With Coinbase going public, the world of crypto now feels very real to many people. Of course, this is an inflection point for the industry – and a very exciting one! I still find it fascinating that no one knows who actually created Bitcoin, but I guess that’s part of the draw and the myth of the origin story.
Having spent the last 9 years working in fintech, I’ve had the privilege of seeing many trends first hand, and from several different angles. I got to know several exchanges, brokerages (institutional and retail), and generally intelligent industry people. I watched the experiments they ran and the product decisions they made. Based on that experience, there are two themes that I see playing out at Coinbase, and I believe they are worth considering because they will have some interesting knock-on effects for what overall participation looks like, how it evolves (for both retail and institutional) and who dominates this space long term.
Price – the well trodden race to zero
If you take a look at Coinbase’s site, you can get a quick overview of their fee schedule. While the fees depend on the location, and the transaction type, it usually is a combination of a percentage (%) fee and a fixed ($) fee. The amazing thing is that the percentage fee can range from one to four percent of the transaction. Additionally, if you leave your crypto on the exchange, they allow you to stake it out to third parties (through various options, and this is one of the most interesting and emerging areas of crypto), but they take a 25% commission on that as well.
Suffice it to say, but the fees are quite substantial.
With any brokerage, I can’t help but believe that the long term pressure is towards zero, and specifically, free trading. We’ve seen this in equity trading over the last 25 years. It started with calling in trades for $50, then online trading for $9, then free trading with a certain minimum of volume, and now free trading regardless of volume (enter, Robinhood, followed by everyone else). Timing is always unknown, but ultimately it feels like all trading prices move towards zero in every asset class, and I don’t see why Crypto would be any different.
The question then becomes, how will Coinbase continue to grow revenues? What paths will they take? To me, there are two main strategies they could pursue, and I’m interested to see where they go.
Two strategies going forward: new revenue streams, or new platforms
First, they could pursue the ‘alternative revenue streams’ that retail brokerages have historically leveraged. This is a well built playbook. There are many, but some of the top ones are:
Requiring clients to hold a certain amount of crypto on the exchange, that Coinbase can then lend out/monetize. Brokerages currently do this with ‘minimum cash balances’ or requiring you to hold a certain portion of your portfolio in cash as a ‘hedge’ that they actually just lend out on the short term money market (which turns out to be quite profitable).
Providing margin: this turns out to be very profitable as well, as you can charge a very material interest rate on margin
Selling order flow: this one may turn out to be the most interesting because as it stands right now, I’m not sure if there are any disclosure requirements around selling crypto order flow in the same way there are disclosure requirements around selling retail order flow in equities (it’s called a 606 and 607 disclosure, and you can read Robinhood’s here). Now, I don’t even know if it logistically makes sense to sell Crypto order flow, but it’s proven to be one of the most lucrative revenue streams for equity brokerages, so this just feels like the same model with a different underlying asset class. I guess with Coinbase being public, we might get to see if this is happening (and if so, to what scale)
Second, they could build the ‘surrounding infrastructure’ of a crypto market. As crypto becomes institutional, there is going to be a cottage industry of software and services needed to facilitate that market, and some of those platforms may end up being more defensible than the actual trading market.
As a parallel in a totally different industry, look at how the company behind the very popular “Fortnite” leveraged the cash flow from that game to launch a gaming platform. Realizing that the success of Fortnite was a limited time event, they looked to leverage the success (and cash) from the game into a potentially bigger and more defensible platform.
In the traditional markets, while the Exchanges and infrastructure providers historically made substantial profits, I think it was the communication infrastructure providers that ultimately won and built the most enduring (and profitable) platforms, specifically Bloomberg. By building out their network (built around Bloomberg Chat) they were able to build a massive platform and a massive business.
I can’t help but think that there are similar opportunities in the Crypto space, especially as it begins to blend institutional and retail. There is so much information out there, and while there are several emerging communities, it feels like Coinbase is in a position to establish itself as the center of gravity.
Regardless of what happens, with the Coinbase IPO, it’s a new era for Crypto, and a new era for Coinbase itself, as everyone gets to see under the hood for the first time, and gets to witness how wide those margins actually are.
Nothing attracts competition more than big margins, and big profits.
Just some thoughts from the sidelines, but it will be an exciting year!