Is it too late to let Bitcoin go extinct?
This comes to mind in considering shares of Bitcoin wallet Coinbase COIN — 6.5% of whose float is sold short — which trades 84% below its peak of $368.90 last November, when Bitcoin hit its high of $67,802.30.
With Bitcoin down 53% from that high, another strut holding up the crypto project is crumpling. That strut is UST — a so-called stablecoin that like a share of a money market fund is supposed to remain at $1 peg — which plunged to 35 cents on May 11.
Those prescient investors who bet on its decline should hold on to their positions because this stock has what it takes to fall much further. How so?
- Crypto’s value lies in what a greater fool will pay for it
- Investors are fleeing risk assets and UST’s plunge highlights just how risky crypto is
- Coinbase’s cash burn rate is high relative to its cash
(I have no financial interest in the securities mentioned in this post).
Coinbase’s Ugly First Quarter Report
Coinbase revenue fell 27% in the first quarter and its shares lost as much as 19% after the announcement on May 10, according to CNBC.
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It seems people are losing interest in trading Bitcoins. At least that’s what jumps from the page of its first quarter report which featured $1.17 billion in revenue — $310 million lower than expected along with a loss per share of $1.98.
Users and volumes fell. Compared to the fourth quarter of 2021, retail monthly transaction users dropped 19% to 9.2 million while trading volume of $309 billion was 44% lower than the previous quarter.
Coinbase is bullish about the long-term. In a letter to shareholders, it wrote, “We believe these market conditions are not permanent and we remain focused on the long-term.”
What’s more, Coinbase is betting on the next generation of crypto — which it calls the application era “led by NFDs and decentralized finance, and we are increasingly focusing our efforts on these market opportunities.”
UST’s Plunge to 35 Cents
Along with the drop in Bitcoin’s value, comes the news that another kind of crypto currency is floundering in its efforts to hold a stable value. How so? On May 10, UST lost 65% of its value, according to CNBC.
That’s a problem for Bitcoin because UST is supposed to be like a money market fund — to maintain a peg of $1 per coin. Unlike a money market fund, a stablecoin is not backed by the U.S. government — which in September 2008 stepped in by offering temporary insurance — during the height of the financial crisis when money market funds briefly broke the buck.
UST — the world’s third-biggest stablecoin — claimed that it could hold the $1 peg. How so? According to CNBC, it “uses a complex system of minting and burning tokens to adjust supply and stabilize prices.” For reasons possibly related to the recent crypto sell-off, UST was trading at just 35 cents at 4 a.m. ET on May 11.
Sounding to me like something from Star Wars, UST is supported by its creator Do Kwon’s Luna Foundation Guard fund — which supposedly holds “billions of dollars’ worth of bitcoin to support UST in times of crisis.”
Could Kwon be dumping bitcoin to prop up UST? According to CNBC, on May 10, Kwon said he was “close to announcing a recovery plan” for UST. “Hang tight,” he tweeted.
Crpyto’s Broken Business Model
Coinbase’s revenues are tied to the fate of Bitcoin.
Both look shaky to me. As I wrote last April when Coinbase went public in a direct listing, the company was not worth the $100 billion stock market capitalization at which it was slated to go public.
The upward momentum in my view was based on the brain chemicals Bitcoin trading released. Rather then valuing Coinbase as the present value of its future cash flows, it was soaring “on the realization that its meme-like qualities will ungate a flood of social-media spread dopamine to the brains of bored traders who buy them.”
To be fair, a year ago, the company estimated that its Q1 2021 revenue would pop 906% to $1.8 billion; trading volume would reach $335 billion — 50% more than 2020’s volume; and profit would reach $760 million.
The risks? Most of Coinbase’s revenues came from Bitcoin transaction fees. Sadly for investors, with its fee of 0.46% being 46 times that of rivals such as Gemini, Bitstamp, Kraken, and Binance, those fees were likely to drop — possibly to zero.
Then there is a more fundamental problem — crypto’s value derives not from the cash flows it generates but from the ability to find a greater fool willing to pay more for it than you did.
Warren Buffett stated this very eloquently last week. As I wrote on May 3 Buffett said Bitcoin is not useful. According to CNBC, he said, “If you said… for a 1% interest in all the farmland in the United States, pay our group $25B, I’ll write you a check this afternoon…Now if you told me you own all of the Bitcoin in the world and you offered it to me for $25 I wouldn’t take it because what would I do with it?”
Unlike apartments that produce rental income or farmland that produces food, the only way to get value from Bitcoin is to sell it to someone else. “That explains the difference between productive assets and something that depends on the next guy paying you more than the last guy got,” Buffett said.
He explains the price of Bitcoin as magic. While Buffett does not know whether Bitcoin will go up or down in the future, he concluded “the one thing I’m pretty sure of is that it doesn’t multiply, it doesn’t produce anything. It’s got a magic to it and people have attached magic to lots of things.”
Last April, I argued that Coinbase was not worth $100 billion — instead $18.9 billion would be a good number. On May 10, Coinbase fell below that level — its market capitalization was $18.2 billion — about $94 billion below its November peak.
Investors Fleeing Risk Assets
To be fair, Coinbase is not the only financial investment that has lost value. According the Wall Street Journal, investors have backed off the most speculative assets concluding that financial markets “are at a turning point.”
This is largely due to the Federal Reserve’s roll back of its “easy-money policies” which have led it to raise interest rates — last week’s 50 basis point increased was the largest in over two decades — and to “unwind its asset portfolio.”
Stocks plunged in the wake of that and crypto was down much more. “Bitcoin, which slid for the sixth straight day on Tuesday, is now down 54% from its November high. So far this year, it has lost one-third of its value, while Ethereum is down 37% in 2022. Nonfungible-token sales have flatlined,” wrote the Journal.
One investor considers rising interest rates to be bad news for crypto. As Matthew Tuttle, chief executive and chief investment officer at Tuttle Capital, told the Journal, “When [Coinbase] came out, it was one of the hot, growth stocks, the innovative companies. As soon as the Fed pivoted in November, that was a death knell.”
Not everyone agrees with Tuttle. Indeed the Journal cites “many people in the cryptocurrency industry” as sources for the observation that the current downturn “would be different because of the crypto market’s expansion, broader adoption by Wall Street, and Bitcoin’s value as an inflation hedge.”
Coinbase’s Cash Burning Ways
Coinbase’s cash burn rate is scary — but it had $6.1 billion in cash at the end of March. Sadly in the first quarter alone, it burned through $1.5 billion worth of cash, according to its Q1 2022 shareholder letter. If Coinbase keeps that up for a year it will run out of cash.
Meanwhile Coinbase also has $3.4 billion in long-term debt. Moody’s gave Coinbase’s debt a junk rating of Ba1 last September citing an “uncertain regulatory environment and fierce competition,” according to MarketWatch.
Moody’s analysts Fadi Abdel Massih, Donald Robertson and Ana Arsov wrote that Coinbase’s transaction fee can be very lucrative in an up market, “However, when prices decline, the notional traded amount and the firm’s transaction revenue will also decline unless volumes increase.”
Regulators have stopped a Coinbase diversification effort. The company sought to launch a platform that would allow customers holding stablecoin — USD Coin USDC — to earn interest by lending it to other traders. The SEC nixed the business when it required Coinbase to offer this through a registered broker dealer.
Bitcoin is not an inflation hedge and that is great news for investors who are short Coinbase stock.