It's still the wild west for the cryptocurrency market. To date, most owners of cryptos hold or trade them, because they think they will go up in value. Few use them as a form of digital payment or for some other decentralized finance (or "DeFi") use case -- although that is quickly changing.
The recent precipitous fall in crypto prices sent shares of both Coinbase Global (COIN -10.77%) and Silvergate Capital (SI -2.81%) into a tailspin too, but these two companies have emerged as promising leaders in this space. One of them looks like the better buy right now.
Coinbase: What happens if crypto trading tanks?
Shares of cryptocurrency trading exchange Coinbase have struggled since its IPO in April. The stock is trading more than 40% below its all-time high, but the company's market cap still sits at about $65 billion as of this writing -- a respective nine and 20 times full-year 2021 revenue and earnings per share if extrapolating first quarter 2021 results through the rest of the year. However, with the recent tumult in crypto prices -- Bitcoin (BTC -2.24%) alone was nearly half its all-time peak value in mid-May -- there is investor concern that interest in trading cryptocurrencies could take a hit.
Falling crypto prices could certainly throttle Coinbase's growth (first quarter 2021 revenue was up an incredible 845% year over year). The company earns a variable fee based on transaction size every time a trade is placed, so higher crypto prices would equate to higher fee revenue. But Coinbase's revenue isn't solely dependent on high crypto prices. Ultimately, the number of monthly transacting users (MTUs) and volume of trades are the biggest determining factor for the company's near-term success. And CFO Alesia Haas recently doubled down on the company's second quarter 2021 guidance for trading volume to be similar or higher than it was in the first quarter. In spite of recent turmoil, new MTUs continue to get added at a rapid pace. For the record, Coinbase provided a wide range for 2021 MTUs of 5.5 million to 9.0 million, compared to 6.1 million in the first quarter and only 1.3 million a year ago.
Of course, trading fees are a race to the bottom, and Coinbase is far from the cheapest trading platform out there. Just like what happened to stock brokerages, Coinbase's trading fee bread and butter is subject to disruption from lower-cost competitors. But the crypto industry is young and still developing. New products like crypto-backed loans, debit cards, cloud computing infrastructure for institutions, and a marketplace for tokens (which are used in applications built on blockchain, the digital ledger cryptocurrencies are based on) could help make Coinbase a formidable leader in the industry for years to come.
It will be a bumpy road along the way, but Coinbase is well positioned to withstand the wild ups and downs in the nascent digital currency space. The company had $1.98 billion in cash and equivalents at the end of March, and raised an additional $1.25 billion from the sale of convertible debt in May. Despite recent uncertainty from price volatility, Coinbase is worth keeping an eye on.
Silvergate Capital: A crypto banking platform you've never heard of
A few years ago, real estate banker and lender Silvergate Capital foresaw massive potential for cryptocurrencies and blockchain technology. It launched the Silvergate Exchange Network (SEN) to enable real-time payments and cryptocurrency conversion (when a crypto is exchanged for U.S. dollars). SEN has been a hit. Total customers were at 1,104 at the end of the first quarter, up from 969 at the end of 2020 and 850 the year prior. Among its users is none other than Coinbase, as well as lots of trading exchange competitors like Binance or Kraken and institutional crypto asset managers too.
It's important to note, though, that Silvergate is not a trade exchange like Coinbase is. It's a bank. It thus primarily makes money from banking fees and interest-bearing securities based on customer deposits. And because those deposits have skyrocketed in the last year along with crypto prices, Silvergate's balance sheet has ballooned -- giving it plenty of cash to deploy to make more interest income. Digital currency deposits were $6.8 billion at the end of March compared to $1.7 billion a year ago. Resulting net income was $12.7 million in the latest quarter, up 189% year over year.
The value of customer deposits have likely taken a hit, though, for the same reason there's been concern for Coinbase's fee revenue: Crypto prices are down. Nevertheless, Silvergate was still in the process of deploying all of the new deposits it has amassed in the last year and sees plenty more SEN user additions as well. It also added new Bitcoin-based credit products and could add other banking features to its platform. Following the last quarterly report, it was announced Facebook's U.S.-dollar backed digital currency Diem (formerly known as Libra) will exclusively be issued by Silvergate. Diem was designed to power Facebook's aspirations in digital payments. If it takes off, this could be an incredibly large new customer for Silvergate.
After shares took a hit along with Bitcoin and other crypto prices, Silvergate trades at a price-to-book value of 4.2 and 68 times trailing 12-month earnings per share (based on a current market cap of just over $3 billion). It's a steep price tag for a bank stock, but this is no ordinary bank. This is a forward-thinking enabler of the new blockchain-based financial system that could have lots to gain if cryptocurrencies see widespread adoption in the years to come.
Which is the better buy?
It's important to bear in mind that cryptocurrencies and publicly-traded companies closely tied to their success are a speculative bet. The sharp sell-off in both Coinbase and Silvergate Capital in recent months is proof of that. Investors should tread carefully and keep any investment in either company very small (perhaps 1% or less of your total portfolio value) so as to be able to buy more over time if cryptos do indeed continue their rapid development.
With that said, I like Silvergate's positioning. It was an early entrant into crypto-based banking and counts Coinbase and others as customers, and it could be a beneficiary of Facebook's experiment in digital payments. Coinbase has plenty of competition that could erode its fee revenue in the near term, and monetizing digital assets in other ways could take a while to offset any losses in trading income. For now, Silvergate Capital gets my nod as the better buy.