For the most part, Coinbase (COIN 2.01%) generates revenue from charging its retail users transaction fees for buying and selling cryptocurrencies. The company offers some subscriptions and services, but transaction fees from retail investors accounted for around 83% of total revenue in the first quarter.
Another source of revenue is fees generated from institutional customers. Coinbase Prime is the company's solution aimed at institutions, offering advanced features and functionality. Transaction fees levied on institutions accounted for just 4% of total revenue in the first quarter, with a bit more coming from custodial fees. The percentage is only that high because retail trading activity has plunged this year as cryptocurrency prices crashed.
Much ado about nothing
Shares of Coinbase surged on Thursday after the company announced a partnership with asset management giant BlackRock (BLK -0.86%). Institutional clients of BlackRock's Aladdin platform will have direct access to cryptocurrencies, beginning with Bitcoin, via a connection with Coinbase Prime. Coinbase Prime already has over 13,000 institutional clients, and this deal will likely increase that number.
The deal is certainly a positive development for Coinbase, but what seems to have gotten lost in the news is that the company just doesn't generate meaningful revenue from its 13,000 institutional clients; it lives and dies by its retail customers. The institutional side, at least right now, is a rounding error.
While retail customers make up most of the revenue, institutional customers make up most of the trading volume. Retail customers traded $74 billion worth of cryptocurrencies in the first quarter, generating $965.8 million in revenue for Coinbase. That's a take rate of about 1.3%. Meanwhile, institutional customers traded $235 billion worth of cryptocurrencies, generating $47.2 million in revenue for Coinbase. The institutional take rate was a paltry 0.02%.
The announcement of the BlackRock deal offered no details on how it's structured financially, but there's no reason to believe it will be any more lucrative than Coinbase's existing institutional business. Even if it is, the retail take rate is 65 times higher than the institutional take rate. It's going to be really hard to move the needle by growing institutional trading volumes.
Bitcoin only, for a good reason
The BlackRock partnership will only cover Bitcoin to start, and that's probably not a coincidence. The U.S. Securities and Exchange Commission is reportedly probing Coinbase to determine if the company has allowed users to trade assets that haven't been registered as securities.
Whether a particular cryptocurrency should be viewed as a commodity or as a security is up for debate. A strong argument can be made that Bitcoin should be treated as a commodity, but other cryptocurrencies are a different story. In a separate action, the SEC charged a former Coinbase manager with insider trading, saying in that announcement that some of the cryptocurrencies involved were indeed securities.
Coinbase is facing a prolonged slump in cryptocurrency prices, a severe contraction in trading activity, and regulatory scrutiny that could prove to be an existential threat to its business mode. Any upside associated with the BlackRock deal looks completely meaningless in comparison -- this is not a reason to buy the stock.
