Shares of U.S. crypto exchange Coinbase teetered this morning after its second-quarter results missed both top- and bottom-line expectations, off more than 5% in pre-market trading then jumping as much as 7% after markets opened.
The company, once hugely profitable in the wake of its 2021 direct listing thanks to a run in crypto-related trading activities, is now working to limit costs and brave the ongoing “winter” in its market and stick to prior profitability targets for the full year.
The Coinbase report — read TechCrunch’s initial look here — is replete with fascinating data, making it difficult to detail in just one column. To wrap our minds around what Coinbase reported yesterday and what its notes on the future mean for the crypto startup economy in the back half of 2022, we’re digging deeper today.
What follows are five takeaways from Coinbase’s report that stood out to us. Of course, let us know if you think we missed something critical. To work!
The foreseeable future seems grim for crypto
Coinbase’s shareholder letter included a set of guidance and observations regarding the company’s performance thus far in the third quarter. As these updates have helped elucidate its future performance in the past, they matter.
Coinbase recorded trading volume of $51 billion in July. That pencils out to a quarterly run rate of $153 billion, off a little more than 29% from Q2 2022 trading volume of $217 billion. Given that the majority of Coinbase’s revenue comes from trading-related activity, we can infer that its revenue will dip in the third quarter from second-quarter tallies if crypto trading activity doesn’t rebound in August and September.
At Coinbase’s TechCrunch-calculated revenue take rate as it relates to trading volume — 0.30% in Q2 2022 — its trading-derived revenue could fall to $459 million in Q3, far less than the $655 million figure it reported in its most recent quarter.
Driving that decline in trading volume is a decline in monthly transacting users (MTUs). From 9.0 million in Q2 2022 — compared with 8.8 million in Q2 last year and a peak of 11.2 million in Q4 2021 — the figure fell to 8.0 million in July. If the trend continues, Coinbase could have its quietest quarter in some time.
For crypto-focused startups, we can infer a general decline in the activities likely correlated to their success — consumer engagement, trading volume, etc. Coinbase is not an island, and when it says that winds are blowing, it means the wider industry will be affected too.
Competition will squeeze trading fees (eventually)
TechCrunch maintains a spreadsheet of Coinbase’s trading volumes and trading-derived revenues for every quarter that we can get data. In general, there has been a decline in effective “take rate” over time, with the company’s apparent take rate peaking at around 0.61% of volume in mid-2020, then falling to 0.33% in Q1 2022 and 0.30% in Q2 2022. During the Coinbase earnings conference call, CFO Alesia Haas provided some commentary on the fees front, saying (emphasis ours):
We are okay with being a premium product. We feel like we’ve differentiated versus other services and that customers are willing to pay a premium for that service. And to date, we have not seen fee compression on the retail side and have not seen the need to change that fee model. In fact, we’re experimenting with pricing, like, for example, with Coinbase One, a subscription product, where we’re bundling all these services together and giving our users the opportunity to trade with no fees.
They still pay a spread but no fees to have better product experience. But over the long term, we continue to believe that there will be fee compression, and we started to build a diversified set of products that monetize in other ways, which is why we’re so happy to see subscription and services become an increasing percentage of our net revenue, 18% in Q2.
This is useful commentary. Yes, we have seen Coinbase’s effective take rate decline over time, but that doesn’t appear to be a change driven by evolving consumer pricing. Instead, from our read of the company’s notes and its historical data, it’s caused by a shift in trading activity away from consumers and toward other, lower-fee-generating customers on the corporate and institutional side.
Combining our first note regarding Q3 2022 results thus far and the fee conversation, here’s Haas later in the same call (emphasis ours):
[A]s we think about for the second half, what we’re expecting and what we shared in our outlook is that we think that volumes will be on the lower side or in line with what we’ve seen in July so far. And those are lower volumes, which means we’ll see sort of the — on the higher side of fees, which is probably in line with what we saw in Q2. But again, it’s all mathematical and mix. And we have not seen any impact yet on our fees.
Our thesis that crypto trading fees will compress, then, is holding up on a longer time scale, albeit one that is taking longer to come about than we anticipated. This could represent headwinds for Coinbase’s growth but also may indicate that other crypto-focused companies that eat off their trading volumes — in whatever form that may manifest — should anticipate lower yields from that activity over time.
Revenue diversification is hard
Coinbase is proud of its revenue growth apart from trading-related incomes. And it should be — its co-founder and CEO Brian Armstrong said during its earnings call that “subscription and services revenue, which is more predictable [than trading incomes], has contributed 18% to our total net revenue, which was only up 4% two years ago.”
There’s some wiggle to that number, however. Calculating subscription incomes against a falling transaction revenue result when the former is more stable than the latter sets Coinbase up for a solid comparison in a period of declining trading activity.
Perhaps more important are absolute figures for the company’s “subscription and services revenue.”
Here’s the data, ripped from a number of Coinbase quarterly reports:
- Q4 2020: $20.7 million
- Q1 2021: $56.4 million
- Q2 2021: $102.6 million
- Q3 2021: $145.1 million
- Q4 2021: $213.4 million
- Q1 2022: $151.9 million
- Q2 2022: $147.4 million
Though it is correct that Coinbase’s non-trading revenues have risen as a portion of its total top line, the numbers are still trending down from their peak results. This means that while Coinbase has done a good job of bolstering its non-trading incomes in a period of lower trading activity, those revenues are still cyclical, albeit to a lower degree. As such, they will also rise and fall with the larger crypto market, meaning that they will not be able to fully insulate the company against shrinking during crypto “winters.”
At its peak in Q4 2021, Coinbase’s “subscription and services revenue” was less than 10% of its total revenue, but the revenue category was around 45% larger in that period than it was in Q2. So which matters more: the comparative figure or the absolute?
Revenue diversification is hard at Coinbase for several reasons, perhaps mostly because trading is so damn lucrative.
It also doesn’t help that with more of Coinbase’s retail users staking their crypto rather than actively trading it, the company is seeing lower revenue per user. Haas said during the earnings call that more than a third of its MTUs — 6 million of the 9 million — are now using Coinbase’s non-investing products, driving more revenue from non-trading activity.
While Coinbase says it has seen this before, Haas told analysts the company expects the trend to continue for the rest of the year, “driving down average net transaction revenue per user.”
And if the sequential decline in MTUs continues, Coinbase may find itself losing even those lower-revenue-generating users.
The Coinbase NFT misfire is important
Coinbase’s NFT marketplace was expected to land with a bang. Indeed, it was news that Coinbase — an investor in OpenSea, the current market leader in NFT trading — was looking to compete with its investment in a somewhat direct manner. What venture investor takes on their investments so directly?
As it turned out, the Coinbase NFT market was pretty much a bust in terms of changing the market landscape of non-fungible token trading. TechCrunch counts roughly $6.7 billion in Ethereum-based NFT trading at OpenSea during Q2 2022, along with far smaller totals sourced from NFT activity on other blockchains.
Sure, that figure would not have saved Coinbase from revenue declines even if it had been fully executed on its platform — recall also that Coinbase forwent fees to help start its NFT marketplace — but it would certainly have helped its volume figures in the second quarter, and the third, and so on.
Coinbase’s approach to growth is to present a wide array of crypto-related services to customers of all sizes. Missing out on the tail end of the last NFT cycle, and the continuing volumes thereof, means missed trading volumes today and missed revenues in the future. That’s income that the company would sorely like to have, if for no other reason than to blunt near-term losses while its expenses remain far in excess of its revenues.
The crypto boom/bust cycle does shake out tourists, but it also rattles true believers
Coinbase presents a steady posture when talking about crypto downturns. Been here, seen that, survived — that’s the company’s core line. What’s more, Coinbase explained in its earnings report that crypto periods of less activity can actually be helpful, with Armstrong even saying the following in the earnings call earlier this week:
And so, in down cycles, it’s actually kind of a breath of fresh air. We get to go back and focus on paying down tech debt, doing innovation in our products, growing our existing products. And so, it’s been kind of nice to get back to that and keep focusing on building great products for customers. The other big thing we do is we focus on managing expenses closely to make sure that we can outlast any kind of down cycle.
Coinbase has lots of cash and seems confident, but the rapid change in market conditions did impact leadership. From the company that brought you its own take on the culture wars, the following note from Armstrong hits a more humble note:
I think a lot is going well. But if you look back, I think that we probably could have grown slower over the last couple of years, right? That’s something that we probably could have done better. I think that we’re still iterating on how we communicate. Our expenses are actually quite predictable.
An admission of an error? From a CEO on an earnings call? From this company on its earnings call? That might have been the biggest surprise this week.
Coinbase has myriad products in the crypto market and a strong foothold in one of web3’s largest markets. But no amount of work during the boom could prevent it from suffering sharp declines in activity when the crypto cycle turned.
That means Coinbase is today having to defend its model to investors who may have bought into its stock when it was trading at a multiple of its present-day price. And per its own notes, the bad times are not about to end any time soon. Indeed, things may get worse before they get better.