Coinbase ($COIN) #4 - Competition Deep Dive
I dive deeper into the competition searching for a Moat
03-03-2022 to 03-04-2022
Layout Change:
I decided to make a layout change. From now on you will see the yellow quote lines in my blog only comments and not next to my raw notes. The raw notes are 95% of each post, so it makes more sense this way.The Post:
This is my deep dive approach to analyzing the competition. This can take from days to weeks depending on the information available. This one is relatively short, because none of the competition is public. This has the glaring disadvantage that much of what the future holds is currently not knowable. But my approach follows Li Lu: Be highly certain about your worst case future and buy with a margin of safety. Sounds simple doesn’t it?Emotions
$COIN has been declining in the last few days. The one thing I do not like about doing deep dives and scuttlebutt like I did is that many of the websites simply show the current market price. My human mind simply cannot ignore all the fancy Green and Red. So I have been feeling “the fear of missing out“ a lot today. I have no magic formula to give you except that I have no problem ignoring it. I can remind myself of everything I have learned from Munger and the feeling subsides.
Competition Deep Dive
How difficult is it to switch from one platform to the other?
It seems that for the trading side of the business there aren't any switching costs. See research below.
Interface
Mostly an interface review. Seems all are similar. Binance does seem to offer the best interface for serious traders.
Kraken seems to be the loser on interface. However, a lot of that comes down to personal preference. Additionally, I cannot take the opinion of the video creator into account. The impression I received from watching the interfaces is that they are all the same things. Serious traders may prefer Binance.
This was more interesting regarding the deposit options. FTX supports much more currencies, while Coinbase supports PayPal. This fits with the regulation first approach, but I need to make sure that FTX does have regulatory risks. In customer support Coinbase was not reviewed well.
Reddit
https://www.reddit.com/r/CryptoCurrency/comments/plqnz4/kraken_vs_coinbase_thoughts/#bottom-comments
Kraken seems to be the winner because of lower fees and amazing customer support. Several users suggested to use both apps at the same time. This would indicate that there are no switching costs except convenience.
https://www.reddit.com/r/CoinBase/comments/lh384h/coinbase_vs_binance_vs_other/
Complaints about Coinbase locking out funds when withdrawals are requested. Coinbase policy seems reasonable (https://help.coinbase.com/en/coinbase/other-topics/other/does-coinbase-freeze-accounts). Consensus here is to use Coinbase, because of rules and locality. Again, a lot of people are switching between exchanges.
It seems to me that we cannot define a clear favorite inside the reddit community. Therefore, I will assume that there is no moat for switching costs, but that COIN must differentiate itself through other avenues.
https://www.coinbase.com/legal/user_agreement/ireland_germany
4.7 Redeeming E-Money*
I also went ahead and checked the user agreement related to fund withdrawals. Coinbase reserves the right to conduct fraud checks based on local regulations when a withdrawal request is made. Considering the regulations first approach, the current environment surrounding blockchains with governments I find delays and lock ups to be a good thing, because Coinbase is simply following the rules. This will get faster over time. FB for example had to get their AI smart enough to do better monitoring of content and in 2010 for example that simply wasn't yet available.
* I am a US based investor, but am currently in Europe, hence why it gave me those agreements. I am assuming that the USA will be similar.
Binance
https://www.businessofapps.com/data/binance-statistics/
How popular are they in Korea, Japan and the other regulated economies?
Japan has tight regulations with bitFly and Coinbase inside the legal framework. Again, Binance trades there, because of the nature of blockchain, but COIN does it legally.
How in-depth are their legal troubles in the US and the UK?
https://www.wsj.com/articles/sec-probes-trading-affiliates-of-crypto-giant-binances-u-s-arm-11644948162?mod=Searchresults_pos2&page=1
Binance is being investigated for having undisclosed Market Makers in the middle of the trading. In the article it also states that FTX has middlemen operating. COIN does not have this investigation. In general, the behavior of both companies suggest that they are not "all in USA", because of the sister companies. This from the outset suggest they want the liability protection knowing their practices may not be accepted in the USA.
https://www.wsj.com/articles/binance-became-the-biggest-cryptocurrency-exchange-without-licenses-or-headquarters-thats-coming-to-an-end-11636640029?mod=article_inline
BinanceUS had former COIN executives (Mr. Brooks) resign in August. Many of the legal team employees also left. The CEO who ran the exchange without any main location seemed to balk at suggestions to base coding in the USA. There's internal struggle, especially in the US market.
https://www.reuters.com/business/binance-us-ceo-brian-brooks-resigns-2021-08-06/
This confirms Mr. Brooks departure. It does point or creates the impression that they left, because of the legality of it all. The CEO is rich, so if his exchange cannot become the truly open free marketplace, he envisioned than it won’t hurt him much. Not saying that is the truth, but all of this certainly points in that direction.
https://www.wsj.com/articles/cryptocurrencys-surge-leaves-global-watchdogs-trying-to-catch-up-11629720000?mod=article_inline
General comments about a $100 million fine to another exchange for not having the licenses in place. Binance has been banned in the UK from trading derivatives due to lack of regulatory compliance. That now makes UK + Japan.
https://www.wsj.com/articles/binance-crypto-exchange-ordered-to-cease-u-k-activities-11624812672?mod=article_inline
Here the withdraw from the UK is described in more detail. The battle for users in the USA and Europe is clearly favoring COIN, because of their approach. The battle in less regulated countries is favoring others. Where are the largest trading markets in the world today? Here is Statista’s opinion (https://www.statista.com/statistics/710680/global-stock-markets-by-country/). China has banned Crypto outright, UK and the USA are already in COIN territory let's say that leaves Japan open. And COIN recently entered the Japanese market. Why is this comparison with stocks important? Because the countries with the largest current stock markets will also likely have the financial means to become the largest LEGAL crypto markets. Therefore, COIN controls quite a big chunk of the legal markets already.
What licenses does BianceUS hold?
Few. COIN does have a clear advantage based on the above research.
What do customers say about it?
See the research on Interface
Do they have a VC arm?
Yes, they have a VC arm. Everyone seems to have one.
Kraken
1. Is Kraken licensed to operate like COIN?
2. Is Kraken's UX amazing or does it lack behind COIN?
3. Do they have a VC arm?
Kraken is the best competitor inside the USA. All the questions have been answered inside comments about the other companies. The main difference is that Kraken is also taken a more legal approach. They are much smaller however and quite a bit behind. Most of the information about Kraken is already answered in previous research posts and I will revisit it at the end when I write the actual thesis.
FTX
https://www.coindesk.com/business/2021/10/25/ftx-crypto-exchange-finalizes-ledgerx-acquisition/
https://www.cnbc.com/2022/01/31/crypto-exchange-ftx-valued-at-32-billion-amid-bitcoin-price-plunge.html
Fundraising of $1.3 billion for a valuation of $32 billion. the company operates in the US through a sister company, not a subsidiary. Currently there are no plans to go public.
https://www.marketsmedia.com/ftx-us-attracts-institutions-after-ledgerx-acquisition/
60% of volume from COIN, but catching up to 14% market share
https://www.businessofapps.com/data/ftx-statistics/
FTX has impressive % gains, but remains relatively small in size compared to COIN.
Revenue:
2019 - $7.2 million
2020 - $85 million
2021 - $850 million (850% increase)
The link above shows more data which has FTX growing, but much smaller than COIN.
Is FTX truly superior for traders?
No, they all seem to be the same.
Is the UX superior?
No, they all seem to be the same
What does a pro trader want that COIN doesn't have?
https://www.nerdwallet.com/article/investing/coinbase-vs-ftx
https://www.investopedia.com/ftx-review-5219459
It seems that a key difference is fees and margin trading. Another difference is fiat currency availability on FTX vs. Crypto availability on COIN. Again, we come back to regulations, because COIN is in the USA while FTX is in the Bahamas. So, for worst case scenario we can assume that competition will eventually occupy say 75% of the total market share. I added that and some other thoughts to the Inversion list. In comparison to FTX however COIN is the big dog in the USA. Also, here customer support seems to be the main issue. Considering the investment required to beef up customer support again COIN just seems to be better positioned considering their revenues and size.
The key question will be the next one below. The access to futures markets is no issue anymore due to COIN's acquisition and generally beefing up a pro trading platform isn't a problem either. The key to me will be Network Effects and Brand (Trust).
Regulatory troubles / licenses they currently hold?
See Binance comments for same article.
Do they have a VC arm?
Yes they have a VC arm with $1 billion in funds.
Are they planning to launch non trading services?
I have found other serious competitors who can pose a threat. Alchemy being the most serious as discussed below. FTX itself is launching various things as well.
Competition Thoughts
I am primarily interested to own a company which engages in legal trading. With that being said, the trading itself is not what is most compelling, it is the future of NFT's and the actual useful use cases that it will eventually take hold. The trading of digital assets etc. is not interesting, that is speculation fueled by hype. But having the ability to own digital currency (legal with true fiat exchangeability) and purchasing NFT's that represent the ownership of real assets (houses, cars, paintings etc.) that is huge. It just feels like that FTX and Binance are profiting from the speculation aspect and are now being reigned in, while COIN is carefully moving forward to one day profit from the actual true value of the blockchain. The Binance CEO being defiant with regulators is noble in the pursuit of having a fully decentralized new financial system, but it simply isn't reality. Does this attitude reflect through the culture of the company? I sure think it would and that means the company was founded on economic freedom, yes, but without concern for reality and that will sure be difficult to change now that there is momentum behind the movement. CEO’s are resigning after three months (NDA’s no doubt), legal teams are resigning; it sure seems that their wishful dream thinking got the better of them and COIN and Kraken are much better positioned for reality.
Alchemy
Competition for the cloud. In our worst case we will assume this should be free potential in the future, but non the less we need to evaluate them.
I read a lot of articles. Too many to list, they were all basic google results. Not much detailed information can be gathered about the company. The first impression all these articles gave me was one of a great startup, ready to compete with anyone. It's a tough battle in that space as there were mention of at least 5 others. a16z is also invested in Alchemy. Maybe there is some more information about that because this seems like a conflict of interest in the future.
The competition deep dive is always a scary and daunting task to begin. First there is the feeling: “No, I don’t want to know if some other company is better than mine. I love my company. I just read four days’ worth of reports.” Second is you never know what you’re going to find, which will extend this process for days. But hey, Munger warned us, didn’t he? He clearly told us about human misjudgment, so just because I did a lot of work, doesn’t mean I have to act. Better to wait, take a step back and INVERT. And secondly why should it be easy to get rich? In that spirit I overcame my own emotions, as I always must do, and began.
Right now, I think I have laid out a good conceptualization of why COIN is indeed one of the leaders. The regulator framework is a potential moat. That is visible when one studies how Binance has been banned in the UK and declared illegal in Japan. The internal struggle with their US sister company shows that the company lacks a clearly articulated culture and drive. In that case your UX and lower fees are irrelevant, you will end up losing market share, because there are no switching costs. Similarly, FTX will have problems taking market share from COIN in the USA and Europe. The regulation later approach is simply going to cost them customers. Yes, they can do it financially due to lots of VC hype and funding, but by the time they are done, have the support infrastructure in place many people will have moved to COIN. For my Inversion exercise (which will be next), I will still assume that COIN will have limited Market Share over the next 10 years, because Kraken may kick some serious butt. I think at current growth levels we can ignore Asia (except Japan) and truly focus on the regulated economies for this worst-case scenario. Everything else will be a free plus.
This brings me to the cloud. For the worst-case scenario, I will assume that it doesn’t exist and that only trading will continue to generate revenue. Alchemy looks good on the surface. There is so little information it is simply not knowable what the future will hold. What is knowable however is that the owner of a big bookstore also likes cloud computing and has also the words blockchain on his website. No matter who you are, that should get your attention quickly. I think that the market for cloud computing will be split between various players in the end and I even think that AWS will not have the lions share in this case (I could very much be wrong and will assume that they will have the lions share), but there is some revenue growth for COIN in that space. However, any forecast of how much would simply be guessing and I don’t guess.
Let me summarize how I will continue. The worst-case picture is beginning to pain itself. I will therefore create several bear case forecast scenarios. All of them will exclude the potential of the cloud and the VC arm investments. They will focus on the trading business, the growth potential in the USA, UK, Europe, and Japan. They will be very much in the style of Mohnish: never use excel, easy round numbers and then I will assign probabilities to these scenarios to determine if the current market cap provides me with a margin of safety.