The Possible Future of Coinbase, the "Compass" of U.S. Crypto Regulation

Author: Xi Angxiang, ChainCatcher

As a leading compliant exchange in the United States, Coinbase represents the government's tolerance threshold for the cryptocurrency industry. Its stock price fluctuations not only directly reflect the company's financial performance but also embody the capital market's expectations regarding U.S. cryptocurrency regulation.

It is well-known that Coinbase's listing marked its peak, and in the following years, its performance was dismal, plagued by negative news, leading to a continuous decline in stock price. However, since the beginning of this year, it has finally experienced a rebound from the bottom. With the recovery of the cryptocurrency market, its stock price has more than doubled from a low of over $30.

Currently, the challenges facing Coinbase remain daunting—its recent stock price volatility is closely related to investigations initiated by regulatory agencies. This article will analyze the current fundamental situation, regulatory dilemmas, and potential future developments, starting from Coinbase's past global expansion strategy and combining it with its latest quarterly financial report.

Coinbase's Global Expansion Strategy Has Not Succeeded

As one of the oldest companies in the cryptocurrency industry, having experienced multiple bull and bear markets since its establishment in 2012, Coinbase has rapidly developed into a top cryptocurrency exchange known for its compliance.

However, like many industry giants, Coinbase seems to have fallen into a growth dilemma after its peak. Rapid expansion has not led to impressive growth figures; instead, a significant decline in revenue and profits has caused its stock price to plummet. According to financial reports, Coinbase accumulated losses of $2.069 billion in the first three quarters of 2022.

At the beginning of 2021, Coinbase had only 1,250 employees, but by the end of 2021, it had expanded to nearly 3,200 employees. In a public conference call at the beginning of 2022, Coinbase announced plans to double its workforce, continuing to hire over 2,000 more people. The continuous growth in employee numbers directly reflects Coinbase's ambition for expansion.

However, with the emergence of black swan events like Luna, the cryptocurrency market quickly cooled, forcing Coinbase to adopt a cautious approach: first announcing a slowdown in hiring in May, then stating it would pause hiring and rescind some accepted job offers. Ultimately, it further announced large-scale layoffs, reducing its team size by about 18% to cut company expenses. According to The Wall Street Journal, Coinbase even canceled free employee lunches.

CEO Brian Armstrong pointed out that due to the potential economic recession, Coinbase needs to control its cash burn rate and improve efficiency.

At the same time, as the industry cooled, Coinbase's global expansion strategy faced numerous setbacks.

Take the Indian market as an example. In early April 2022, Brian Armstrong and his team visited Bangalore, where Coinbase had over 300 full-time employees across various states and regions in India during their visit. In related meetings, Coinbase announced it was increasing support for India's UPI payment tool. However, the UPI developer soon denied any collaboration with Coinbase, leading the company to quickly halt its support for UPI.

In fact, the challenges in the Indian market are just a microcosm of Coinbase's global compliance process: despite incurring significant compliance costs, Coinbase's business has struggled to fully integrate into compliant financial systems due to unclear and fluctuating cryptocurrency regulatory policies in various countries, making it difficult to attract mainstream audiences.

Behind Coinbase's Latest Quarterly Financial Report

Despite the unfavorable conditions in 2022, it is worth noting that at the beginning of 2023, Coinbase's rebound from the bottom seems to be sending a sufficiently positive signal to the market: as the second-largest cryptocurrency exchange globally, it still firmly holds its fundamental base.

This is evident from Coinbase's latest quarterly financial report (Q4 2022):

1) Although revenue is significantly declining due to a continuous drop in cryptocurrency trading volume, the company's fourth-quarter performance was solid, with revenue and profit growth exceeding expectations;

2) Coinbase earned substantial interest income from assets held on its platform, with this income increasing by 79% quarter-over-quarter to $182 million in Q4 2022;

3) Its subscription and service revenue also grew by 32.5% year-over-year to $282.8 million.

Since the cryptocurrency market turned bearish in Q1 2022, Coinbase has faced a very difficult situation, which was further exacerbated by the collapses of Terra and FTX. Fortunately, Coinbase has proven to be resilient, maintaining a solid leading position.

The first reason for its "stability" is the healthier source of trading volume on its platform.

The table above reflects the trading volume share of different asset classes on the Coinbase platform, including Bitcoin, ETH, and others, with "others" comprising some so-called "altcoins."

Comparing the past five quarters, the share of the "other" category dropped from 68% in Q4 2021 to 33% in Q4 2022. This is both a result of the rapid decline of "altcoins" and new ICOs, and it indicates that more relatively high-quality and stable trading is continuously growing on the Coinbase platform.

The second reason for its "stability" is the healthier customer types on the platform.

The table above shows the trading volume contribution from two types of traders on Coinbase. Breaking it down, retail (Consumer) trading volume fell from $177 billion (32% share) in Q4 2021 to $20 billion (14% share) in Q4 2022; although institutional (Institutional) trading volume also declined from $371 billion in Q4 2021 to $125 billion in Q4 2022, its share increased from 68% to 86%.

This is beneficial for Coinbase, as it indicates that institutional funds are taking cryptocurrency assets more seriously as a new asset class (even if interest has declined in the short term), and it also proves that Coinbase is earning the trust of institutions (hence their choice to trade here).

In Q3 2022, Coinbase was selected by the world's largest asset management company, BlackRock, to provide cryptocurrency trading channels for its Aladdin (end-to-end investment platform) clients. In January 2023, BlackRock chose to add Bitcoin as an investment target to its global allocation fund.

During the Q4 2022 earnings call, Coinbase's management also stated that they are seeing an increasing number of institutional investors joining their Coinbase Prime program.

The third reason for its "stability" is that Coinbase is developing new sources of revenue.

Coinbase is generating income from the assets held on its platform through a combination of staking and interest income. According to the financial report, its interest income in Q4 2022 increased by 79% quarter-over-quarter to $182 million. This was mainly driven by rising interest rates, which yielded significant returns on the large customer assets it manages.

Additionally, the company's subscription and service revenue grew by 32.5% year-over-year to $282.8 million (as shown in the chart below). This growth is primarily attributed to the continued momentum of the Coinbase One program and ETH staking.

Possible Future for Coinbase

Although Coinbase currently has a relatively solid fundamental position, its future development needs to consider a series of "tailwind" and "headwind" factors.

Clearly, the most significant factor affecting Coinbase is when the cryptocurrency market will recover. The reason is simple: the increase in Coinbase's revenue begins with the return of investors, and the return of investors will inevitably be due to the overall price increase in the cryptocurrency market. Although the Q4 2022 financial report exceeded expectations, it must be acknowledged that it faced heavy blows in 2022, with monthly active users and trading revenue continuing to decline.

Therefore, the return of a cryptocurrency bull market is crucial for Coinbase. This is the most effective catalyst for helping Coinbase win back lost users.

The second most important "tailwind" factor for Coinbase is naturally the new sources of revenue.

One highlight to look forward to is staking income, which has been on the rise. In 2021, staking accounted for less than 1% of Coinbase's total revenue; by Q3 2022, it accounted for over 10% of revenue.

Of course, the issue here is that the SEC has made staking a regulatory focus. In February, the SEC imposed a $30 million fine on the cryptocurrency exchange Kraken for offering staking products to investors and hinted at a crackdown on the entire industry. In response, Coinbase has repeatedly emphasized that staking is not a securities product. However, the ultimate outcome remains uncertain.

Aside from staking, Coinbase is also seeking other sources of revenue. One is subscription revenue, such as fees from products like Coinbase Cloud. The other is international business—Coinbase Global. It continues to push for global expansion and shows no signs of slowing down.

Coinbase's strategic initiatives also include collaborating with Optimism to launch Base, a secure, low-cost, developer-friendly Ethereum L2 solution. Perhaps it could ultimately serve as a platform for institutional investors, especially in providing new DeFi products, which could open up new revenue streams for Coinbase.

However, all these numerous "tailwind" factors will ultimately be constrained by one question—how many legal and regulatory risks will Coinbase still face?

It seems that every month, the SEC announces new heavy-handed actions against the cryptocurrency industry.

Coinbase needs to address this issue head-on or at least show the market its determination. This is why it has taken a confrontational stance with the SEC regarding staking, as it not only indicates the importance of this revenue source to the company but also signals its willingness to actively respond to significant challenges that may exist in the industry.

Additionally, Coinbase recently launched the "Crypto435" advocacy campaign, which will promote lobbying efforts for supportive cryptocurrency policies in 435 congressional districts in the U.S., encouraging legislators to be more friendly towards cryptocurrencies.

All evidence suggests that Coinbase is preparing for a protracted battle.

Brian Armstrong emphasized in a letter to employees, "Over the past decade, Coinbase has weathered multiple bear markets." He believes that Coinbase will benefit from stricter cryptocurrency regulatory policies, as this helps eliminate underperforming companies in the industry.

We believe that Coinbase's growth reflects the transformation of the entire industry. Although many use cases supported by the underlying blockchain technology have yet to truly take effect, or have not fully operated as envisioned by their inventors, cryptocurrency companies represented by Coinbase are still actively seeking solutions to drive the industry forward.