For all those who have bought in the Coinbase (NASDAQ: PIECE) IPO in April was not a fun month. Shares of the cryptocurrency trading platform are now trading below their IPO price of $ 250, and they have been nearly halved from their all-time high.
At first glance, the stock looks incredibly cheap. Coinbase reported first quarter revenue of $ 1.6 billion, down from just $ 179 million the year before. Net income jumped to $ 771 million from just $ 32 million. At the current rate, Coinbase is trading seven times sales and 15 times profits.
But Coinbase stock is not cheap because the business is not sustainable. Coinbase generates revenue by charging fees to those who trade cryptocurrencies on its platform. It’s great when the prices of Bitcoin (CRYPTO: BTC) and other cryptocurrencies are booming, but it’s terrible after a stock market crash.
The bubble can burst
As of this writing, Bitcoin is trading just above $ 35,000. This represents a drop of almost 50% from its peak last month. Other cryptocurrencies don’t do better. The price of Ethereum has almost been halved, and Dogecoin is even lower. Things change quickly, so those numbers could be out of date within minutes. But it’s the biggest sale yet this year.
People trade anything – stocks, cryptocurrencies, options – because they think they can make money. Making money in cryptocurrency this year has been easy, at least until recently, as prices were rising rapidly. The ever-increasing prices have attracted more people, increased the number of Coinbase users, and generated record transaction volumes. The trading volume on the Coinbase platform grew 11 times in the first quarter on an annual basis.
Coinbase recognizes that its activity is unpredictable and therefore does not provide any specific guidance. The company provides a few scenarios related to users doing monthly transactions, but the most pessimistic is still very optimistic.
The worst-case scenario presented by Coinbase is that users doing average monthly transactions drop to 5.5 million in 2021. This is down from 6.1 million in the first quarter, but it’s still much higher than the last year. Coinbase only had 1.3 million users transacting per month in the first quarter of 2020.
If cryptocurrency prices continue to plummet and aren’t recovering anytime soon, why would all of these people continue paying outrageous fees to Coinbase to trade? Coinbase charges a variable fee in addition to the fixed fee for all buy and sell transactions. It’s not cheap to trade cryptocurrencies on Coinbase, but it doesn’t matter when users expect to make money fast. Take the get-rich-quick aspect out of cryptocurrencies, and the main draw for many people is gone.
The worst case scenario for Coinbase is a massive and permanent drop in the number of trading users and trading volume far below the worst case presented by the company. Coinbase will then have to compete for users, which means its fee structure will be under pressure. All of this could drag Coinbase’s profits into the ground.
Coinbase has been around since 2012. The company has experienced several cryptocurrency crashes and has a ton of cash on the balance sheet. Coinbase will survive this crash. The question is: how much is the business really worth? Is he worth his current market cap of $ 45 billion?
Like any cyclical business, pricing Coinbase on peak profits is not a good idea. Coinbase expects to break even, on average, for now, so the bad times are going to be bad enough. It has other irons in the fire beyond transaction fees – the company offers Bitcoin-backed lines of credit, for example. But this activity will also not work if Bitcoin prices fall off a cliff.
Is it the big crash that puts cryptocurrencies in a prolonged bear market? Or will prices recover as they have every time they have fallen this year?
I have no idea. But what I do know for sure is that I have absolutely no interest in Coinbase stock.
This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a premium Motley Fool consulting service. We are motley! Questioning an investment thesis – even one of our own – helps us all to think critically about investing and make decisions that help us become smarter, happier, and richer.