Coinbase: Cryptocurrencies Moving From 'New Paradigm' To Denial (Rating Downgrade)

Coinbase: Cryptocurrencies Moving From 'New Paradigm' To Denial (Rating Downgrade)

Summary Coinbase has seen a ~234% return in the past year, following the trend of major cryptocurrencies like Bitcoin. Momentum in cryptocurrencies appears to be fading, potentially pointing to the end of the bull market. While some cryptocurrencies may have viability, I argue Bitcoin, in particular, is not a viable currency, inflation hedge, or a means of storing wealth. Cryptocurrencies are not a direct inflation hedge but a sign of rebellion against a precarious monetary system. Coinbase's valuation appears too high even if we assume strong EPS growth, giving me a long-term outlook depending on whether the current Bitcoin bull market ends. Coinbase ( COIN ) has been among the top-performing stocks over the past year, with a staggering 234% return. The company has rallied following the trend in major cryptocurrencies like Bitcoin ( BTC-USD ) and others. In addition, its valuation has increased as investor sentiment surrounding the company has improved. I became bullish on COIN in January 2023, arguing that its low valuation, waning trust in fiat currencies, and Coinbase's higher security compared to its competitors (as a public company) improved its outlook. I remained bullish on COIN until December when I downgraded it to neutral on the view that Bitcoin's rally had become too mired in retail speculative exuberance. COIN rose by just over 300% over that period but has increased by an additional 49% since I became neutral. Those who've read my research know I am not one for fear of missing out. Indeed, I'd much rather miss out on gains than put my portfolio at risk. I invest based on fundamentals and macroeconomic trends and care little for what I feel to be emotion-driven speculation. Undoubtedly, most of the actively trading cryptocurrency market that Coinbase caters to is the speculative crowd looking for high short-term profits but not necessarily long-term portfolio stability and growth. This is important to point out as much of my opinions surrounding Coinbase are based on my bias toward fundamentals over technicals, though I aim to consider both. The momentum surrounding COIN, Bitcoin, and others is fading. The stock is down by about 25% from its highs. Bitcoin is down by about 12% and could either be in a consolidation pattern that may lead to new highs or has reached another cyclical peak. Undoubtedly, many speculators and investors in cryptocurrencies are lining up their bets. Based on my qualitative assessment of most vocal market participants, there is great hope and speculation that it will rise to over $100K after this consolidation. COIN's trend is closely tied to Bitcoin, so an outlook for the cryptocurrency market will be similar to COIN's. See below: Data by YCharts Even then, COIN is not performing as well as Bitcoin. Although COIN's trend matches Bitcoin's, how cryptocurrency prices impact its profitability is unclear. More importantly, Coinbase faces competitive factors that could upend its ability to keep up with the market. Similarly, Bitcoin faces competitive risks from cryptocurrencies that may prove to be more viable means of storing wealth or as a currency. With both in such a precarious position, it appears to be an excellent time to analyze the company and its drivers. An Outlook for Cryptocurrency COIN is driven primarily by cryptocurrency prices, so we cannot discuss its outlook without first assessing Bitcoin and its peers. I'll aim to do this without offending people, but the fact is that I do not believe Bitcoin is a viable currency or means of storing wealth. For one, most people think about Bitcoin in terms of how much it is worth in US fiat currency, implying many still care a great deal about its currency value then it. The same is true for gold, silver, and others, but in my view, not nearly to the same degree. Bitcoin is not very transactable, and transaction fees are usually very high and volatile. Its network processes between three and six transactions per second, compared to Visa, which claims to process over 65K per second. Adding on its lack of scalability and energy use, the argument that it is a store of wealth or an alternate currency falls short. Bitcoin is also not an anonymous or private way to move assets. Bitcoin is also not a true hedge against inflation or market risk. Its transaction costs should rise with inflation, as it depends indirectly on energy prices. Further, unlike gold, it has no strong inverse correlation to real interest rates. Real interest rates are rates paid on bonds after accounting for expected inflation. Low real rates signal a low time value of money, which should benefit inflation hedges like gold. That is likely not the case for Bitcoin. See below: Data by YCharts Of course, gold today is rising while real rates are high. Technically, based on real rates, the time value of money is so high that inflation hedges should be unattractive. However, as I've discussed, it seems the market is bracing for an inflationary rebound. Yes, that may fuel the speculation around cryptocurrencies. Still, the fact remains that none of the major cryptocurrencies have proven the same inflation hedge power as gold, which has hedged inflation since recorded human history began. El Salvador is trying to use geothermal energy to "mine" Bitcoin to use as legal tender. It will be fascinating to see how this experiment unfolds. However, I can't help but feel that power sources may be better used to create tangible physical items or resources for its people. To me, Bitcoin is fundamentally a digital asset with artificial scarcity. Its benefit to fiat currencies is that they cannot be printed. Still, they lack the stability that most central banks try to create and, more importantly, are terribly inefficient to transact. That said, I indeed admit that cryptocurrency may be viable if backed by physical assets like gold, thus solving gold's (or similar) translatability issues. There are some efforts to create gold-backed cryptocurrencies with provable reserves that have low transaction overhead and some privacy. In my opinion, that would be an ideal alternative to both fiat currencies and gold. Given my negative outlook for fiat currencies , based on global debt levels and social issues, I think Coinbase may eventually trade cryptocurrencies that could be viable means of wealth savings and exchange outside the traditional banking system, which I feel may be on the verge of significant pressure . Notably, Bitcoin and other significant cryptocurrencies may continue to rise in the current speculative rally. In my view, people are attracted to these digital tokens primarily as an act of rebellion against a monetary system that seems not to be working favorably for most people. As is often the case, it is easy to see the correct issues and hard to find the correct solutions. I think people buy cryptocurrencies because they correctly see the monetary issues today. However, that alone does not make the dominant cryptocurrencies today superior or viable; it only gives them temporary attractiveness that waxes and wanes with social trends. What is Coinbase Worth Today? When I became bullish on COIN in January 2023, sentiment surrounding the company and the cryptocurrency market was low. I thought people would flock to it because they saw that the monetary instability and inflation issues would not fade quickly and could grow. My view was largely correct, as 2023 saw bank failures and persistent inflation. In the future, I expect Coinbase and the other cryptocurrencies to reverse as speculators take profits and investors begin to realize that most of the dominant cryptocurrencies are not viable means of exchange for wealth preservation. Again, most people buy them and watch their USD price, implying they care about the USD more than using it as a hedge when the value proposition of cryptocurrencies is, supposedly, that they're an alternative to USD. Because enthusiasm remains strong, I would not be surprised to see Bitcoin hit $100K or more in 2024. I will not make that bet, but I would avoid betting against it or COIN as the apparent "cryptocurrency collective consciousness" seems quite eager to see a breakout. There is a 40% chance of short-term upside and a 60% chance of downside in the coming months, but an 80% chance of downside by a year from now. Those odds are only based on my assessment to illustrate that my position on Coinbase is based on a one-year outlook and not the short-term one, which many readers likely care more about. Still, the company's valuation is likely unreasonable at its current price. Based on two-year ahead EPS expectations, its earnings yield is 1.7%. That equates to a "P/E" of 58X. Based on two-year ahead expectations, its EBITDA-to-EV is 6.2%, equating to a forward "EV/EBITDA of 16X. See below: Data by YCharts I'm using these "yield" figures because the charts go hyperbolic during periods of negative expectations. Ideally, even for a fast-growing firm, I'd aim to see a forward "P/E" of ~30X (3.3% earnings yield) (on a two-year outlook) and an EV/EBITDA analyst consensus , COIN's forward "P/E" today is 17X even using a 2033 EPS projection that assumes annual EPS growth over 10% over the next nine years. Under normal circumstances, a growth rate may not be feasible. It depends mainly on the company's ability to overcome competition and lower its operating overhead or raise its revenue without increasing its overhead. The company has decreased its OpEx dramatically in the past year, primarily by cutting R&D and stock-based compensation. That is the primary driver of its higher operating income. See below: Data by YCharts Its stock-based compensation is still high and could be dilutive if its market capitalization declines. Still, it is clear that the company's managers likely feel ahead of its competition enough that it can reduce R&D and improve its profitability. That is a good sign and will allow us to see how much profit the firm can create. Of course, its valuation still seems too high at its current and expected profit levels. My previous argument that Coinbase had a competitive edge was based on the then-recent failure of FTX, which I expected would encourage cryptocurrency participants to move to more secure and regulated exchanges like Coinbase. Coinbase is publicly traded while its peers are not, giving it more transparency that offers customers trust. However, that trust comes with a cost. Coinbase has higher fees than its peers, fewer options than many, and arguably worse customer service. Coinbase is often the go-to for beginners but is not necessarily the best choice for those beyond that stage. I'd also argue that others like Kraken, Gemini, and others have improved their safety and regulatory aspects over the past year following the Federal government's crackdown on the sector. No doubt, Coinbase is the dominant player, but I would not value it under the assumption that it will maintain its edge forever. If cryptocurrency takes off, traditional banks and other financial institutions will develop their own platforms. If it wants to create a competitor, Schwab ( SCHW )has far more income and market capitalization to deploy. As we've seen with stocks, competition drives fees down, potentially upending Coinbase's long-term income. The Bottom Line Now, some analysts I've seen value COIN on the assumption that cryptocurrencies will eventually replace fiat currencies, giving the company immense growth. To me, Coinbase faces the same issue as gold miners . Yes, a hyperinflation crisis would raise the value of alternate mediums of exchange (and therefore its sales), but not necessarily by more than the decline in the fiat currency. A hyperinflationary crisis would increase labor and energy costs, cutting profit growth. Quite frankly, it is impossible to value any company based on fiat currency failure because, in many cases, inflation will increase costs faster than demand and create added strain for companies trying to keep up with chaotic prices. Yes, Coinbase shares may be worth millions if the US dollars were replaced with cryptocurrency, but that is not meaningful if the US dollar is devalued by a million times. Thus, I value COIN on the assumption that fiat currencies will remain turbulent but not collapse. In my view, COIN's fair value is around $110 today. That price gives it a forward "P/E" of ~30X based on its two-year forward EPS expectations. I believe that valuation generously accounts for its growth potential. I am bearish on COIN and expect it will eventually trade at this price. However, I would not bet against it today as there is some potential that Bitcoin will break out to a new high under its remaining momentum. While I do not believe Bitcoin or most of the dominant cryptocurrencies are viable mediums of exchange or wealth storage, Coinbase is still valuable as it can trade alternatives that may. read more