Coinbase Q3: Stablecoins, Layer 2, And Beyond

Summary Coinbase aims for $2 billion in subscription and services revenue by 2024, up from $1.4 billion in 2023, diversifying beyond crypto trading. The company is enhancing its ecosystem with EURC stablecoin growth, a user-friendly smart wallet, and the low-cost Base Layer 2 solution. Despite a challenging Q3, Coinbase remains well-positioned for future growth, focusing on regulatory clarity and expanding into derivatives markets. Last time I covered Coinbase ( COIN ), we delved into the pivot to a subscription-based model and institutional adoption. On that front, the 3Q24 earnings release brought additional progress with the company targeting $2 billion from subscriptions and services in 2024, a significant improvement from $1.4 billion in 2023. In the earnings call , the company revealed further progress in driving utility beyond crypto trading. They see a lot of potential in stablecoins, especially for low-cost transactions like remittances. They also think that Base, their layer 2 solution, will help scale blockchain transactions globally, making them fast and low-cost. Deep dive on recent initiatives Coinbase launched EURC , the company’s Euro stablecoin, on Base. In Q3, EURC’s market capitalization doubled, making it the largest euro stablecoin. With this, the company tapped into the global market beyond the USD, opening the door to other currencies, which will increase utility for users globally. They have also introduced a smart wallet to make the onboarding process easier. Coinbase’s wallet doesn’t rely on recovery phrases; instead, it uses passkeys or biometrics. Traditional smart wallets were a barrier to adoption, given the history of forgotten passphrases and loss of funds. Finally, Base, the company’s Layer 2 protocol, is reducing transaction costs to under $0.01 with near-instant transactions. One of the main advantages is the use of common names instead of complex wallet addresses. Financial performance Coinbase posted revenues of $1.2 billion for Q3; transaction revenue was down 27% sequentially from the previous quarter, mostly due to the reduced volatility in crypto assets and an 18% decline in trading volume. Sequentially, subscription and service revenue is down 7%, with the bright spot being stablecoin revenue. The company has been betting on stablecoins through product updates for advanced traders. Coinbase On the expense side, total operating expenses are also down 6%, in part due to lower transaction expenses and gains on crypto held for operations. With that, net income was $75 million, also impacted by an unrealized loss in their crypto investment portfolio. Coinbase Looking ahead, the company expects some revenue headwinds stemming from the Ethereum price decline in October, due to products like staking that depend on the asset value. Additionally, lower interest rates can also be a burden for the company, especially in the interest-sensitive stablecoin segment. Coinbase Business model considerations One of my most important theses regarding this company was that it is on its way to reducing its dependency on trading activity . Nevertheless, the main indication from this earnings release is that the company continues to depend on high volatility and the ensuing higher trading activity as hedge funds, market makers, and other advanced traders join in. As we have seen, once volatility abates, the company’s profits follow suit. There is nothing inherently wrong with this business model; its drawback is simply that it is not Wall Street-friendly. Investors prefer to see stability and stickiness in revenue, and this volatility in revenues and profits gives them vertigo. In any case, the company is operating in an expanding sector. One example is that the following year will likely bring regulatory clarity, which might unlock a wider range of assets beyond Bitcoin and Ethereum. It might also enable stablecoins for merchant payments, making it a mainstream payment option globally . Several potential growth avenues are still unexplored in crypto, and Coinbase remains incredibly positioned to take advantage of them. Valuation As the only listed crypto exchange in US markets, Coinbase is in a category of its own. Nevertheless, we can use a set of peers that allow us to contextualize its valuation. For that, I chose a traditional exchange, Nasdaq (NDAQ), a fund manager with close ties with crypto, BlackRock (BLK), and a social media company that has delved into the metaverse, Meta (META). YCharts Looking at the valuation figures for sales and profits, we can see that Coinbase is well within the valuation interval for the peer set. Risks So far, we have framed Coinbase as a company native to digital assets, with much room for improvement, numerous opportunities to explore, and still fine-tuning its business model. Nevertheless, it is important to highlight the risks facing the company. One of the major risks is regulatory uncertainty and the potential cost of compliance. The crypto regulatory framework in the US remains in flux, with much uncertainty. Unfavorable regulations could create substantial compliance costs that might make the company’s business model uneconomical and harm some business segments. For instance, the ambition to enter the derivatives market might be hindered by regulatory challenges, while competitors might capture market share faster. Staking, also a significant revenue stream, is under scrutiny, and the company might face constraints in different jurisdictions. On the other hand, Coinbase’s revenues are still highly dependent on crypto market volatility. A prolonged bear market or waning interest in crypto trading could lead to lower revenues. There is also exposure to the company’s crypto holdings, as asset price declines could reduce the value of its balance sheet. There will likely be competitive pressure on the technology side. Base, the company’s Layer 2 solution, is a promising product, but various competing products will likely emerge. Given its technology profile, cyber risks are also a potential issue , and a security breach could even result in lost funds. Nevertheless, to the best of our knowledge, the company has been capable of managing these issues and thriving. Conclusion Investing in this company relies upon a couple of theses that this earnings release has not negated. Revenue diversification as a strategic hedge against low market volatility is still in play and although this wasn’t a bright quarter in terms of growth in this segment, the company is still on track to surpass $2 billion in 2024. With a significant effort underway to build a recurring revenue base, the company is improving its ability to navigate crypto’s cyclical nature. Then, the company also has a differentiated technological approach by being crypto-native. The company has developed its Layer 2 blockchain solution, which allows seamless integration into the company’s platform, while also being friendly from the developer’s perspective. Its low transaction fees and ease of use make it a very compelling option . Finally, the expansion to derivatives markets is a very interesting growth opportunity for the company. The MiFID license in Europe should open the doors to 20 additional EU markets, and it should be a compelling solution for institutional clients seeking regulatory-compliant solutions. Given the TAM for crypto derivatives, this could become a major revenue contributor. CCData As we have seen, the growth in revenue has come in waves that are tightly linked to the sentiment in crypto markets. Although the company is trying to create a recurring revenue base, this will take time, and I think the previous pattern of revenue growth in waves will remain for the time being. In that case, and given the immense opportunities surrounding the company’s markets, we can illustrate a potential price target in case we see another growth burst. Seeking Alpha For instance, if we use as reference the highest estimate for 2025, considering a 12% growth in shares dilution and a 9.5x sales multiples, we would get the following price target for next year. Author’s computations In my view, the thesis for Coinbase is untouched after reviewing the 3Q24 earnings release. Therefore, we are maintaining our rating.

Source: Seeking Alpha