Coinbase: high potential rewards but huge risks too

Trading platform Coinbase (NASDAW:COIN) made its debut last Wednesday amid a great deal of fanfare around the world about the seriousness the listing proffers to the fledgling asset class of cryptocurrencies. But beware: while rewards from this stock could be stonking the risks are commensurate.

Coinbase started its first session well, opening up 52% off its reference price at $328.28 and reaching an intra-day and to-date peak of $429.54. Since then, it’s seen some dips but by Friday gained ground (thanks in part to ARK Invest taking a hefty $168 million stake). Tuesday, it closed at $333, putting its market capitalisation at $65.52 billion. Not a bad start at all but is it overvalued?

The buzz around crypto is no longer focused on hacking fears and talk of a bubble (not that we would dismiss that possibility). Now it’s also about how the Coinbase IPO, increased institutional investor interest and investments by industry heavyweights Tesla (NASDAQ:TSLA) and Square (NYSE:SQ) (not to mention celebrities getting in on the act), are lending credibility and mainstreaming this asset class.

This is good news especially for Coinbase as analysts have said this is a relatively safe way for investors to dip their toes into what remains a volatile asset class by taking a stake in a company that has been approved for listing by the US SEC. On the face of it, the company looks solid with monthly transacting users (MTU) of 6.1 million at the end of the first quarter. Among its users are 7000 institutions.

All this has prompted an initiation of coverage by brokerage firm BTIG with a ‘buy’ rating and an incredibly bullish target price of $500. Analyst Mark Palmer has said repeatedly to various media that Coinbase is a “safe haven” — no issues with regulators and no hacking so far — and that he expected the company to reap substantial institutional subscription and services revenue.

Multiple risks are still inherent in Coinbase

But where there are rewards, there are risks, not least in the asset class itself as Coinbase’s revenues depend strongly on the performance of cryptocurrencies. On Sunday, Bitcoin (BTC-USD) fell 11%, its largest drop in two months. Dogecoin (DOGE-USD) meanwhile has been rising sharply with retail investors bulling it up to high levels, prompting fears it will become another Gamestop (NYSE:GME).

Bitcoin, which makes up a large percentage of trades on Coinbase, is seen as more established and thus a safer bet. According to research published April 8 by ARK Invest, the HODL waves for Bitcoin (which essentially measure the number of transactions in a given period) show that 55% of its supply hasn’t moved in over a year, “we believe illustrating investors’ longer-term conviction and focus”.

One way to minimise the risk of a cryptocurrency punt according to several analysts is to consider the famous price cycles of cryptocurrencies, buying the dip and holding on. Previous cycles, according to Coinbase, have lasted from two to four years, although it noted that while crypto market capitalisation has increased each cycle, these cycles have been “highly volatile”.

Institutional revenue flow is not predictable

Coinbase has also warned it its 2021 outlook that it faces three scenarios: high (7 million); mid (5.5 million); or low (4 million) MTU. Its rather complex outlook has a very simple takeaway: the company expects “meaningful growth” but institutional revenue (the big pull for people of the same mind as BTIG’s Palmer) is “unpredictable” and only in one of these scenarios does the MTU exceed that of the first quarter.

This risk aside, there’s still the regulatory risk which abounds globally. Although the SEC investigation into Ripple Labs (CCC:XRP) has shown some positive developments, there has been pressure in Asia (notably in Japan), Europe is gearing up to introduce regulation, and the volatility, especially if we do see a repeat of Gamestop, is likely to prompt yet further scrutiny.

A third factor is competition from new entrants and from incumbent trading platforms. With such hype, it’s widely expected by analysts that other exchanges will go public, driving down profits as they seek their slice of the pie. Meanwhile, Wall Street’s big boys have rebounded in the last quarter. The Financial Timeswarned what it dubbed the “crypto kids” not to assume the boomers are dead yet.

We believe that crypto will continue to grow and bring gains for bold investors, but they should remember that high reward here equates with high risk; and while there is a clear scenario in which crypto continues its climb, giving rewards to those who cling on to Coinbase to ride out these famous price cycles, there are a lot of factors that will make this a rollercoaster ride.

This article was brought to you in partnership with The Armchair Trader.

Emma Portier

Emma Portier has more than 20 years’ experience as a financial journalist, starting out as a regulatory correspondent for Euromoney and then joining the Financial Times group as a wealth management writer. She has spent several years as a financial markets reporter for AFX News in Stockholm and then as an EU antitrust reporter in Brussels where she then joined Reuters.

Emma’s core expertise is following EU regulatory developments and how these affect financial markets. She set up the climate change and energy news service for the regulatory risk news agency MLex and then worked as a special EU correspondent for the Bureau of National Affairs. Emma has advised key players in Brussels on their media relations strategy and provides content to a range of private and institutional clients.