When traditional markets sense optimism, crypto markets go straight to the moon. Bitcoin (“BTC”) has been on a tear this year supported by hopes of spot BTC ETF launch, rising regulatory clarity, and monetary policy easing. When BTC sentiment turns bullish, it leads to sharp outperformance in digital asset-linked stocks as previously.
Coinbase is a top ranking performer. The crypto exchange stock is up a whopping 387% YTD outperforming BTC by almost 2.5x.
Outperformance during rallies is usually followed by sharper corrections during downturns. Buy the rumour and sell the news is common. In fact, it is more pronounced in crypto markets.
BTC trading at record prices for the year combined with bullish catalysts materializing soon, the risk of drawdown in prices remains high.
Digital asset linked stocks are likely to correct alongside BTC. But Coinbase is uniquely positioned to remain resilient. This paper posits a hypothetical trade set up with a long position in Coinbase and short position in BTC to position well into potential pull back in prices in the new year.
COINBASE’S “REGULATIONS FIRST” APPROACH HELPS BUT RISKS REMAIN
Coinbase adopts the strategy of regulation-focused expansion, giving it an upper hand in the otherwise largely unregulated digital asset industry.
That said, Coinbase faces its own raft of regulatory headwinds. In June 2023, the SEC sued Coinbase for operating as an Unregistered Securities Exchange, Broker, and Clearing Agency. Later in August, Coinbase filed a motion to dismiss the case on the basis that the cryptocurrencies listed on Coinbase do not qualify as securities.
Coinbase’s staking platform is another concern. Legal outcome remains uncertain. Regulatory overhang persists over Coinbase.
COINBASE HAS GAINED MARKET SHARE FROM CRISIS AT OTHER EXCHANGES
Coinbase has been holding up well when competing crypto exchanges have suffered collapse or punitive record regulatory fines. Consequently, it has been successful in swaying traders to its platform. News of Coinbase’s approval as a Virtual Asset Services Provider is just one of many global regulatory licenses the company has sought.
FTX collapse, regulatory action against Binance, and the shuttering of smaller exchanges like Bittrex has benefited Coinbase. It has gained BTC trading volume market share compared to last year (13.7% in 2023 v/s 5.7% in 2022), although it remains lower than its market share (18.1%) during the 2021 rally.
While Coinbase has taken volume share from Binance, both these crypto exchanges have lost share on BTC derivatives trading to CME Group. It is likely that Coinbase would lose out on some of the BTC trading volume to spot ETFs.
COINBASE IS THE CUSTODIAN FOR MOST OF THE PROPOSED SPOT BTC ETFs
While Coinbase may lose out on some of the trading volumes, it stands to benefit from the increased institutionalization of BTC.
The company has positioned itself to benefit from the institutional market as well. Coinbase Custody and Coinbase Prime are two of its offerings that stand to gain from spot ETF approval.
In Q3 2023, Coinbase derived 46% of its net revenue from transaction commissions (comprising of 95% from retail and 5% from institutions) and 54% from subscription and services revenue. This is a stark shift from Q3 2022 when 63% of its revenues came from transaction commissions. The shift towards services enables resilient growth from sustainable institutional sources.
Stablecoin revenue is the primary driver of services revenue for Coinbase. It has increased by 125% YoY. Stablecoin revenues represents earnings from stablecoin reserves linked to its partnership with Circle (USDC issuer).
While stablecoin revenues have driven growth in a high interest rate environment, Coinbase’s custodial revenue has lagged. Custodial income is up 9% YoY but 7% lower QoQ. Spot BTC approval with Coinbase as the custodian will help drive greater revenue resilience.
The following ETF’s which are up for approval imminently use Coinbase as their custody provider:
Important to note that these agreements are not yet finalized and are subject to change. In fact, one of the SEC’s key concerns over approval has been the centralization of custody services with Coinbase. This recently caused Blackrock to amend the role of Coinbase in the proposed iShares Bitcoin Trust ETF. The goal of the amendments is to integrate refinements and improve the likelihood that the application is accepted by the SEC.
BITCOIN RALLY HAS OVERREACHED
A long position in BTC may be hard to justify given the massive price appreciation through 2023. BTC is up a mammoth 154%. Prices face risk of a sharp drawdown from profit taking.
Long-Term BTC holders have been accumulating their holdings all year. Many of these holders are now in profit. Nearly 90% of the total supply of BTC is in profit as per Glassnode.
While long-term holders have remained committed all year, realising these gains before a sell-the-news trigger will eventually lead to price pullback.
THIS TIME, IT IS DIFFERENT FOR COINBASE
Coinbase performed poorly during the last Crypto drawdown. Back then, Coinbase was in dire straits. Losses looked precarious. Valuations were still roaring from its heady IPO levels. Now, both these metrics provide a reasonable entry.
Coinbase stock is still 50% lower compared to its level in Nov 2021 when BTC prices started collapsing.
HYPOTHETICAL TRADE SETUP
The hype in the run up to the approval of Spot BTC ETF is palpable. Downside risk prevails across BTC and Coinbase.
If buy-the-rumour & sell-the-news plays out, Coinbase is expected to remain resilient (relative to BTC) given larger market share and revenue diversification. Higher institutional income will also help bolster revenues along with increased trading volumes typically experienced during market shocks.
Investors can position to benefit from Coinbase’s relative resilience by opting for a long position in its shares hedged by a short position in CME Micro Bitcoin Futures expiring in January (MBTF2024). Each MBT contract provides exposure to 0.1 BTC (~USD 4,278). This requires 25 shares of Coinbase to balance the notional values on both legs.
The hypothetical trade set up would involve:
• Entry: 0.404% (USD 173.2 divided by USD 42,780)
• Target: 0.480%
• Stop Loss: 0.365%
• Profit at Target: USD 670
• Loss at Stop: USD 467
• Reward/Risk: 1.43x
Note: As of close of markets on 26th December 2023; Coinbase shares: USD 173.2 and MBTF2024: USD 42,780
MARKET DATA
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