Coinbase, the leading cryptocurrency exchange, confidentially filed for an IPO in December.

If you don’t know what Coinbase is, it’s the most popular place for retail traders and investors to buy mainstream cryptocurrencies like Bitcoin and Ethereum.

The process is meant to be as easy as possible, and Coinbase’s high fees reflect that. 

The company opened for business in 2012 and became a Silicon Valley unicorn just a few years later with it’s 2017 Series D round of venture capital funding.

The company’s list of investors is pretty impressive, counting venture capital magnates Andreessen Horowtiz, IVP, and Tiger Global as shareholders.

Quick Facts on the Coinbase IPO

• Coinbase announced that they confidentially filed their S-1 with the SEC on December 17th, 2020. It usually takes a few weeks for the SEC to publish the S-1 in a confidential filing.
• There’s speculation that the IPO may occur through non-traditional means, like a direct listing or even a digital token. Coinbase co-founder Fred Ehrsam told Fortune that the company is spiritually built to IPO through a digital token, although it’s unclear whether the SEC would support this.
• Coinbase’s most recent private valuation was $8 billion in 2018.
• Cryptocurrency analysis firm Messari estimates Coinbase’s valuation to be roughly $28 billion.
• Coinbase is doing about $1 billion in daily volume as of December 2020.

The Market Environment

Coinbase was clearly strategic in their S-1 filing timing, as today’s market is nearly the perfect storm for a successful IPO for Coinbase’s investors. 

For one, the market is hungry for high-growth tech IPOs, which have been relatively scarce in the last few years.

Just look at the performance of recent tech IPOs like Snowflake (SNOW), which not only revised its IPO price upwards multiple times but also went on a tear once it began trading, as well as Unity (U) and Asana (ASAN), which were recently successful IPOs. 

The crypto market is also on another wild breakout, with Bitcoin at nearly $40,000 at the time of writing.

Whenever crypto makes a big run, crypto-related stocks follow lockstep. But there are few pure plays on crypto right now.

You have MicroStrategy (MSTR), a software firm that keeps some of its corporate treasury in BTC, Silvergate (SI), which does banking with crypto firms, and CleanSpark (CLSK), which does some crypto mining, as the popular plays right now, all of which are crypto-adjacent rather than pure plays.

On top of that, Coinbase is the undisputed leader in the crypto space.

If institutional investors deem any company in the space investable, it will most likely be Coinbase with its status as the leading exchange based in the highly regulated US. 

As an exchange, increases in crypto trading volume equal increases in revenue for Coinbase.

It’s a direct play on the crypto market’s growth, assuming that Coinbase will be a significant player in the future. 

Is Coinbase How Institutions Will Buy Bitcoin?

It’s easy for everyday retail investors to buy Bitcoin.

We might buy a few hundred or thousand dollars worth and store it on a digital wallet on a USB stick or something. We might even leave it on an exchange.

It’s not that easy for institutions.

Should the exchange they stored their coins on gets hacked, or their wallet files get corrupted, they can face massive lawsuits from their investors.

Also, even if a fund is confident enough in their tech skills to store their coins securely, it might not even be legal under many investment fund structures to own unregulated securities like cryptocurrencies. 

As such, most institutions stay far away from holding Bitcoin, even if they would like to own some in an ideal world.

As we know, institutional money dominates all financial markets, so these types of structural preclusions will put a severe hamper on the potential of any investment.

It’s like a stock that has everything going for it except that it trades on the OTC Pink Sheets.

There are some notable exceptions, like Paul Tudor Jones investing a “low-single-digit” percentage of his hedge fund into Bitcoin through Bitcoin Futures as an inflation hedge, and Chamath Palihapitiya of Social Capital, who made a case for a $1 million Bitcoin price over the next two decades.

However, for most institutional investors, Coinbase’s stock could be the only acceptable vehicle for Bitcoin exposure.

Being a successful Silicon Valley unicorn blessed by the top names in venture capital, Coinbase is presenting itself as the safe way to invest in the future of crypto without the headaches of buying crypto itself. 

Crypto’s Biggest Potential Pitfalls

For most institutional investors, crypto represents too much risk.

The industry is mostly unregulated and is home to too many shady business practices.

One of crypto’s biggest pitfalls is custodianship. It’s far too easy for exchanges or wallets to get hacked or for bad actors to steal the coins. This isn’t practically possible in the stock market.

A rogue employee at an investment bank can’t just steal a handful of stock certificates and try to sell them on an exchange. It just doesn’t work that way.

I’m unfamiliar with the specifics of how Coinbase stores their tokens or secures wallets, and I’m sure most potential investors are.

Even if Coinbase does everything perfectly in this regard, this is still underlying anxiety of investors they can’t get around. 

Recently, the famous Australian short-seller John Hempton blogged about how, in crypto, even if you do everything right, you still might lose all of your money.

When interviewing a potential analyst for his firm who suggested he short Ripple (XRP), Hempton explained that it like this: 

“The problem is acute. I am most likely to win in this trade in the event of a collapse in cryptocurrencies generally – and that is the time the broker is most likely to default and wind up not paying me. I can imagine it being a really bad trade whatever the market outcome. If I am wrong and crypto just keeps going up I will lose money. If crypto collapses I can’t collect my winnings – indeed I just lose my collateral.” 

Consider Mt. Gox, which was the largest crypto exchange at the start of 2014, only to lose 850,000 Bitcoins and file for bankruptcy by the end of February that year.

While that event was in the very early days of an unregulated crypto market, its still stained in the mind of many otherwise interested investors. 

Problems with token issuers themselves are also possible, which is on display right now as the SEC is suing Ripple, the company behind XRP. The SEC is basically saying that XRP is a security and that Ripple failed to register them. 

Coinbase has done its best to insulate itself from these pitfalls.

They do this by limiting the tokens they list on their exchange and performing deeper due diligence on those they do list.

According to CoinMarketCap, Coinbase Pro has just 47 listed tokens, compared to Binance’s 322 listed tokens. 

Bottom Line

We can’t know a great deal about the Coinbase IPO at this time. As a private company, they were pretty hush-hush about their financials outside of the broad terms of their private financing.

Without their S-1, we can only speculate about their profitability, margins, growth, etc.

We plan to publish an analysis of Coinbase’s prospectus when the SEC publishes it.