Coinbase (NASDAQ:COIN) launched its direct listing of shares earlier in April. It’s one of the largest public company debuts in history, with Coinbase achieving a market capitalization well north of $50 billion right out of the gate.
COIN stock has attracted a ton of interest, and with good reason. Coinbase is making large profits now. This puts it well ahead of most listed crypto alternatives, such as the Bitcoin (BTC-USD) mining firms.
However, after opening trade around the $400 mark, COIN stock has lost some of its initial buzz. Shares have slipped to around $300 each now.
That’s not a bad showing at all, but it’s worth examining why there has been some selling interest in Coinbase.
Bring up COIN stock and what are you going to hear? People are going to fret about the price of Bitcoin and Ethereum (ETH-USD). Clearly, if crypto prices plunge, it’d have a meaningful impact on Coinbase’s profitability. Coinbase earns money based on percentage-based transaction fees.
So as prices drop, commissions tend to get smaller. And if the market goes into a prolonged slump, trading volumes could drop as well.
However, unless the crypto market crashes permanently, price fluctuations won’t doom Coinbase. Both stock exchanges and equity brokerage firms have been strong investments historically, despite frequent bouts of market volatility and occasional panics.
There will be more shocks to the crypto ecosystem as it develops, and Coinbase’s earnings will have their ups and downs with it. However, that’s not a major reason to avoid COIN stock.
The Hidden Risk: Falling Commissions
Bitcoin prices will fluctuate. If prices do indeed crash, that’d be a negative for COIN stock, to be sure. However, it’d be a negative for any other crypto investment, be it a bitcoin trust, crypto miner, or whatnot.
No, the real risk here is margin compression. Coinbase makes a large chunk of its revenues from retail trading fees, charging a roughly 0.5% spread when traders buy or sell crypto.
On the purchase of one Bitcoin, that’d be a roughly $50,000 transaction. So Coinbase would grab a chunky $250 of that as its cut. That’s why Coinbase looks so profitable right now, but what happens when that $250 commission drops to a much lower number in the future?
To be fair, high commissions are normal behavior for a brokerage. Or, at least they were until a decade ago. Now, though, brokerages charge only tiny fees on stock trading, and Robinhood has opened the door to totally commission-free equity trading.
It’s ironic that Coinbase is currently making a fortune charging large fees when one of the reasons people like crypto is that it is supposed to democratize finance and make everything more available. Huge commissions don’t fit well with that picture.
Investment bank Mizuho weighed in on this, saying: “Over time, COIN’s fees may face downward pressure from competing platforms following the footsteps of zero-commission stock trading because platforms like PayPal and Cash App primarily use crypto trading products as engagement tools.”
And that’s exactly right. It’s only natural that PayPal (NASDAQ:PYPL), Square (NYSE:SQ), Robinhood and others are going to try to take market share from Coinbase.
The easiest way to compete is with price, and Coinbase’s fat profit margins practically beg the competition to enter the arena.
Another Issue: Tether
While fee compression is the big long-term risk, Coinbase has another potential negative catalyst. Recently, Coinbase announced that it will accept controversial stablecoin Tether (CCC:USDT) onto its platform.
In theory, Tether is supposed to facilitate trading by allowing customers to sell crypto and receive Tethers, which are always valued at $1. Using a substitute for fiat makes trading faster and easier.
However, Tether has run into a great deal of trouble. After trading losses, traders began to doubt whether Tethers were indeed fully backed with dollars, as its sponsors have claimed.
The New York Attorney General detailed numerous troubling operational developments at Tether. Recently, she banned Tether from doing business in New York and fined the firm millions of dollars.
Coinbase runs a grave risk by letting Tether onto its platform. For one, Coinbase could lose access to customers in New York, since it would facilitate transactions in a token that is banned in that jurisdiction. New York is doubly important; not only is it a large state in its own right, but it also is home to countless systemically-important financial institutions.
If you want to be a leading financial firm, you should be able to operate in New York. Furthermore, if Tether does end up collapsing, as its skeptics predict, it would give brokers that offered Tether a black eye.
COIN Stock Verdict
It seems a lot of people are bearish on COIN stock because they think Bitcoin will go down. That’s understandable. In fact, I recently made the case for why Bitcoin is in danger of crashing.
That said, if Bitcoin price risk was the only major issue, Coinbase might still be a decent investment today. In any case, if you’re bullish on Bitcoin, it’d be easy to brush aside those concerns about Coinbase.
However, even if Bitcoin continues to rise, Coinbase won’t necessarily increase in value. If and when the company has to start cutting its trading commissions dramatically, it will punish the company’s profitability metrics regardless of where BTC itself is trading.
On the date of publication, Ian Bezek did not have (either directly or indirectly) any positions in the securities mentioned in this article.
Ian Bezek has written more than 1,000 articles for InvestorPlace.com and Seeking Alpha. He also worked as a Junior Analyst for Kerrisdale Capital, a $300 million New York City-based hedge fund. You can reach him on Twitter at @irbezek.
