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2 Reasons the Coinbase IPO Is a Risky Buy

By Lawrence Nga - Updated Apr 12, 2021 at 9:13AM

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While its prospects are good, this cryptocurrency company does not belong in the portfolios of conservative investors.

Coinbase, a leading cryptocurrency exchange platform, will make its stock market debut in a direct listing this Wednesday, trading under the ticker COIN. This public debut will be a historic moment for the crypto industry and its early proponents.

The listing will also come just months after the total market value of all Bitcoin (BTC -1.14%) in circulation crossed the $1 trillion mark for the first time. Ethereum (ETH -0.75%), the world's second-largest cryptocurrency, is also trading around record highs.

Obviously, Coinbase is betting that rising demand for cryptocurrencies will make its public offering and its business model a success. Certainly, it's listing at just the right time. But for more conservative investors, Coinbase looks like a very risky bet.

Gold coin with bitcoin symbol on it.

Image source: Getty Images

An overreliance on trading to drive profits

Coinbase stands out among other recent hypergrowth IPOs like Roblox and Snowflake because it's already in the black. The tech company booked a net profit of $322 million in 2020, against a net loss of $30 million in 2019. Revenue surged by 139%, and operating leverage kicked in -- Coinbase grew revenue faster than its costs, which resulted in expanding margins and an improving bottom line.

That's all fine and dandy, save for one huge caveat. Coinbase generated 86% of its revenue last year from transaction fees -- mainly from cryptocurrency trading. And in 2020, trading volume shot up 142% year over year, producing a 137% rise in transaction fees. But investors should note that 2020 was a particularly great year for cryptocurrencies, during which Bitcoin's price rose fourfold from $7,184 per token to $28,972 per token.

In other words, booming cryptocurrency prices can boost Coinbase's trading volumes. But the opposite also holds. In 2018, cryptocurrencies crashed -- and Bitcoin prices fell 72% from $13,850 to $3,747. That year, Coinbase's trading volume slid by more than 80%. Over the same period, the number of users making transactions on Coinbase every month fell by 67%. 

In sum, Coinbase's revenue is linked to cryptocurrency trading volume. Should trading activity drop in a big way, Coinbase could wind up back in the red. Though traditional exchanges like CME Group and Intercontinental Exchange are not immune to the volatility of trading activity, the latter two are way more diversified in terms of services and product offerings -- which minimizes the volatility that any single product can cause to the overall financials. 

Priced for perfection

When it comes to Coinbase, there's much to get excited about. It has won the trust of retail and institutional investors alike, who have parked 12% of all cryptocurrency assets on its platform. 

As a leading player in its industry, Coinbase is in a sweet spot. The cryptocurrency economy has explosive growth potential, and if that potential becomes reality, the company can ride the wave while expanding its share of the market.

But for investors, the chance to profit from these huge potential opportunities won't come cheap. Coinbase's direct listing could value it at $100 billion, or 77 times sales. This isn't too alarming. Recent cloud computing IPO Snowflake now trades at over 100 times sales. But it's still excessive by any measure. For perspective, Hong Kong Exchanges and Clearing Limited -- operator of the world's third-biggest stock market -- is valued at $76 billion.

Investors might try to justify Coinbase's valuation by bringing up its impressive historical growth rates, as well as its exciting prospects. But if it fails to meet its rosy expectations, its valuation could easily collapse. Coinbase may also be dragged along in a tech stock crash -- corrections tend to hit pricey names the hardest.

Should investors buy the Coinbase IPO?

In the long run, Coinbase looks poised to grow along with the crypto economy. But buying in at such a steep valuation carries obvious risks. Most investors would be well-advised to stay on the sidelines, watch how Coinbase performs, and -- if they are interested -- await a more attractive entry point.

If you're willing to take the risk of buying Coinbase the day it begins trading, it would be better to initiate with a small position, and add to it over time.

Lawrence Nga has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Bitcoin and Snowflake Inc.. The Motley Fool has a disclosure policy.

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Stocks Mentioned

Bitcoin Stock Quote
Bitcoin
BTC
$23,759.33 (-1.14%) $-272.85
Snowflake Inc. Stock Quote
Snowflake Inc.
SNOW
$167.35 (-1.81%) $-3.09
Ethereum Stock Quote
Ethereum
ETH
$1,874.97 (-0.75%) $-14.19
Roblox Corporation Stock Quote
Roblox Corporation
RBLX
$47.76 (-2.45%) $-1.20

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