Why Coinbase's Slow Start Spells Opportunity

The excitement around Coinbase Global's (COIN 7.04%) initial public offering (IPO) was certainly short lived. And many analysts have outlined risks facing the crypto exchange company. However, Coinbase's decline could spell opportunity for investors who understand the many ways the company can capture more wallet share in this fast-growing industry.

Laying the foundation

Bitcoin (BTC 0.16%) sports a market capitalization of more than $1 trillion. Dogecoin (DOGE -1.49%) has climbed from less than $0.01 to $0.47 in a matter of months. However, stock analysts regularly question if the crypto industry is here to stay, or whether this is all just a massive bubble waiting to pop. For Coinbase to be a solid long-term investment, investors need to accept the crypto market as an investment alternative, instead of an opportunity to gamble.

Image source: Getty Images.

Several factors suggest that investors should consider allocating part of their portfolio into crypto. First, Facts and Factors Research projects that by 2026, the crypto market will reach $5.2 trillion, suggesting a 30% compound annual growth rate. As an independent research firm in China, Facts and Factors has been around for more than 20 years. According to Bakkt Holdings, a firm that specializes in digital assets, the crypto market could reach $3 trillion by 2025.  If a rising tide lifts all ships, then crypto investors have a veritable tidal wave to push them forward.

Second, each time a multibillion-dollar company puts its weight behind crypto, it's like another verification for investors that crypto is here to stay. PayPal's (PYPL 1.41%) inclusion of crypto trading  through PayPal and Venmo is the most recent example. Square (SQ 1.68%) has helped many retail investors discover bitcoin through the Cash App, and Tesla (TSLA -3.40%) allows customers to pay with bitcoin .

Third, Sean Horgan of Rosenblatt Securities believes that Coinbase's opportunity lies not only in the growing market, but also by growing wallet share. According to Horgan, the crypto market could reach $11 trillion over the next few years. Coinbase market share currently sits at about 11%. If the company maintains this percentage, this would mean a $1 trillion opportunity. Some potential investors may dismiss crypto as a bubble, yet there are multiple ways for Coinbase to prove its doubters wrong.

Making sense of the noise

There are multiple assumptions being made about Coinbase's business model that don't hold up to scrutiny. One concern is that crypto could eventually be accepted as mainstream and thus exhibit less volatility. Theoretically, if there is less volatility, Coinbase will make less money because there will be less trading and less commissions.

However, the history of the S&P 500 index would seem to contradict this worry. In the last 90-plus years, the S&P 500 has reported an annual gain or decline of at least 20% in 31 different years. In addition, in 68 out of the last 93 years the S&P either increased or decreased by 10% per year. Despite decades of volatility, brokerage companies, ETFs, and mutual funds have done very well. If crypto follows the stock market's pattern, Coinbase would stand to continue to benefit from increased activity as mainstream investors take advantage of the crypto market.

The second worry facing Coinbase is the idea that if competition heats up, the company will end up in a race to the bottom when it comes to its lucrative commissions. But Coinbase's fee structure isn't as fragile as some might believe.

Strangely enough, Coinbase is one of the few crypto sites that not only lets users transfer their crypto assets out of Coinbase's site, but also allows them to cash out to their bank account. Though Robinhood and SoFi offer crypto and could undercut Coinbase's fees, neither site allows users to transfer their crypto off site. This is akin to a brokerage company suggesting that once you've bought a stock, you are not be allowed to transfer the shares to another brokerage. In addition, if investors can't transfer their investments off-site, they are stuck with the limited crypto options that discount firms offer.

Some of Coinbase's competition does allow off-site transfers; theoretically, they could charge less than Coinbase to do so and damage its future growth. However, this worry also seems overblown.

As a quick example, the cost to transfer bitcoin off site is priced very differently depending on which site you choose. Coinbase's pricing for withdrawals is a percentage of the amount, whereas the other companies charge a fixed amount of the coin. For larger transfers, the fixed amount is a better option. However, many retail investors aren't transferring thousands of dollars at a time, and Coinbase's pricing is compelling relative to its peers.

(Data sources: Coinbase, eToro, Binance, and KuCoin. Assumes BTC price of $57,500.)

Another way Coinbase differentiates itself from its peers is by helping novice crypto investors understand they can stake their coins to earn rewards. Staking means the investor pledges their crypto to the exchange or platform of their choice. In exchange, they receive interest in the form of additional coins.  Coinbase offers limited staking options, like a 6% annual percentage yield on Algorand (ALGO 0.51%) simply for holding this coin. If investor are looking to stake their coins elsewhere, Coinbase is happy to charge them a commission to buy the crypto, and then collect a further fee to transfer that asset elsewhere for staking.

250 billion reasons to consider COIN 

Coinbase is a leader in the roughly $1 trillion crypto market; as mentioned above, it boasts roughly 11% market share and seems to offer advantages over its competition. If crypto goes mainstream, the company could benefit from the influx of novice crypto investors.

Coinbase could also grow by consolidating the crypto exchange market. According to CoinMarketCap, there are no less than 300-plus exchanges processing volumes ranging from a few thousand dollars to billions of dollars in a 24-hour timeframe. Coinbase's public stock could be used as currency to build its offerings by acquiring other exchanges.

Coinbase may also grow in the future by expanding the assets it supports. At present, Coinbase supports about 55 currencies, whereas a site like KuCoin offers 75 cryptocurrencies and more than 300 trading pairs. Though Dogecoin gets a tremendous amount of press, this is just one example of a coin that Coinbase does not yet support.

When it comes to the valuation concern facing the crypto exchange, analysts expect Coinbase to generate $5 billion in sales for the full year 2021. On the surface, Coinbase's market cap of about $56 billion may appear richly valued. However, if the crypto market grows to $5 trillion or more as projected, the calculations change quite a bit. In fact, if Coinbase's market share declined from 11% to 5% over time, the company would generate sales of at least $250 billion. Though investing in cryptocurrency isn't for the faint of heart, Coinbase could be a way for investors to generate profits from this burgeoning asset class.