Cryptocurrency exchange Coinbase (COIN -3.24%) is now more than 46% off of its recent highs from November, amid a sequential slowdown and the overall market sell-off. Coinbase makes most of its money from crypto transaction fees, but it's exploring new markets. When you couple the company's competitive strengths and high growth potential with its new, cheaper value, Coinbase's recent slide could offer investors a great buying opportunity.
How Coinbase makes coin -- and keeps it
Coinbase aims to make it easy and affordable for anyone to buy or sell crypto – while taking a cut of each of those transactions for itself. Transactions provided most of Coinbase's overall revenue in Q3 of 2021, at $1.09 billion. But it's trying to start a subscription business that allows customers to trade without any fees, called Coinbase One. It currently offers another subscription, Coinbase Prime, that gives institutions advanced trading, analytics, and other features. And its Coinbase Cloud offers programmers the ability to use its own blockchain tools to build their own cloud applications. These three still-early efforts form its subscription and services segment, which only generated $145 million in Q3.
Coinbase's industry-leading, easy-to-use exchange platform helped it gain an 11.3% market share in crypto assets, making it one of the largest exchanges in the world. And this market share is not reliant on any single cryptocurrency.
Image source: Getty Images.
Crypto assets other than Bitcoin and Ethereum made up 57% of transaction revenue in Q3 of 2021. Compare that to Robinhood (HOOD -2.63%), where Dogecoin alone made up 40% of its revenue in Q3 of 2021.
But Coinbase's success nonetheless depends heavily on Bitcoin and Ethereum performing well. Those two coins make up 64% of the total assets held on the platform. Any damage or outages on the Ethereum or Bitcoin blockchain or networkcould lead to an overall sell-off that would harm Coinbase's business. This is part of the risk involved with investing in a crypto-exchange platform.
Coinbase has a first-mover advantage in North America. Its ease of use has given the company a significantly stronger brand than other competitors, with over 73 million verified users. Even though it charges higher fees than rivals, Coinbase's simplicity helps it hang on to its customers.
The largest exchange in the world by volume, Binance, has only 28.5 million users, but its lower trading fees give it much more trading volume than Coinbase. If competitive pressure drives fees down industrywide in the future, Coinbase's big user base could benefit from increased transactions, too. Lower fees might hurt its business initially, but they also tend to attract more traders. And depending on how the Coinbase One subscription plan fares, its ability to make unlimited trades for a single set price could draw in high-frequency day traders.
Fast expansion at a bargain price
Coinbase has been growing at phenomenal rates. For the trailing-12-month period ended Sept. 30, 2021, the company's free cash flow grew 66%, revenue rose 105%, and net income increased 178%. The stock price, however, has fallen 42%.
As the saying goes, "Past performance does not predict future returns." 2021 was a historical year for crypto trading volume. If that volume continues to rise, Coinbase should continue to grow. If it doesn't, the company will struggle.
Coinbase sees this risk and has used its cash flow to invest in a new venture into non-fungible tokens or NFTs. Opensea, the most well known NFT marketplace, surpassed $10 billion in volume in the third quarter of last year. As a whole, the NFT market has experienced 704% growth since Q3 of 2020.
Opensea makes users overcome many hurdles to purchase an NFT, including setting up a wallet, transferring crypto, and navigating an overall bad user experience. If Coinbase can translate its simplicity to NFT's, it could become a major player in a fast-growing market.
Although NFT's are growing rapidly, their real-world usefulness remains questionable. A small group of people are still driving this market, and the boom they've created might not last. The same goes for crypto. Buying Coinbase relies on crypto's success, a gamble that potential shareholders should consider before deciding whether or not to buy in.
Fast revenue and earnings growth often earns companies a higher valuation from investors. Coinbase has experienced the opposite; as its fundamentals grew and its share price shrank, its P/E multiple has dwindled to 17 – its lowest since it IPO'd at 100 times earnings.
What to watch for next
If you believe that crypto is the future, Coinbase looks like a great investment. I expect that its growth will be very volatile because of its dependency on transaction revenue, but Coinbase's future looks bright.
Stay on the lookout for the continued growth of transaction volume and revenue over the course of years, not quarters. Each quarter could look very different for Coinbase, which may scare investors away. If you're interested in riding the crypto rollercoaster, beware that it could be a wild ride.
