Winter is here, and Coinbase Global (COIN -0.50%) is frozen in a crypto blizzard. During the final months of 2021, high-flying technology stocks witnessed significant sell-offs. These sell-offs have mutated beyond stocks, and cryptocurrencies are the next asset to experience valuation compression.
After reaching all-time highs in November 2021, Bitcoin (CRYPTO: BTC) and Ethereum (CRYPTO: ETH) began 2022 in a downward spiral. In the first week of January, Bitcoin experienced its longest continuous price decline since 2018. Moreover, leading cryptocurrencies Ethereum and Solana (CRYPTO: SOL) have also fallen over 20% since the beginning of the year. As investors navigate this "crypto winter," Coinbase's management may be signaling where it is seeing opportunity.
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What does the business look like today?
Coinbase is a platform on which users can buy and sell a variety of cryptocurrencies. Coinbase generates revenue by collecting a fee attached to each trade. Due to the inherent volatility of cryptocurrencies, Coinbase's revenue experiences ebbs and flows as enthusiasm for crypto and widespread adoption begin to take hold.
Through Sept. 30, 2021, Coinbase reported total revenue of $5.3 billion and a net profit margin of 52%. Coinbase's profitability profile provides it with a high level of capital efficiency, thereby allowing it to invest in innovative products and services.
The company's management has kept a keen eye on trends powering the crypto markets and has been making strategic moves in an effort to capitalize. For example, in 2021, Coinbase announced that it would launch its own non-fungible token (NFT) platform, given the rise in popularity of these assets. This seemed like a natural move for Coinbase to make, given that the company already held a minority investment in lending NFT platform OpenSea.
However, the company's latest move may signal its next growth catalyst. Coinbase announced last week that it would be acquiring crypto derivatives company FairX.
Important trends in the crypto economy
Although Coinbase has been able to generate billions of dollars in revenue and profits from its trading feature, it is clear that the company will need to diversify its products and services to differentiate itself from competing crypto platforms. These additional offerings should help the company expand its total addressable market, leading to more users across a wider demographic. Ultimately, as Coinbase acquires new users, it can cross-sell additional products and create a full-spectrum crypto ecosystem.
It is important to note that the company's moves into NFT's and derivatives could fuel meaningful future growth. One Wall Street analyst believes that the NFT marketplace alone could generate over $100 million of annual revenue.
It is no surprise that rival crypto exchanges FTX and Gemini, both privately held, have also made moves in the NFT and derivatives marketplace. In August 2021, FTX acquired derivatives platform LedgerX. After raising $27.5 million in venture capital, FairX launched its futures platform in May 2021.
FairX is a designated contract market (DCM) registered with the Commodity Futures Trading Commission (CFTC). This means that it is allowed to offer futures products in the U.S. Futures enabling investors to gain exposure to cryptocurrency without having to hold the underlying token. They are similar to a futures contract for a traditional commodity or stock in that they allow investors to speculate on the specified cryptocurrency's future price. Coinbase's acquisition of FairX is a stepping stone for its mission to build a transparent and robust platform as crypto becomes more developed as an asset class.
Why is this important?
There are currently only a handful of exchanges that allow U.S. investors to trade crypto futures. In addition to FTX's acquisition of LedgerX, Crypto.com acquired derivatives platform Nadex in December 2021 for $216 million.
These derivative products are in high demand from investors looking to gain exposure outside of traditional spot markets. The spot market is where financial instruments, such as stocks, currencies, and commodities are traded for immediate delivery (i.e. the exchange of cash). On the other hand, a futures contract, is based on the delivery of the underlying asset at a future date.
Coinbase believes that developing a transparent derivatives market is a critical inflection point for any asset class. Investors can use futures to hedge against their positions in the spot market. For example, if an investor bets on a price increase for a cryptocurrency in the spot market, then they might also short its futures as a hedge. Thus, they stand to make money even if the token price moves in a direction opposite to the one specified in their bet.
Through its acquisition of FairX, Coinbase should unlock further participation in the crypto economy from both retail and institutional investors. FairX's futures products are offered through major brokerages, including TD Ameritrade, E*Trade, ABN AMRO, Wedbush, and Virtu Financial, among others.
These relationships are crucial because they allow Coinbase to layer FairX's infrastructure on top of its own platform and immediately offer new products to its U.S. customers. Per the company's press release, the acquisition is expected to close during Coinbase's first fiscal quarter. As a shareholder, it is encouraging that management is not allowing the current decline in traditional crypto assets to distract from the overall mission of building and powering the leading platform for the crypto economy.
