It wasn't too long ago that cryptocurrency-exchange Coinbase (COIN 3.86%) was printing profits. The company booked a net profit of $3.6 billion on $7.4 billion of revenue in 2021 as the frenzy around cryptocurrencies led to nearly $1.7 trillion of trading volume on Coinbase's platform. No one cared about excessive fees because they thought Bitcoin, Ethereum, and other cryptocurrencies were going to the moon.
The cryptocurrency market has since crashed and burned. Bitcoin has plunged from its highs, and a series of scandals, blowups, and bankruptcies has rocked the crypto world. Interest has cooled dramatically.
This creates a significant problem for Coinbase. In 2021, the company converted just around 1.2% of the trading volume from retail investors on its platform into transaction revenue. Not only has transaction volume been decimated, but it's also becoming much harder to justify paying that kind of fee when quick profits are no longer the norm.
Legendary short-seller Jim Chanos recently appeared on the Market Champion podcast and didn't mince words. Chanos believes that Coinbase's business model simply doesn't work. He may be right.
The race to the bottom
Coinbase serves both retail and institutional clients, but Chanos doesn't believe either part of the business works. On the retail side, the problem is competition. Chanos sees it as only a matter of time before a company like Fidelity or Vanguard offers basic crypto trading with fees that dramatically undercut Coinbase.
Fidelity, in fact, is already working toward exactly that. The company is allowing customers to sign up for early access to Fidelity Crypto, its commission-free Bitcoin and Ethereum trading service. There are no direct fees involved, although a spread will be factored into the execution price.
As competition puts pressure on Coinbase's ability to charge high fees, the company is likely going to need to slash those fees to retain customers. That will make the bottom line, which has swung deep into the red this year, look even worse. With trading volume collapsing this year, Coinbase booked a net loss of $545 million on revenue of $576 million in the third quarter.
On the institutional side, the problem is that Coinbase just doesn't generate much revenue. Around $133 billion of trades were conducted by institutions in the third quarter, but that translated into just $19.8 million of revenue for Coinbase.
The institutional business would have to become enormous for it to be meaningful. Chanos doesn't expect Coinbase to ever make any real money from institutions.
A long way down
Shares of Coinbase are already down more than 80% this year, but that decline may be just the beginning. The company is still valued at more than $10 billion, which makes absolutely no sense.
Just like the fees for trading stocks have disappeared over the years, the fees for trading crypto will disappear, as well. Coinbase does generate some revenue from services, but its costs are out of control. Even after multiple rounds of layoffs, quarterly operating costs are running at over $1.1 billion, nearly twice total revenue. That's not sustainable.
While Coinbase has around $5 billion of cash, the bond market is pricing in a catastrophe. Notes maturing in 2028 are selling for $0.55 on the dollar, pushing the yield to maturity above 13%. If Coinbase needs to raise capital, the bond market isn't going to be receptive.
If a business only works in the best possible environment, then that business doesn't work at all. With the frenzy surrounding cryptocurrencies now dead and buried, it's hard to see how Coinbase turns itself into a viable business without another cryptocurrency bubble.
