in its
user base.
In June, a flash crash on GDAX caused ethereum’s price to briefly
drop below a dollar before recovering. Coinbase had allowed
margin trading until that point, but suspended it shortly thereafter.
Coinbase faces fiat exchange competition
24hr trading volume ($B). January 8, 2017
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GDAX has continued to experience service outages, with some
lasting hours.
In a Q3’17 blog post, Armstrong addressed the company’s scaling
challenges, writing that Coinbase would “[rebuild] pieces of
our backend, [focus] on uptime and reliability, [scale] customer
support and [provide] faster response times, [and improve] the
customer experience.” Mr. Armstrong also posted a chart on
Twitter indicating that Coinbase would have over 200 customer
support representatives by October 2017, up from around 50 in
June 2017.
Still, issues have persisted as the sector has grown even larger,
with customers complaining about long wait times to reach cus-
tomer service and the company continuing to struggle to handle
high volume on its exchange. In a blog post published early this
year, Dan Romero, GM of Coinbase, highlighted that Coinbase
has scaled its transaction capacity by 7,700% and increased the
number of customer support agents by 887%, both over the past
year. Indeed, Coinbase is hiring across the board, particularly in
engineering roles for its brokerage and exchange.
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Coinbase continues to invest heavily in
engineering talent
Coinbase job openings. January 2, 2018
Key recent hires at Coinbase include Asiff Hirji (President and
COO), David Marcus (Board of Directors), and Tina Bhatnagar
(VP of Operations and Technology). Hirji joined the company in
December 2017 from Andreessen Horowitz and brings financial
services experience from TD Ameritrade. Marcus also joined the
Coinbase continues to invest heavily in engineering talent
Coinbase job openings. January 2, 2018
27
company in December, and comes from Facebook Messenger
and Paypal. At Paypal, he led the company’s global expansion and
product strategy. Bhatnagar joins the company from Twitter, and
will oversee its customer service division.
Coinbase has faced challenges as key employees have left for
other ventures, prompting some to reference a “Coinbase mafia.”
» Olaf-Carlson Wee, an early product manager at the company,
left in mid-2016 to start Polychain Capital, which is widely con-
sidered an elite cryptoasset hedge fund.
» Nick Tomaino, a business development hire, left in February
2016 to invest at venture firm Runa Capital, and recently
started his own cryptoasset investment fund, 1confirmation.
» Charlie Lee created Litecoin (as a fork of the Bitcoin block-
chain) in October 2011, and served as Coinbase’s director of
engineering until June 2017.
» Former Coinbase product manager Linda Xie and software
engineer Jordan Clifford launched a cryptoasset fund called
Scalar Capital.
» In addition, Fred Ehrsam, co-founder of Coinbase, has since left
the company to pursue other ventures.
Market risk
As a final challenge, Coinbase faces acute risk from market
forces. Exchanges are particularly exposed to market demand. In
the event of a market downturn, Coinbase could see its revenue
drop precipitously.
Further, while Coinbase is directly exposed to risk from cryptoas-
sets listed on its platform, it’s also indirectly exposed to other
more volatile cryptoassets. Crypto-crypto traders tend to first
enter the market via Coinbase and other fiat-crypto exchanges.
This means that cryptoassets not listed on Coinbase could still
have a material effect on Coinbase’s core businesses; if the
market flees to safety (perhaps due to a regulatory crackdown)
and trades back into fiat, Coinbase could face liquidity issues. In
other words, a major sell-off in broader cryptoasset markets could
make it hard to find buyers.
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Facing the challenges outlined above,
Coinbase continues to expand its core
businesses and explore farther-ranging
opportunities.
To hedge its exchange, Coinbase plans on adding more assets
to its platform according to its “Digital Asset Framework.” Doing
so would certainly pad the company’s pockets, but it would also
allow a large user base to explore new use cases for blockchain
technology. Additional assets, then, are both a hedge and a
gamble on the sector’s future.
With bitcoin’s first proposed use case as a “means of exchange”
not quite taking off, Toshi is an attempt by the company to find
other use cases for blockchain technology. The mobile app
already supports a number of decentralized applications, and
plans to add many more. Coinbase hopes that its massive user
base – first acting as speculators – will use Toshi for broader
financial applications and create the sector’s “Netscape moment.”
Still, VC investors are unlikely to want to see a significant strategic
shift until they see some sort of liquidity event. To this end, Hirji,
the company’s COO, has said that “the most obvious path for
Coinbase is for us to go public at some point.”
Ultimately, Coinbase’s story mirrors the sector as a whole. Bitcoin
hasn’t really worked yet, at least not in the way it was supposed
to. Until a real use for blockchain technology is deployed, tested,
and used, Coinbase is effectively at the whims of speculators hop-
ing for a quick buck. Coinbase understands its current and future
position well, and is actively working toward finding solutions that
work while riding this market for as long as possible.
Closing
thoughts