Just how overpriced are crypto startups?

In the fourth quarter of 2021, Coinbase’s stock was trading around record highs, worth more than $340 before starting to fall as technology stocks corrected into the new year. Those declines persisted into 2022, causing Coinbase to continue losing altitude as the year began.

The company’s Q4 earnings released in February were strong, but it warned of a slowdown in its trading business. That deceleration in trading activity continued, leading to the U.S. crypto exchange’s first-quarter earnings pushing the value of its shares to new lows.

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Despite rebounding to around $67 as of this morning, Coinbase’s worth fell to as little as $40.83 during its selloff, which started in November.

From a high-flying direct listing with a massive market cap that proved crypto-forward companies could generate metrics that made traditional investors take note, Coinbase’s fall has been dramatic.

The drop of its stock has also been painful, as its declines were not simply due to changing market sentiment about technology companies — though that didn’t help. The company’s rising cost structure and falling revenues made it clear that ripping cash out of the crypto market was more expensive and variable than some public-market investors anticipated.

As much as Coinbase helped boost investor interest in crypto startups last year, it may now have the opposite impact. Coinbase was proof that crypto companies could post huge profits, but its success was built on top of rising demand for crypto assets and services. A strong Coinbase meant a strong web3 market.

What is the value of those same startups now that Coinbase has been repriced, and its underlying market flounders in the crypto equivalent of a recession?

In its recent Q1 results’ investor call, the company had notes on that very point. Let’s explore.

The public-private valuation gap

Before we dive in, it’s worth noting that little in our work today is unique to crypto. Most investors, both private and public, overvalued technology companies last year. Those erroneous valuation marks, set during one of the hottest periods for investment ever, landed all around the technology market and are still being dealt with today.

But the crypto market does have a special issue in that its venture capital totals did not peak in Q4 2021, but in Q1 2022, meaning that the crypto startup investment cycle stayed hot longer, and that crypto startups will feel the pain (when it comes to managing too-rich private valuations) a little later than their more traditional counterparts.

In response to a question about Coinbase’s position in the current crypto winter, CFO Alesia Haas noted the company could grow via organic and inorganic means — the latter is business slang for “buying other companies.”

After Haas made the comment, Coinbase CEO Brian Armstrong added the following, according to a transcript (emphasis ours):

Yeah, I guess the last thing I’ll just mention is that there’s a pretty big gap between revenue multiples for us as a public company and what we’re seeing and private market crypto investments currently. And so I think the reality is probably somewhere in the middle, that gap probably needs to close. And so we anticipate probably over the next year or so that we’d see corrections in private markets for that or, in both directions, frankly. So that’ll take some time to kind of move through the private markets. And I think that could change the outlook on the M&A front as well.

Translating that from CEO-speak, when we consider Coinbase’s current valuation, the valuations of many private-market startups are too high. That gap between private and public valuations in crypto will decline over time, and when it does, Coinbase may scoop up some smaller companies.

For Coinbase investors, this is good news, of a sort: Their investment may be able to snag some key talent and features via M&A on the cheap in the coming quarters. But this is awful news for venture capitalists who bet long on crypto startups during a period of elevated prices — their deals are likely underwater, and the best they can hope for is a Coinbase mercy killing at a discounted price perhaps later this year. Yowza.

Usually when The Exchange beats the “this thing over here is overpriced” drum, we sound a bit like haters — or at least that’s how the tech-wealthy appear to consider such notes from the media. But here, Armstrong is doing the work for us, meaning that I hope that this small piece is less acrimonious than some of our other “Bad News Bears” entries.

Just how far off are private-market crypto valuations versus where Coinbase is trading today? Somewhere between a country mile and a light-year. Coinbase currently has a price/sales multiple of just over 2x, per Yahoo Finance data this morning. At that valuation mark, most crypto startups would be facing a repricing of most of their present-day value, set during their most recent private financing round.

Naturally, startups with faster growth rates won’t get a flat Coinbase multiple, so they are not doomed. But threading the needle between their current worth and how public-market investors are valuing Coinbase, the shining light of U.S. crypto, is going to be a painful struggle. And it’s going to happen soon.