Interpretation of Coinbase Q2 Financial Report: What Did the Data and Conference Call Say?

Written by: jk

Financial Report Data

In the second quarter of this year, Coinbase (COIN) outperformed market expectations, reporting revenue of $708 million and an adjusted loss of $0.42 per share, exceeding the market's expected revenue of $628 million and a loss of $0.76 per share. However, despite the overall earnings exceeding expectations, trading revenue and trading volume fell to $327 million and $92 billion, respectively, both lower than the figures from the first quarter. Although the company's stock price rose for a period after the earnings report was released, it ultimately fell by 1.4% to $89.48, currently reported at $87.31.

In terms of revenue, Coinbase's financial situation underwent significant changes in the second quarter of this year. Subscription and service revenue (including custody fees, interest income, and staking income) reached $335 million, accounting for 51% of total net revenue, marking the first time in the company's history that non-trading revenue surpassed trading revenue. Nevertheless, some key components of the subscription and service business, such as interest income, showed a decline amid a decrease in market value. Of the interest income in the second quarter, $151 million came from its holdings of USDC.

In the second quarter, Coinbase's institutional trading revenue was $17 million, a 24% decrease quarter-over-quarter. Institutional trading volume was $78 billion, down 37% from the first quarter. The decline in institutional trading volume was primarily due to a decrease in market trading volume (including trading platform market maker volume) caused by a low volatility environment. However, trading volume on Coinbase Prime continued to grow, helping to support higher average fees in the second quarter compared to the first quarter.

Coinbase Q2 revenue data. Source: Coinbase official website

On the cost side, Coinbase continued to focus on operating with higher costs and efficiency. Total operating expenses in the second quarter were $781 million, a 13% decrease quarter-over-quarter. Of this, recurring operating expenses— including technology development, sales and marketing, and general administrative expenses— decreased by 1% to $664 million.

Coinbase's trading expenses in the second quarter were $108 million, a 12% increase quarter-over-quarter. The main drivers of the increased expenses were higher staking rewards paid to consumers and increased miner fees due to heightened Ethereum network activity. The proportion of trading fees to net revenue in the second quarter was 16%, up from 13% in the first quarter. This increase was due to a shift in revenue composition towards blockchain reward income and rising miner fees.

Coinbase Q2 expense data. Source: Coinbase official website

In terms of trading volume, despite Coinbase's stock price rising 160% this year, this did not change its challenges in trading volume. In the second quarter, total trading revenue fell 50% to $327 million, down from $655 million a year ago. The ratio of individual to institutional trading volume remained imbalanced. Institutional trading volume accounted for 85% of the total at $78 billion, while retail consumers accounted for only $14 billion. Despite the rebound in cryptocurrency prices, it did not attract more traders back to the Coinbase platform, with the number of monthly trading users decreasing by 19% to 7.3 million in the second quarter.

Key Questions from Earnings and Analyst Call

Here are some key questions extracted from the earnings call, to which Coinbase's CEO Brian Armstrong and CFO Alesia Haas, among other executives, responded.

Vice President of Investor Relations Anil Gupta: Our next question is, how does Coinbase plan to generate revenue directly or indirectly from the upcoming Base L2 platform? Will this encourage more users to leave Coinbase for on-chain operations, thereby harming trading volume? Brian?

Co-founder and CEO Brian Armstrong: Yes, I can answer that question. First, I want to correct a misunderstanding in the question itself. So the question is, will there be more users leaving Coinbase for on-chain operations? Coinbase is fully embracing on-chain operations. In fact, I believe this will be the easiest way to access everything you want to do on-chain. This isn't new. It's been this way for a long time; even when Coinbase launched 10 years ago, we allowed people to send and receive transactions that would occur on-chain while you were online and offline on the platform.

In recent years, we have allowed people to access decentralized exchanges and various smart contract protocols through the Coinbase wallet, and we are making this increasingly easier in our main retail applications. So just to be clear, we want Coinbase to be the easiest way to access everything on-chain. We believe on-chain is a very important part of the future development of this industry. People will achieve this through Coinbase. So these are not contradictory projects.

I think the key question is really asking how we profit directly and indirectly through Base (our Layer 2 solution). Just to briefly introduce, not everyone may be fully aware, blockchain transactions are conducted on what is called Layer 1. They often take longer to confirm and have slightly higher transaction fees, so the industry has been researching how to make it more scalable, how to lower costs, and how to make it easier for developers to build on what is called Layer 2 for a long time.

It's like the internet moving from dial-up to broadband. As an innovative company in the industry, Coinbase has been trying to help this happen. Based on the Optimism stack, we launched our own Layer 2 solution called Base, which will decentralize over time. Many developers are interested in this, and we are conducting many activities around this initiative.

So how will we make money from it? Simply put, Base will generate revenue through what are called sequencer fees. When any transaction is executed on Base, these sequencer fees can be earned, and essentially, Coinbase can run such a sequencer over time like others. Now, indirectly, it also helps us generate revenue because it helps us grow the market size. It helps us expand the ecosystem. Again, it goes back to the internet analogy. But if we can increase so much utility and make global payments faster and cheaper, then more and more people will use cryptocurrency every day, and that’s how it indirectly helps our business grow.

Anil Gupta: Next question. Recent enforcement actions remain a top concern for many shareholders. Can you provide an update on the litigation process with the SEC? What are the key issues? How should we view the timeline and milestones moving forward? Paul?

Chief Legal Officer Paul Grewal: Thank you, Anil. Regarding the litigation with the SEC, I want to be very clear that we do believe we can win. We look forward to winning. But it’s important to understand that our goal is not just the litigation, but also all of our interactions with the SEC and the entire U.S. government. Our goal is to achieve regulatory clarity, protect consumers, promote innovation, and establish clear rules of the road that everyone can understand and follow. We believe that no matter the outcome of any particular case, this is how we all can win. That’s why, while we are focused on enforcement actions, we are also looking at legislation and other efforts that may provide the clarity I mentioned.

Now, the reason we are so focused on pushing for regulatory clarity in the U.S. is that under the current circumstances, we are receiving very conflicting messages about the legal definitions, especially considering that these laws were enacted before the internet emerged. Take, for example, the conflicting statements from the SEC Chair and the CFTC Chair about whether Ethereum is a security. Or consider the significant differences in the SEC Chair's stance over the past two years regarding whether regulatory authority applies to cryptocurrency exchanges like Coinbase. Therefore, in any particular case, the outcome is what we ultimately define as regulatory clarity…

In fact, tomorrow, in our case in the Southern District of New York, we will be asking the court to dismiss the entire case. We will submit a brief outlining all the arguments we are asking the court to consider, and we expect to complete this by the end of October for consideration. We are confident in the arguments we are presenting to the court. We certainly appreciate the opportunity the court has given us to be heard early in the case, as we have been working hard to achieve clarity.

Bank of America Jason Kupferberg: Your growth in staking is really impressive, and I’m curious what trends you are seeing in adoption? I assume most of it is Ethereum, right? If you could provide us with more information on this, that would be great.

Chief Financial Officer Alesia Haas: We are seeing good adoption in staking. One exciting thing we saw in the second quarter was widespread adoption among our institutional clients after the Shapella upgrade, when customers could have truly liquid assets on Ethereum. Clearly, a major barrier to their participation in staking was that they could not access liquidity. Therefore, we saw rapid acceptance of these balances. By the end of the second quarter, we shared that our institutional clients had staked approximately $2 billion worth of Ethereum. We also saw stable growth in quarterly staking balances.

I want to comment that each chain is a different story. So, investors on each chain first want to own that asset, and once they own that asset, they will decide whether to stake their assets. So, this will depend on the growth and interest of each different proof-of-stake network. But we are indeed seeing, especially on the institutional side, that Ethereum is becoming a driver of growth.

KBW Kyle Voigt: Maybe we can circle back to the retail fee rate issue. The comments in the first quarter were that there were changes in rates during the first quarter. I think this means that the first quarter may not represent the run rate for simple trading fees. So I understand that most of the retail fee rates are related to the mix. But I also want to know if you can quantify how much of the increase in retail fees from the first quarter to the second quarter was due to the rate increases implemented in the previous quarter?

Chief Financial Officer Alesia Haas: So we do consider and attribute it internally, but the vast majority of the impact is due to the mix. This impact far outweighs any other changes in this quarter.

Kyle Voigt: It looks like customer fiat balances decreased by $1.5 billion this quarter. I’m curious what drove this quarter-over-quarter change? Also, did the Coinbase platform see net customer inflows or outflows in the second quarter?

Chief Financial Officer Alesia Haas: Specifically regarding customer fiat balances, I need to look back and remind everyone what happened in the first quarter. In the first quarter, due to the banking crisis, we actually saw fiat inflows during that quarter. And these fiat inflows were primarily concentrated among a few institutional clients. So large, block deposits came in at the end of the first quarter. When people thought it would be safer to move fiat from some challenged banks to Coinbase, there was a chase for quality assets. As we saw the banking sector stabilize, these funds flowed out in the second quarter.

Overall, if I expand from the first quarter to the second quarter, fiat balances tend to track overall market activity. So, as we saw lower volatility and a decrease in trading volume, we naturally saw fiat decrease from the platform. The fiat balance at the end of the second quarter is somewhat similar to our fiat balances during other low volatility, low trading volume periods. Therefore, I think we should view the second quarter as slightly more normal, while the first quarter appeared higher due to the overall events in the banking market.

Major Events and Summary of Coinbase's Second Quarter

In terms of the timeline, the major event Coinbase experienced in the second quarter was the SEC lawsuit, so the sluggish data was somewhat expected. The U.S. Silicon Valley Bank crisis and Wells Fargo notifications occurred in the first quarter, while the XRP ruling that caused Coinbase's stock price to surge occurred in July, and its impact on Coinbase's revenue will be recorded in the third quarter, so it can be seen that Coinbase's outlook for the third quarter is relatively positive.

Major events in the crypto market, correlation between total market capitalization and weekly volatility. Source: Coinbase official website

Overall, while Coinbase's overall financial performance in the second quarter exceeded market expectations, the decline in trading revenue and trading volume reflects the impact of reduced volatility in the cryptocurrency market. However, the company's subscription and service revenue performed strongly, surpassing trading revenue for the first time, indicating that Coinbase is diversifying its business model to adapt to market changes. For institutional clients, the decline in trading volume was primarily due to a decrease in market trading volume. In terms of operating expenses, Coinbase achieved a quarter-over-quarter decrease and continued to focus on improving cost and efficiency. Looking ahead, Coinbase will continue to adjust its business strategy to address the challenges and opportunities in the cryptocurrency market.