Even before the FTX disaster, trouble was already brewing in the burgeoning crypto market this year. Several trading exchanges and crypto tokens have gone defunct, leaving many investors with losses and an inability to make withdrawals. FTX is a different story, though. It was once regarded by many as a type of beacon in the shady crypto world, and some consumers now feel justified in avoiding cryptocurrencies altogether. Whether they're right or wrong to feel that way, "crypto winter" could be a long and drawn-out event.

Where does that leave Block (SQ -0.28%), the company formerly known as Square that changed its name to reflect its crypto economy aspirations? FTX's sudden demise certainly isn't great news for it. However, the bulk of Block's business is still doing just fine, though some much-needed housekeeping is in order.

Will Block be fine even without crypto?

First, a definition of "crypto winter." The phrase refers to a long period of depressed digital asset prices. The prices of Bitcoin, Ethereum, and countless other digital currencies have indeed collapsed. And with a big exchange like FTX declaring bankruptcy, a quick resurgence in consumer interest -- let alone mainstream confidence -- is unlikely.  

Bitcoin Price Chart

Data by YCharts.

Even before recent events, Block had been reporting a collapse in its Bitcoin trading capabilities, which are run through the consumer-facing Cash App. The app for sending and receiving money from friends and family launched its Bitcoin trading service all the way back in early 2018. By the time the pandemic struck two years later, Cash App activity soared. The ability to trade the skyrocketing Bitcoin gave Cash App the ability to cheaply and quickly onboard millions of new users, like hitting a grand slam off of a lob.

Now those fortunes are being reversed. Bitcoin revenue is shrinking back from all-time highs.

Period

Cash App Bitcoin Revenue

Percentage of Block's Total Revenue

2019

$516 million

11%

2020

$4.57 billion

48%

2021

$10.0 billion

57%

First nine months of 2022

$5.28 billion

41%

Data source: Block.

This retreat from highs looks as if it could be a disaster, but here's the thing: Even at its height, Bitcoin trading did nothing for Block's bottom line. In 2021, the gross profit generated from Cash App Bitcoin trading was a meager $218 million -- a pitiful gross margin of just 2.2%. When you take into account operating expenses in 2021 associated with the trading business (including Bitcoin impairment losses of $71 million), Bitcoin likely was a drag on Block's ultimate net profit margin.

Again, the real benefit of this feature was to onboard new users. Then Cash App could promote its other, higher-value services -- like a bank and debit card (which generates digital payment transaction fees and interest on idle cash in savings), the ability to buy and sell stocks, and, more recently, the ability to file a tax return. Block has also been working on connecting Cash App's ecosystem with its Square services for merchants, creating a two-sided network that generates a steady stream of profitable revenue growth for parent company Block.  

Where is Block today?

Bitcoin is still a sizable chunk of Block's revenue, but one that we can assume will go down from here, given the crypto winter. Excluding the still-sizable Bitcoin revenue stream, though, Block is still doing quite well. Total revenue minus Bitcoin has remained in strong growth mode throughout 2022, increasing 37% to $7.6 billion through the first three quarters of the year.

Even more important, gross profit (which takes into account cost of revenue like hardware and transaction costs) has grown 34% from a year ago to $4.33 billion so far in 2022. The Cash App ecosystem is still healthy, as Cash App debit cards are fueling profitable growth, the Square merchant services segment has fully recovered from the pandemic and then some, and the acquisition of buy now, pay later (BNPL) company Afterpay is helping launch Block into the international market.

This isn't to say I'm perfectly square with where Block is at the moment. I mentioned some housecleaning was needed. Even at this juncture, the business is generating net losses -- to the tune of $435 million over the first nine months of 2022. Employee stock–based compensation ($795 million) and noncash amortization and depreciation expense of long-lived assets ($250 million) are the primary reasons for the net loss. On a free-cash-flow basis, Block is in positive territory, but barely. Free cash flow was $9 million this year, compared to $555 million during the same time period in 2021.

Suffice it to say that Block needs to put some cost controls in place to start driving profitable growth. Management has said it is doing just that and has put a freeze on hiring, but such things take time to filter into financial reports.

Crypto winter has already taken a heavy toll on this financial services technologist, though. The stock is down over 70% over the last 12-month stretch. Until the company returns to profitability, there isn't a great way to stick a valuation on it as an investment. But Block has at least demonstrated its ability to operate in the black in the recent past. Assuming it can generate a free-cash-flow profit margin of 5% next year (similar to where it was at times in 2021 before the bear market started), Block is trading for roughly 48 times 2023 free cash flow.

Of course, that valuation reflects some sweeping assumptions that are most likely not accurate. However, given the company's continued strong growth and profit-generating potential, I'm staying patient with my investment in the company. At this point, though, view Block as a higher-risk stock, and one that could take a few years to prove it still has true worth.