Global Coinbase (NASDAQ: COIN) has become a popular name among investors who wish to gain exposure to cryptocurrencies through the stock market. Although its stock price has fallen more than 25% since its IPO in April, the growth of the company is undeniable. Second-quarter revenue topped $ 2 billion, more than 11 times what the company reported in the prior year period.
It may seem like I’m running Coinbase, but it’s not. There are some serious concerns investors need to think about if they are considering buying this stock, and it all depends on the volatility of digital assets.
Here’s why Coinbase is in a tough spot no matter what’s going on with the cryptocurrency.
If volatility remains
Everyone knows that cryptocurrencies are extremely volatile. Bitcoin, the largest cryptocurrency by market capitalization, has been on a roller coaster this year. Its price soared more than 100% in mid-April, only to drop all those gains three months later. Ethereum, n ° 2 by market capitalization, had an even wilder race in 2021.
Huge day-to-day price swings are the norm, and for Coinbase it has been a godsend. The number of monthly transaction users of the company increased from 1.5 million in the second quarter of last year to 8.8 million in 2021. In addition, the transaction volume has skyrocketed to nearly half a trillion dollars.
The success of Coinbase is highly dependent on the volatility of the cryptocurrency market. The company derives 95% of its revenue from transaction fees with retail and institutional clients who trade on its platform. While it has been lucrative so far, Coinbase has come under fire for its high fees, and there are plenty of other cryptocurrency exchanges eagerly looking to meet user needs.
Makes me think of how companies like Charles Schwab and Robin Hood now offer zero dollar stock transactions. What happens to Coinbase’s business if fees go down to zero due to increased competition? The business is thriving today, but the small services segment had better start growing significantly if Coinbase is to remain differentiated enough to achieve long-term success.
And then there’s the fact that cryptocurrencies were never meant to be a speculative financial asset. One of the main goals of Bitcoin, for example, is to democratize finance, and the increase in utility can only occur if volatility drops significantly, which would present yet another problem for Coinbase.
If volatility goes
Large investment banks like Goldman Sachs and JPMorgan Chase experience huge fluctuations in the performance of their business divisions each quarter. Unsurprisingly, when the stock market hits all-time highs and volatility is high, income rises. Much of it is unpredictable, and these financial institutions are successful in the long run because they offer other value-added services.
As mentioned earlier, Coinbase needs to step up its non-transaction activities and align itself with a situation where the utility of cryptocurrency is increasing. And it can’t just focus on investments and speculative customer needs. In addition to hedging against the potential for large quarter-to-quarter fluctuations, Coinbase needs to prepare for cryptocurrencies to eventually fulfill their goal of going mainstream. For Bitcoin, this ultimately means being used as a medium of exchange.
If people start doing more transactions with Bitcoin in their daily financial life, then its volatility must have decreased significantly. This is what many cryptocurrency enthusiasts are hoping for, and it would deal a direct blow to Coinbase’s bread and butter business. A standard fintech player As Pay Pal, with its massive user base of over 400 million consumers and merchants, already allows people to shop and pay with cryptocurrency. Can Coinbase go from being a speculation facilitator to a utility? I do not have the answer.
Coinbase is clearly growing at the moment, but I remain bearish as the company faces some fundamental hurdles. If the volatility of the cryptocurrency remains high, competing services may reduce Coinbase’s booming transaction revenue by lowering their fees. On the other hand, if cryptocurrencies, and mainly Bitcoin, see their volatility drop, Coinbase’s profit machine is left for dead.
This is why I suggest staying away from the stock.
This article represents the opinion of the author, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Challenging an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.