For Coinbase’s founders and investors, the timing of its initial public offering this week couldn’t have been better. Bitcoin has been trading at an all-time high, above $60,000. Just eight days ago, Coinbase announced that first quarter revenue in 2021 tripled from the prior quarter, hitting $1.8 billion, while net profit reached nearly $800 million.
On the stock’s first day of trading on Wednesday, it nearly doubled then settled back down for a 30% gain, closing at a market value of $86 billion. CEO Brian Armstrong’s net worth hit $11.8 billion. Cofounder and board member Fred Ehrsam, $3.8 billion. Chief product officer Surojit Chatterjee, $660 million.
As the most popular digital asset brokerage and exchange in America, Coinbase’s key competitive advantages are its brand and deep trading marketplace. The more customers it has, the easier it is for each one to buy and sell at attractive prices when he or she wants to. Today it has 56 million verified users. But now that the nine-year-old San Francisco company is public and under a brighter spotlight, it faces growing threats to its outsized profits.
A Rush of New Competition
Avichal Garg, a managing partner at Electric Capital, one of the largest cryptocurrency investment firms in the U.S., says Coinbase will start seeing much more competition. “It’s going to be a big wakeup call for banks and financial institutions,” he says. He thinks Fidelity is a few years ahead of other incumbents in building a crypto trading business thanks to CEO Abby Johnson. She led the company to start mining bitcoin in 2017 and has created a 150-person team dedicated to helping large investors buy, sell and hold bitcoin.
Fidelity doesn’t yet let average Americans buy bitcoin directly, but Garg thinks that will change. “They have their core retail brokerage business—imagine putting Fidelity-branded crypto products into that thing. Now you don’t have to leave Fidelity to get access to bitcoin or ethereum.” (Fidelity declined to comment on whether it’s building such a product.)
Interactive Brokers, the Greenwich-based $30 billion trading platform that caters to professional traders and sophisticated investors, plans to offer bitcoin trading to customers by the end of this summer, a spokesperson says.
In late 2019, brokerage Charles Schwab released a report showing that the bitcoin-tracking investment product GBTC was a top-five holding in accounts held by Millennial customers. Schwab probably won’t stay on the sidelines if there’s such pent-up demand among its customers, Garg says. A Schwab spokesperson declined to comment on specific plans but noted that it lets customers trade bitcoin derivative securities, adding, “We will continue to listen to our clients’ feedback to make sure that our offering meets their needs.”
Binance, the largest cryptocurrency exchange in the world, launched a U.S. arm in September 2019, and its trading volumes keep hitting record highs, recently transacting $1.3 billion a day to Coinbase’s $5 billion, according to CoinGecko.
Cryptocurrency exchange-traded funds (ETFs) are also on the verge of approval for the first time in America, which will make it easier for retail investors and wealth managers to get exposure to bitcoin through almost any brokerage. Companies ranging from Fidelity to Wisdom Tree have crypto ETF applications sitting on the desk of the Securities and Exchange Commission.
Rich Repetto, a managing director at investment bank Piper Sandler who covers online brokerages, expects the first U.S. crypto ETF to get approved this year. Gary Gensler’s confirmation as SEC chairman makes this even more likely—the former Goldman Sachs banker used to teach a class on blockchain technology at MIT.
All this extra competition for Coinbase means it’s almost inevitable that its high fees will come down. To buy $100 worth of crypto on Coinbase today, it costs $2.99, or 2.9%. To buy $1,000, you’ll pay $14.68, or 1.5%. Prices decrease percentagewise if you’re spending more—average fees across all Coinbase’s brokered transactions were 0.57% in 2020, financial disclosures indicate.
That’s a stark contrast to what it costs to buy a stock today, which is $0 thanks largely to Robinhood. (Coinbase declined to comment for this article due to the regulatory “quiet period” it’s under during its public stock listing.)
Nearly everyone thinks crypto trading fees will fall, but many think it won’t happen quickly. When online brokerages like Etrade came out in the late 1990s, they charged $30 to buy a stock. “It took two decades for those fees to compress to zero,” says Repetto, who has been studying online brokerages since 1999.
According to Electric Capital’s Garg, people have been talking about Coinbase’s fees shrinking for the past five years, so it’s hard to say when it will finally happen. “I think we need some sort of catalyst for it. And I don’t know what that is. Maybe it’s Fidelity, Schwab or somebody like that coming into the market.”
San Francisco-based Kraken is the second-largest U.S. crypto exchange, and its fees are about half those of Coinbase. For a retail investor to buy $100 worth of crypto, it costs 1% to 1.5%, a spokesperson says. When does Kraken think fees will drop? “No one knows for sure. We do think that fees will hold steady, given the tough technical challenges that come with operating an exchange,” says Jeremy Welch, Kraken’s chief product officer.
True to form, Robinhood is trying to speed up fee compression. It recently announced that 9.5 million of its users traded crypto in the first quarter of this year, compared with just 1.7 million in the last quarter of 2020. At a virtual speaking event in March, CEO Vlad Tenev criticized Coinbase’s high fees. “A lot of people will say, we don’t want to compete on price,” Tenev said. “Robinhood will compete on price.”
There are no trading fees to buy crypto on Robinhood—the company makes money by getting rebates from trading firms that execute Robinhood users’ orders, using the same business model it employs for stock trading. Ironically, many of those crypto trades probably get executed on Coinbase’s exchange, since Coinbase has 41% of the U.S. bitcoin trading market, according to Piper Sandler’s research (Kraken has a 19% share).
That means Coinbase is profiting even from the trades that Robinhood users make. Coinbase’s position as both a brokerage that sells you crypto and an exchange that settles your trade is unusual in financial markets and gives it even more dominance in the industry.
Trading Volume Volatility
Another big challenge Coinbase faces is business volatility. Big moves in crypto prices usually mean more active trading (and more fees for Coinbase), but if prices start leveling off, customers can lose interest. For example, in June 2019, 800,000 bitcoins traded hands on Coinbase, according to research site Bitcoinity. Six months later, in January 2020, less than 400,000 traded—a drop of more than 50%—while bitcoin’s price fell just 10% during that period.
Such volatility is rare for a business of Coinbase’s size and will come into sharper focus now that it’s public. That volatility could cause wild swings in Coinbase’s stock price and make strategic, long-term planning difficult, especially as the company grows larger and profit margins potentially narrow. The stock’s gyrations can also be a major distraction for executives and employees.
Customer Service Woes
Like Robinhood, Coinbase suffers from customer service problems, with some users saying they’ve had their crypto stolen from them and that Coinbase hasn’t provided ample support. Brooklyn-based user Michael Pierre allegedly had $100,000 worth of digital assets liquidated from his Coinbase account by a fraudster, according to the New York Times. Now he’s suing the company. A Coinbase spokesperson told the Times that a “24/7 crypto economy, which, combined with a substantial increase in demand, has created a unique set of customer experience challenges” and that .004% of its users had their accounts fraudulently taken over in the past year.
Regulation is the largest existential threat to Coinbase’s business, says Garg. If the U.S. government suddenly started to tax cryptocurrency gains at higher rates than capital gains on other assets or decided that all other digital assets except bitcoin were illegal to trade, it could do major damage to its business. “But I think it is very unlikely,” he says. “I think the U.S. government has gotten its head around the inevitability of crypto. The position has shifted to how we make sure that all the innovation that’s happening here happens in the U.S., rather than happening somewhere else.”
I lead our fintech coverage at Forbes, and I also write about blockchain technology and investing. In October 2020, three of my colleagues and I won the Excellence in Personal Finance Reporting award from the RTDNA and NEFE for our stories on Robinhood. I’ve also written frequently about leadership, corporate diversity and entrepreneurs. Before Forbes, I worked for ten years in marketing consulting, in roles ranging from client consulting to talent management. I’m a graduate of Middlebury College and Columbia Journalism School. Have a tip, question or comment? Email me firstname.lastname@example.org or send tips here: https://www.forbes.com/tips/. Follow me on Twitter @jeffkauflin. Disclosure: I own some bitcoin and ether.