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BlockFi: another one caught swimming naked
2022 is a brutal year where many crypto bulls have been caught swimming naked. Luna (LUNC-USD) is done. 3AC is done. Celsius (CEL-USD) is done. Voyager (VYGVQ-USD) is done. Following the latest FTX (FTT-USD) scandal by crypto wonderkid Sam Bankman-Fried, BlockFi just filed for Chapter 11 as traders removed $6 billion from the platform within 3 days and Binance (BNB-USD) did not come to rescue.
According to the bankruptcy filing, BlockFi’s substantial exposure to FTX and Alameda Research was the culprit where Alameda defaulted on ~$680 million of collateralized loan obligations to BlockFi. Despite pausing user withdrawals, BlockFi was not able to overcome the liquidity crisis and had to sell its crypto holdings to raise $238.6 million in cash to fund the bankruptcy process. BlockFi owes almost $1.2 billion to its top 10 creditors, including Ankura Trust ($729 million), FTX US ($275 million), and the SEC ($30 million). Valar Ventures, a US VC fund co-founded by Peter Thiel, owns 19% of BlockFi.
BlockFi was founded in 2017 and saw phenomenal growth where LTM trading volume grew from just $2 million in 2019 to >$23 billion in March 2022. During the same period, the platform’s deployable assets increased from $345 million to almost $15 billion, while gross loan originations jumped from $687 million to >$47 billion. Due to evaporating confidence in the crypto market, however, Block’s lendable assets fell to <$2 billion in November.
Is Coinbase a safe haven?
Let’s start this section from a user perspective. You’ve successfully avoided Celsius, Voyager, Gemini, FTX and BlockFi by putting all your Bitcoin (BTC-USD), Ethereum (ETH-USD), and Tether (USDT-USD) in Coinbase (NASDAQ:COIN). Does that guarantee the safety of your assets in the event that Coinbase files for bankruptcy? Not if you quickly skim through the company’s most recent 10-Q where management disclosed the following:
“Because custodially held crypto assets may be considered to be the property of a bankruptcy estate, in the event of a bankruptcy, the crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings and such customers could be treated as our general unsecured creditors.”
As of 3Q22, Coinbase had a total of $101.7 billion in custodial fiat currencies and cryptocurrencies on behalf of customers. While Coinbase is clearly not FTX or BlockFi given its commitment to keep customer assets 1:1 (does not lend out client assets) and $5 billion of cash on the balance sheet, the broadening fallout in the entire crypto ecosystem has made investors seriously nervous about the safety of their holdings whichever platform they’re on. Following the recent FTX disaster, Coinbase’s trading volume spiked, but this was likely a result of users selling their cryptos entirely to avoid any further losses.
Does Coinbase have a viable business model?
Coinbase is a crypto exchange that makes money from transaction fees. In 2021, retail transactions represented over 80% of revenue, while institutional accounted for just over 4%. In the first 9 months of 2022, Coinbase’s total revenue fell 52% YoY to $2.6 billion as retail transaction revenue dropped 55% to $1.9 billion, accounting for 75% of total revenue. Evidently, this is a highly volatile business that depends heavily on retail transactions, which in turn are heavily influenced by the price of Bitcoin and Ethereum, the two most traded cryptocurrencies on Coinbase.
While Coinbase merely takes a cut of every transaction on the platform and should in theory benefit from increased volatility in the crypto market, this is completely not the case as seen in traditional exchanges such as CME (CME) and NYSE (ICE). With trading volume and revenue halved in 1Q-3Q22, Coinbase reported an operating loss in excess of $2 billion, operating cash flows of negative $4.8 billion, and diluted EPS of -$9.39 vs. $11.9 in 1Q-3Q21. Of course, there’s always the good old stock-based compensation expense which came in at $1.1 billion.
Coinbase recorded total OPEX of $4.7 billion in the first 9 months of 2022, while total crypto market capitalization fell from $2.25 trillion to $900 billion. As of writing, the entire crypto market is now valued at $788 billion. With a market share of ~7% and ~$1.6 billion in quarterly expenses, Coinbase will need a significantly higher take rate (1.3% for retail and only 0.01% for institutional in 3Q22) and transaction volume to make the math work.
All told, the simple answer is that Coinbase is an expensive operation offering a commodity-like product in a shrinking market. While the business model could work in an easy monetary environment with free money, it is very unlikely to work in today’s environment. Should Bitcoin and Ethereum prices remain challenged, Coinbase is likely to do shareholders more harm than good. After the FTX collapse, there’s also the concern that regulations in the crypto space will only become more restrictive/expensive going forward.
What’s the intrinsic value of Coinbase?
The performance of Coinbase is very closely tied to the performance of crypto prices (most notably Bitcoin and Ethereum), therefore the intrinsic value of Coinbase’s stock is only as good as where crypto will be in the future. Given there’s really no scientific way of estimating the values of most cryptocurrencies (no revenues, earnings, dividends, interests, rental income, etc.), I believe prices are essentially supported by the greater fool theory. I therefore do not believe Coinbase can be valued by any convention metric such as P/S or EV/EBITDA. In other words, owning shares of Coinbase is equivalent to owning either Bitcoin or Ethereum.
What to do with the stock?
Coinbase is a sell on any rally given the crypto rout is nowhere near the end in my view. That said, it would be equally dangerous to short the stock just because prices can always rally for non-fundamental reasons (e.g. better-than-expected inflation). Perhaps the stock will work when the Fed pivots, but it’s important to understand that interest rates will remain high as long as inflation does not fall back to the 2% policy target. Until there’s a clear path that rates will again fall back to 0% and animal spirits are to return, avoid Coinbase at all costs.
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