Deep dismantling of Coinbase: from the king of encryption to the open financial system glory and risk coexist

Coinbase is the most popular consumer-oriented crypto asset exchange in the United States, and it has gained a significant reputation in the consumer/transaction field of crypto enthusiasts.

In May 2021, Coinbase once again ascended to the top position of the Apple App Store. Although it has been in the first place for a short time, its popularity has soared and it has positioned itself as a “safe haven” among crypto exchanges. And “the entrance to mainstream crypto investors.” In addition, Coinbase is also frantically pursuing compliance with existing regulations and law enforcement, and placing its business in the right position of the law-this is a “huge asset” in the crypto industry that still urgently needs regulatory guidance.

This helped Coinbase obtain nearly $540 million in equity financing from some big-name venture capital institutions, and made the company a “crypto unicorn.” Coinbase was listed on the Nasdaq in April 2021, and its direct listing opening price was $350 per share, which was $100 higher than its set reference price.

Although Coinbase is known for its crypto asset trading business, its ambition goes beyond helping people buy and sell crypto assets. The company’s goal echoes the ultimate vision of crypto asset enthusiasts: to create an “open financial system.” However, for now, Coinbase looks a lot like a traditional financial services company, making money by charging brokerage and transaction fees, and custody user funds like a bank, and decide which crypto assets can be listed on the trading platform.

This begs the question: Is Coinbase still interested in encouraging the adoption of encrypted assets to build a new financial system, or is it mainly dedicated to promoting the increase of its trading business?

In this article, we will study Coinbase’s operation method and its efforts in promoting blockchain technology from the perspective of Coinbase’s strategy, financing history, product supply, business plan, threats and challenges.

A brief overview of Coinbase’s business

Today, Coinbase operates in more than 100 countries/regions, and its 21 products can be divided into 3 main business lines:

  • For individuals: Coinbase, wallet, USD Coin
  • For enterprises: Prime, Commerce, Exchange
  • For developers: Cloud, Connect, WalletLink

Coinbase Prime: Enables institutional investors to buy, store and trade crypto assets on a large scale.

Coinbase Commerce: Enable companies to use the Coinbase Commerce platform to accept encrypted payments.

How does Coinbase make money?

Coinbase’s revenue in 2020 reached $1.3 billion, but this number pales in comparison with its financial performance in 2021. The company reported $2.2 billion in revenue and $1.6 billion in net income in the second quarter of 2021 alone. This money comes from three different sources of income.

The first is the trading income of retail and institutional investors. Coinbase will charge transaction fees ranging from 0.5% to 3.99%, depending on the payment type, user’s country of residence, account type, transaction value, etc. In the second quarter of 2021, Coinbase reported retail transaction fee income of US$1.8 billion and institutional transaction fee income of US$102.4 million.

Followed by subscription and service revenue. This $102.6 million in revenue includes custody fees, blockchain rewards, interest income and other types of services.

The third source of income is the sale of crypto assets owned by Coinbase. Companies may sometimes sell their own assets to customers and record them as income. In the second quarter of 2021, this revenue is worth nearly $195 million.

Although the company’s revenue still relies heavily on retail transaction fees, it has had early success in increasing other sources of revenue. For example, it increased the income earned by institutional investors (such as hedge funds and family offices) from US$8 million to US$10243 million in one year.

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Source: Coinbase SEC documents

How did Coinbase become the king of encryption?

Coinbase has become the “King of Encryption” in the eyes of crypto investors, and this development has largely benefited from “encrypted assets evolving into investment tools.” Coinbase’s outstanding performance in security, regulatory compliance, and ease of use has helped drive the growth of the number of users.

Drive adoption

Although Coinbase’s initial promise of “instant payment and widespread adoption” of crypto assets is progressing slowly, Coinbase is taking steps to make crypto assets a more acceptable method of payment. To this end, the company cooperated with payment giant Visa to launch a “Coinbase debit card” in the United States, the United Kingdom and the European Union, which can be used to make payments and withdraw cash from ATMs. Coinbase stated in June this year that customers can now link their Coinbase debit cards with Apple Pay and Google Pay to make it easier to use crypto assets to make payments.

Compliance

As we all know, encrypted assets have a history of use in the black market. At the beginning, it was Bitcoin , but now it is mainly some privacy coins (such as XMR and Zcash). Coupled with the renaissance of the crypto industry, regulatory agencies in various countries have been working hard to define, legislate, and tax crypto assets.

Coinbase has invested heavily in regulatory licensing and compliance to differentiate itself from other exchanges. Coinbase has clearly complied with the “Money Transmission Act” of each state and is one of the few companies that holds a “crypto asset license” in New York, which requires high costs to obtain.

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In addition, Coinbase operates its exchanges in 32 countries at the same time, including the United Kingdom and Switzerland. Coinbase stated that it is “committed to obtaining legal licenses for the countries in which it operates.”

In general, Coinbase’s focus on compliance provides security for investors and regulators.

Cooperation with law enforcement

Likewise, Coinbase works closely with law enforcement agencies. Coinbase follows strict identity verification procedures to comply with regulations such as KYC (Know Your Customer) and AML (Anti-Money Laundering), and to track and monitor the transfer of encrypted assets.

Therefore, Coinbase is the gospel for regulators and law enforcement agencies to decipher black market activities. Some blockchain tracking companies, such as Chainalysis, have partnered with Coinbase (and other exchanges) to assist in anti-money laundering enforcement. As U.S. Treasury Secretary Steve Mnuchin said in a recent interview: “If you have a Coinbase wallet with bitcoin, then Coinbase has the same obligation as banks to know your identity, and We can track your crypto asset activity.”

At the same time, Coinbase also fought back what it believed was excessive government intervention.

Recently, Coinbase CEO Brian Armstrong detailed on Twitter how the Biden administration’s proposed infrastructure bill (designed to tax crypto transactions) will harm innovation in the crypto industry and may ” Push innovation overseas”.

Although crypto assets are still a largely unregulated area so far, the bill aims to impose stricter taxes on cryptocurrency transactions by taxing them as capital gains and losses, similar to stock trading. This clause is expected to generate 28 billion U.S. dollars in revenue for the government in the next ten years.

Support from many investment institutions

Although Coinbase reached its target valuation of US$100 billion on the first day of listing, its market value in September 2021 was US$54 billion. In order to justify its initial valuation, Coinbase will have to beat its competitors and become the world’s largest crypto exchange.

Looking back at investors in the past, Coinbase has attracted many venture capital institutions and companies. Since 2012, Coinbase has raised nearly US$540 million (including its seed round financing) through 15 equity financings. Well-known venture investors-Union Square Ventures and A16z entered it very early and continued to participate in other financing rounds of the company.

In January 2015, large financial institutions such as the New York Stock Exchange and USAA became part of the company’s US$75 million Series C financing. According to a press release from the New York Stock Exchange, the Series C financing will help “Coinbase learn about the global distribution capabilities and expansion expertise of the New York Stock Exchange.” “

Coinbase opened its business in Japan in August 2021 through its cooperation with Mitsubishi UFJ Financial Group (which previously invested in Coinbase), which is a banking group with 40 million customers in Japan. Coinbase provides users of the bank with 5 cryptocurrencies-Bitcoin, Ethereum, Litecoin, Stellar and Bitcoin Cash , and plans to add more crypto assets that can be traded in Japan.

The future of Coinbase

Nevertheless, the question remains: Is Coinbase simply profiting from the bull market in the crypto market, or is it built on the original vision of an “open financial system”?

Expansion strategy

Coinbase CEO Brian Armstrong recently stated that the company’s core mission is to “increase the economic freedom of the world.” In order to achieve this mission, Coinbase will implement a “three-pronged” expansion strategy to upgrade the positioning of encrypted assets to “investment tools, new financial systems and application platforms.”

The “three-pronged approach” strategy will guide the company over the next five years. The strategy is based on three pillars:

  • Encrypted assets as an investment. Crypto asset trading is still Coinbase’s core business, and plans to add new crypto assets to its platform at a faster rate. Coinbase will also provide professional traders with sophisticated trading tools similar to traditional markets. At the same time, Coinbase plans to continue to expand to countries/regions that are not currently operating.
  • Encrypted assets as a new financial system. Coinbase will develop new products to help cryptocurrency holders access the DeFi field.
  • Encrypted assets serve as an application platform. Coinbase believes that crypto innovation is not limited to DeFi, the company will also help its users discover new crypto applications, and will fund the applications through Coinbase Ventures (Coinbase’s investment agency).

Acquire crypto startups for your own use

Since the beginning of 2018, Coinbase has acquired 19 crypto startups, bringing the total to 21. These acquisitions help Coinbase execute its expansion strategy.

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For example, in August 2021, Coinbase acquired Zabo, an account aggregation startup that enables users to view the balance and transaction history of third-party accounts in the Coinbase app. Zabo’s API can extract data from multiple encrypted exchanges, protocols, and wallets.

Coinbase also acquired Skew in 2021. The UK-based crypto startup provides a platform for real-time tracking and visualization of the crypto market, and helps Coinbase further improve its products to institutional investors.

In 2019, Coinbase acquired Neutrino, a crypto startup, which aims to simplify the process of mapping and tracking crypto transactions, which allows Coinbase to prevent theft and investigate ransomware attacks.

As Coinbase hopes to diversify its sources of income and reduce its dependence on retail investor transaction fees, we are likely to see more acquisition news in the next few years.

Large-scale investment in crypto companies without even letting off competitors

Coinbase Ventures (CV) is a venture capital institution launched by Coinbase in 2018. As of August 2021, CV has invested in more than 150 companies and was the third active venture capital institution in the first half of 2021. As expected, most of the investments are directed at a range of crypto startups, including:

  • Taxbit: A tool for automatically paying crypto taxes
  • Zora Labs: Crypto Market
  • Arweave: Provide digital storage services
  • Opensea: Currently the largest NFT market

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In addition, in order to obtain space that may challenge its core exchange products in the future, Coinbase has also invested in many DeFi companies, such as Vega, Saddle, Uniswap, etc., and also invested in some centralized exchanges similar to its products, such as Pintu, Bitso and CoinDCX. Coinbase President and COO Emilie Choi said that investing in competitors is a policy strongly supported by co-founder Brian Armstrong.

Challenges and risks

Similarly, Coinbase is also facing competition from many trading business participants and emerging decentralized exchanges while expanding.

Competition among peers

Coinbase faces direct competition from many legal crypto exchanges. Bitfinex, Bitstamp, Kraken, and bitFlyer are Coinbase’s main competitors, as well as traditional brokerage companies like Robinhood (now support crypto asset trading in all states in the United States except Hawaii and Nevada). At the same time, Coinbase also expanded its crypto trading business to 42 countries/regions around the world, including the United States, Canada, India, Brazil, and South Korea. Therefore, the company is now also competing with Binance, the exchange with the largest trading volume. (Binance’s daily trading volume is as high as $25 billion)

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Another competitive angle comes from decentralized exchanges. Although decentralized exchanges have higher technical content and are more difficult to use, they actually have no central point of attack and therefore provide higher security. Nevertheless, compared with major centralized exchanges, trading volume is still limited, and Coinbase can respond to the threat in a longer time frame.

Coinbase also faces custody competitors such as Gemini, BitGo, PAXOS and NYDIG in the field of digital asset custody.

Market risk

Like crypto investors, Coinbase will also face risks from the crypto market. Exchanges are particularly vulnerable to market demand. If the market is down, Coinbase’s revenue may drop sharply.

Second, if regulatory crackdowns cause market assets to escape and exchange for fiat currency, Coinbase may face liquidity issues. In other words, large-scale selling may make it difficult to find buyers.

In addition, the large-scale sell-off in the crypto market will also have a negative impact on Coinbase’s multiple business lines. For example, the income of users pledged crypto assets will decrease, the reasons for using mortgage lending or coinbase wallets will also decrease, and institutional investors may become more conservative in using crypto assets to diversify their investment portfolios.

Regulatory risk

Since its inception, Coinbase has been committed to establishing a good relationship with regulators, and these efforts have also paid off.

But there are risks associated with regulatory advantages. The law may change because the legislative process will hardly be affected. For example, Coinbase and the entire crypto community cannot influence the Senate to change the infrastructure bill, which may force wallet developers, app developers, and miners to stay away from the United States due to settlement.

The United States Securities and Exchange Commission SEC also dealt a blow to Coinbase. The US Securities and Exchange Commission warned Coinbase that its proposed crypto lending product would allow users to earn interest by collateralizing crypto assets, which poses a security risk. In response, Coinbase delayed the release of the product.

In addition, other countries that are friendly to crypto assets are also formulating new crypto regulations, but the impact on Coinbase has not yet been announced. For example, the European Commission is developing a piece of legislation aimed at establishing rules for issuers and service providers of encrypted assets in the European Union.

Thoughtful summary

Faced with the above challenges, Coinbase continues to expand its core business and explore broader opportunities, such as establishing the NFT market; in order to hedge against other exchanges, Coinbase plans to add support for more crypto assets. Doing so will not only enrich the company’s revenue, but also allow a larger user group to explore the application and innovation of encryption/blockchain technology.

With Coinbase going public in April 2021, the company now has the resources and expertise needed to accelerate its expansion. But achieving its goals requires not only handling the crypto market well, but also establishing communication channels with regulators and legislators around the world. As the development momentum of encryption/blockchain technology is getting better and better, it is becoming more and more important for the encryption industry to involve policy makers in it.

The Coinbase story also reflects the entire crypto industry. Bitcoin and several other major crypto assets are closer to mainstream adoption, but have not yet reached the status that crypto enthusiasts hope. Coinbase should have a better understanding of its current and future status, and strive to find solutions that make the entire crypto industry more prosperous while maintaining its dominant position in the trading business.

risk warning:

According to the “Notice on Further Preventing and Disposing of the Risks of Virtual Currency Trading Hype” issued by the central bank and other departments, the content of this article is only for information sharing, and does not promote or endorse any operation and investment behavior. Readers are requested to strictly abide by the laws and regulations of their regions. Participate in any illegal financial activities.

Posted by:CoinYuppie,Reprinted with attribution to:https://coinyuppie.com/deep-dismantling-of-coinbase-from-the-king-of-encryption-to-the-open-financial-system-glory-and-risk-coexist/
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