Coinbase Global (COIN -2.27%) has become a popular name among investors who want exposure to cryptocurrencies via the stock market. Although its share price has fallen over 25% since going public in April, the business's growth is undeniable. Revenue in the second quarter topped $2 billion, more than 11 times what the company reported in the prior-year period.
It might sound like I'm pitching Coinbase, but that's not the case. There are serious concerns investors need to think about if they're considering buying this stock, and it all hinges on the volatility of digital assets.
Here's why Coinbase is in a difficult spot no matter what happens with cryptocurrency.
If the volatility stays
Everyone knows cryptocurrencies are extremely volatile. Bitcoin, the largest cryptocurrency by market capitalization, has been on a roller-coaster ride this year. Its price soared more than 100% by mid-April, only to give up all of those gains just three months later. Ethereum, No. 2 by market cap, has experienced an even wilder ride in 2021.
Huge day-to-day price swings are the norm, and for Coinbase, this has been a boon. The company's monthly transacting users grew from 1.5 million in the second quarter last year to 8.8 million in 2021. Additionally, trading volume has skyrocketed to almost half a trillion dollars.
Coinbase's success is highly dependent on the volatility of the cryptocurrency market. The company derives 95% of its revenue from transaction fees with both retail and institutional clients trading on its platform. While this has so far been lucrative, Coinbase has received criticism over its high fees, and there are many other cryptocurrency exchanges out there eagerly looking to fill users' needs.
This makes me think of how companies like Charles Schwab and Robinhood now offer zero-dollar stock trades. What happens to Coinbase's business if fees race toward zero as a result of increased competition? The company is thriving today, but the tiny services segment better start growing meaningfully if Coinbase wants to keep itself differentiated enough to achieve long-term success.
And then there's the fact cryptocurrencies were never meant to be a speculative financial asset. One of the main goals of Bitcoin, for example, is to democratize finance, and increasing utility can only happen if volatility significantly drops, which would present yet another problem for Coinbase.
If the volatility goes
Major investment banks like Goldman Sachs and JPMorgan Chase experience huge fluctuations in their trading divisions' performances each quarter. Unsurprisingly, when the stock market is hitting all-time highs and volatility is elevated, revenue gets a boost. This is largely unpredictable, and these financial institutions are successful long term, because they offer other value-added services.
As previously mentioned, Coinbase needs to strengthen its non-transaction business and align itself for a situation where cryptocurrency utility rises. And it can't just focus on clients' investment and speculative needs. In addition to hedging against the potential for wide fluctuations quarter to quarter, Coinbase must prepare for cryptocurrencies to eventually fulfill their purpose of going mainstream. For Bitcoin, this ultimately means being used as a medium of exchange.
If people start transacting with Bitcoin more in their daily financial lives, then its volatility must have fallen substantially. This is what many cryptocurrency enthusiasts are hoping for, and it would deal a direct blow to Coinbase's bread-and-butter trading business. A huge fintech player like PayPal, with its massive user base consisting of more than 400 million consumers and merchants, already lets people make purchases and check out with cryptocurrency. Can Coinbase shift from a facilitator of speculation to one of utility? I don't have the answer.
Coinbase is clearly growing at the moment, but I remain bearish as the company faces some fundamental hurdles. If cryptocurrency volatility stays high, competing services can chip away at Coinbase's booming transaction revenue by reducing their fees. On the other hand, if cryptocurrencies, and mainly Bitcoin, see their volatility fall, Coinbase's profit machine is left for dead.
That's why I suggest staying away from the stock.