Coinbase: how optimists quarreled with pessimists

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

Table of Contents

History of creation

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

While working at Airbnb, Armstrong noticed high commissions, the company’s opaque settlement system with Latin American countries and decided to create an electronic cryptocurrency wallet as a mobile application. As conceived by the programmer, his invention would significantly speed up transactions, reduce commission payments and make financial flows easily verifiable. But the project was ahead of its time and did not gain popularity.

The failure did not bother Armstrong, and he set to work on a new development – a cloud service for buying, selling, exchanging and storing cryptocurrencies. This idea formed the basis for the creation of Coinbase. The young American presented the project as part of the Y Combinator startup accelerator and managed to get an investment of $150,000. At this stage, Brian met the second founder of the exchange, Goldman Sachs trader Frederick Ersam. The latter’s connections allowed Coinbase to enlist the support of several banks in conducting foreign exchange transactions and raise funding of about $500 million from venture capital firm Andreesen Horowitz.

The third co-founder of Coinbase was Armstrong’s friend, programmer Ben Reeves. However, he was soon forced to leave the team due to disagreements over the centralized storage of passwords. Brian was convinced that the exchange should keep copies of user passwords on its servers. This would allow you to quickly restore access to your own funds in case of loss of keys. The problem was especially relevant for beginners, 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 was forever deprived of access to his coins.

Coinbase now

The listing of the second largest cryptocurrency platform on the stock exchange is the first time in history when the largest blockchain company has acquired an open status and at the same time did not use popular market entry schemes (IPO or SPACs associated with the issuance of new shares). Coinbase opted for direct asset placement (DPO), without the participation of intermediary underwriters. In this case, the company does not issue securities, those that are owned by current shareholders go on sale. In the first minutes, the value of Coinbase shares (stock ticker COIN) rose to $428.9, but soon corrected to $328.8. This led to the fact that the company’s capitalization at the moment exceeded $100 billion. For a short time, Coinbase became the largest exchange in the world, surpassing even the NYSE and NASDAQ. True, by the close of trading, her portfolio had decreased to $86 billion. But even this amount was 30% higher than the 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 – $322 million). This is 250% more than a year earlier ($483 million).
In 2017, the exchange became the first unicorn company among bitcoin startups. Its capitalization exceeded $1.6 billion.
In 2019, it topped the list of 11 unicorn companies in the cryptocurrency industry with a valuation of $8 billion.

At the same time, Coinbase financial statistics are already breaking all industry records:

Q1 revenue was $1.8 billion and net income was $800 million;
trading volume for the first 3 months exceeded $330 billion;
on the exchange there are a total of $223 billion of funds from its clients, which is more than 11% of the volume of the entire cryptocurrency market (of which more than half are the assets of institutional investors);
the number of active visitors to the site – more than 6 million people, verified accounts – more than 55 million;
administrative expenses and investments in blockchain technologies 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 depositing and withdrawing funds;
users’ money is insured by Lloyd’s;
has a license of a broker and a bank transfer operator;
one of the first to receive permission to work with cryptocurrency;
transactions of participants are regularly monitored for signs of money laundering, reporting is maintained for the US tax authorities.

At the same time, Coinbase strives to maintain the anonymity of its users. Once the exchange had to go to court to challenge the instructions of the US Internal Revenue Service to provide access to all data of its clients, up to private correspondence. Despite the fact that, by court order, Coinbase was forced to disclose the data of 13,000 people, information about the remaining 500,000 did not go to the side.

Exit to DPO: details

At the end of 2020, Coinbase made the decision to place shares through a DPO, a direct listing. This happened immediately after the removal of the SEC (US Securities and Exchange Commission) restriction.

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

DPO helps save money on investment bank fees, marketing and presentations to potential members. But this type of accommodation also has certain disadvantages:

there is no possibility to raise additional capital;
there is no insurance and guarantees from intermediaries.

The latter option is usually chosen by companies that are confident in their abilities and attractive to investors.

Coinbase introduced two types of stocks: Class A and Class B. The difference between them is as follows:

class A papers give investors 1 voting right;
class B papers – 20 votes at once.

B-class shares are allowed to be exchanged for A-class shares. In total, 114,850,769 assets of the first type and 15,850,115 of the second type were placed. Thus, holders of B-shares own more than 90% of all votes. It is curious that each of the 1,700 employees of the exchange received 100 securities.

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

Coinbase’s entry into the stock market generated solid returns for early investors. The venture capital fund Intialized Capital invested about $300,000 in total in Coinbase in 2012-2013. In 2015-2018, additional shares were bought for another $1 million. The average purchase price was only $0.15 per unit. After listing on NASDAQ, this investment generated $680 million in revenue for Intialized Capital.

Slightly less profit per dollar of investment received:

Union Square Ventures and Ribbit Capital, which purchased Coinbase shares at $0.2;
Andreessen Horowitz, average purchase price – $1 per paper;
DFJ Growth – $2.76 and more

Coinbase assets are also available as tokens on the blockchain. This allows you to earn on fluctuations in the exchange rate of securities without investing fiat money, but using cryptocurrencies to buy.