I’d love to spend this morning writing about yesterday’s announcement that Square will be developing what sounds like its own decentralized finance (DeFi) platform on Bitcoin. But there’s nearly no information in the world about the project right now – even the name is (for now literally) TBD.
We do know it will be led by Mike Brock, a former Red Hat team member. The idea of building DeFi on Bitcoin, which doesn’t natively support all of the smart contracts required, is exciting and novel and frankly a little weird. But I trust Square CEO Jack Dorsey, so I’m eager to hear more.
But in the absence of that “more,” let’s talk about the fact that markets seem so indifferent to this possibly game-changing news, and what that means for other crypto businesses – specifically, exchanges.
Bitcoin edged up less than 1% in the last 24 hours, which is a pretty typical daily fluctuation and can’t be tied to the Square announcement. For first-timers, that’s because we’re entering at least a bit of a crypto pause, with public interest having been redirected to, among other things, going outside. Search volume for both “bitcoin” and “Ethereum” have cratered over the last few weeks, and as we’ll discuss, so have exchange volumes. Hopefully this won’t turn into a full-fledged bear market like 2018-2019’s “Crypto Winter,” but at least for a little while, this kind of news may just not move the needle as much as it would have closer to the market top when there were more eyes on the sector.
That’s a problem, above all, for cryptocurrency exchanges, which make most of their money from trading fees. In the past, trading lulls have led to lots of layoffs and strategic contraction. But this time around, there’s something new to consider: Among all cryptocurrency exchanges, dormant cycles may be worst for those that are publicly listed.
Long periods of dormancy have so far proven typical for crypto, as adoption waves come and go like tides. These big fluctuations in public interest are very bad for the bottom lines of companies like Coinbase, not only because they’re making less money, but because Wall Street is not particularly well set up to value businesses with that kind of intrinsic ebb and flow.
But first, let’s look at just how bad things are out there! The situation was highlighted last night by Frank Chaparro, news director of The Block, who characterized exchange volumes as “falling off a cliff.” But I’ve seen actual cliffs I’d rather fall off – aggregate exchange volumes are down roughly 60% since the May market peak. Some exchanges are doing better than others: Binance, possibly thanks to its legal troubles, is off more like 85%, according to data from CoinGecko. Derivative trading volume on FTX is down roughly the same amount. These may be higher than the aggregate because newcomers were more likely to use these more prominent platforms. It’s also quite possible that smaller exchanges in the aggregate are spoofing volume, and everyone’s down as much as the big boys.
Trading volume on Coinbase, according to my calculations, is off an even more chilling 92% from its May peak. As Jeff Roberts over at Decrypt pointed out, this will lead to a pretty crazy situation for Coinbase’s stock. They should report second-quarter earnings soon, but that will be for April through June, which includes the May peak, so that report will probably look great. The report will also (because the SEC has some standards) include major caveats about how their third quarter outlook – that is, the business actually happening at the time – is an absolute dog’s breakfast.
This is not the type of performance Wall Street likes. Wall Street, big surprise, likes numbers to go up – the more steadily, the better. Even if you’re a money-losing public startup, you’d better be able to lose a little bit less money each quarter. Coinbase, because it is deeply tied to a market that moves in rather long, slow, and deep cycles, is going to have a very hard time meeting those expectations.
Some Wall Street analysts may be knowledgeable and generous enough to try to make allowances for Coinbase’s unusual market position. But most won’t, and they’ll look at the huge gap between the Q2 numbers and the publicly-viewable volumes actually happening the same day, and they’ll think, “My god, this stock is terrible.” I’d bet there’s resistance to even covering the stock, since analyst reputations hinge on the accuracy of their calls, and setting a medium-term price target for Coinbase’s stock is like trying to guess which way a hand grenade will bounce. (Coinbase does have non-exchange revenues, such as custody services, but transaction fees are as much as 96% of its revenue.)
That said, this arguably creates an opportunity. For many, many years, Bitcoin has been slammed for its volatility, but supporters said that things would smooth out with enough adoption – enough coins spread out across enough hands creates stability. That has started to show signs of coming true. In fact, the past two months of relatively tight trading between $30K-$34K has been far worse for exchange trading volumes than a few wild swings would have been.
By a similar token (pun intended), Coinbase is a long-term bet that crypto exchange activity will diversify and deepen to a degree that its revenues smooth. Both the Nasdaq and Intercontinental Exchange, the parent company of the New York Stock Exchange, are publicly listed, and they’ve been pretty good long-term bets. If you think the crypto market will thrive alongside the stock market in coming years, Coinbase is still probably a good bet – but maybe wait a few weeks to fill your bags. A lot of investors have already concluded they aren’t interested, which is why $COIN is off a precipitous 31% since its initial stock listing. But as the current bloodbath makes its way into Wall Street’s full awareness, there’s further left for it to fall, at least in the near term.
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