One of the most polarizing asset classes in recent memory is cryptocurrency. One day blockchain tokens are being hailed as "digital gold." A week later economists are sounding the alarm that crypto is a giant Ponzi scheme. In addition to the seesaw opinions over crypto's legitimacy, social media influencers have found their way into the mix, pumping various tokens claiming they will go "to the moon."
The largest publicly traded crypto exchange is Coinbase (COIN 1.47%). Since its public offering last April, the company has been no stranger to the limelight. Most recently, the Securities and Exchange Commission (SEC) slapped Coinbase with a Wells notice, a document outlining the SEC's beliefs that the company (or individual) in question should expect to be charged with securities violations.
Unsurprisingly, Coinbase stock dropped like a rock on this news. How much of a problem is this for the biggest U.S. crypto exchange? Let's dig in.
Peeling back the onion
For the year ended Dec. 31, 2022, Coinbase reported $3.1 billion in total revenue. To put this into perspecticve, 2021 revenue was $7.4 billion. To make matters worse, Coinbase reported a net loss of $2.6 billion in 2022, compared to positive net income of $3.6 billion in 2021.
While some of the financial results can be attributed to macro events such as the downfall of FTX, Coinbase's key metrics shed plenty of light on investor lack of enthusiasm for crypto. For example, total assets on the platform declined from $278 billion in 2021 to $80 billion by December 2022. Unsurprisingly, trading volume fell in lockstep, decreasing from $1.7 billion in 2021 to $830 million in 2022.
Given the lackluster financial performance, it's difficult to understand why Coinbase stock is up 98% year to date, and nearly 14% in just the past five trading days. Given the company's Q4 and 2022 earnings results, such a dramatic increase in the stock may be overdone.While some investors may believe Coinbase is undervalued, a stock price doubling in just four months is hard to justify.
What does the road ahead look like?
From March 21 to March 23, Coinbase stock cratered by 27%. The primary catalyst was the announcement that Coinbase is being investigated by the SEC over potential securities violations. More specifically, the Wells notice outlined that the SEC is concerned about some of Coinbase's listed digital assets, as well as its crypto staking service (Coinbase Earn), and its Coinbase Prime and Coinbase Wallet products.
This shouldn't be entirely surprising. In February, the SEC fined Coinbase competitor, Kraken, $30 million and forced it to shut down its staking service, asserting that it was offering unregistered securities on its platform. Staking is like putting your money in a bank and earning rewards.
Per Coinbase's blog, Chief Legal Officer Paul Grewal stated:
The bottom line remains: Coinbase does not list securities or offer products to our customers that are securities. Coinbase has a rigorous process to analyze and review each digital asset before making it available on our exchange -- a process that we shared in detail with the SEC as part of our public listing.
Honestly, it appears that Coinbase's argument revolves around a technicality. Coinbase, technically, does not list securities.Similar to assets like oil and wheat, crypto tokens are considered commodities in some quarters. Whether the SEC has oversight or jurisdiction over commodities and where these assets are traded is a bit of a grey area.
Nonetheless, Coinbase's response strikes me as pretty weak. The company has almost 10,000 different tokens on its exchange. And while it does promote more mainstream, large-cap cryptos like Bitcoin, it also lists a number of questionable assets.For example, Coinbase's asset roster includes Dogecoin (DOGE -3.97%). As a reminder, Dogecoin, for whatever reason, has earned a soft spot in the heart of serial entrepreneur Elon Musk. Despite its cute logo of a Shiba Inu puppy, Dogecoin does not provide any real utility. It's a meme. While there is money to be made from these altcoins, it is unbelievably risky. You're better off looking for loose change on the sidewalk.
Image source: Getty Images.
Time to panic?
One of the most crucial rules of investing is to keep your emotions in check. Generally speaking, emotions get in the way of making sound decisions.
Whether Coinbase is breaking any laws is above my pay grade. However, in my view, it could be viewed as predatory to list the number of tokens available on the platform, especially when most of them are not widely known and probably have no value.
At the end of the day, it's pretty obvious that crypto at large needs some broader oversight. And since Coinbase is the poster child of public crypto companies, the SEC may find (or create) a way to become more involved. Alternatively, the Commodity Futures Trading Commission (CFTC) could lead the charge.
For investors who own Coinbase stock, the prudent thing to do is to hold. Although the announcement of a government investigation can be unnerving, Coinbase isn't at risk of being delisted, and panic selling won't solve much. However, it is critical for investors to understand that this isn't an opportunity to buy the dip. The stock could be in for some big declines, especially if earnings prove disappointing or the SEC imposes an enormous fine. Using this as an opportunity to try and lower your cost basis would be irresponsible, and not aligned with the underlying fundamentals of the business.
