Coinbase Business Model: How does Coinbase make money?

Coinbase ranks amongst the top 10 Crypto Exchanges in the world by Trading Volumes. While they are predominantly present in the US, they are now planning to expand into Europe. But before we get into that, let us understand their business model. How is it that they make money, and what are their plans and strategies for the future??

Hello again, to all my Kammunity Lovelies. If you’re new here, then Welcome to Kam Questions, my weekly Newsletter where I talk all things Fintech and Business. So if that is your that jam, then do consider subscribing, because I tend to share a lot of deep dives, replete with data and insights, peppered with snarky comments, with the aim of educating and entertaining you. Investment advice is not my forte, and not something I plan to start doing either, so read on, only if you wanna tingle your grey cells.

And today we are going to be looking into CoinBase, a crypto exchange that has been in the news a lot not only for their recent round of Layoffs, but for their expansionary plans and strategies for the ongoing Crypto Winter. So let us try to understand what is it that CoinBase does? How do they earn, who do they earn from, w hat are their product offerings, what are some of the risks involved, and what is their future role in the Decentralised Finance world!

What is Coinbase?

?Coinbase?is an online crypto platform for buying, selling, transferring, storing , staking borrowing, lending, distributing and insuring cryptocurrency and digital assets. Phew that is a whole lot of activities isn’t it. But lets rewind the clock and understand how they got here.

CoinBase was founded by Brian Armstrong, a former airBnB Engineer, in 2012, when Brian received a $150,000 funding from Y-Combinator, and was later joined by Goldman Sach Executive, Fred Ersham. Shortly after, in May 2013, the company received its $5Million Series A funding from ?Fred Wilson?of the venture capital firm?Union Square Ventures. And then again the company managed to raise another $25 Million in December the same year from the venture capital firms?Andreessen Horowitz,?Union Square Ventures?(USV), and Ribbit Capital.

Armed with adequate money in the bank, the company grew to 1 Million users in 2014, both through organic route and by acquiring allied products and services, such as Blockr and Kippt, a blockchain explorer and bookmarking company respectively. In fact on of their earliest acquisitions was Compound Lab, a startup that specialized in building Ethereum smart contracts. They also launched their Vault services, to help their users secure their crypto assets. But most of all, their biggest win was that they managed to partner with several companies to enable them to accept payments in Crypto, notable amongst them being?Overstock,?Dell,?Expedia,?Dish Network, and?Time Inc

CoinBase’s belief in Decentralisation is seen in their company’s operations too. They do not have a physical headquarter and promote a fully remote work structure. Although, what I would have liked seeing them implement would probably be a truly hierarchy-less organisation, which is pretty much the promise of decentralization isn’t it? Maybe then we wouldn’t see them coming up in the news for rampant layoffs, for which they have been pretty much infamous for the last few months (On that note, if you were affected by the recent coinbase layoffs and are still looking out for an opening do send me an in-mail, I shall try my level best to help you get at least an interview with other Fintech firms which are hiring at present)

To make their mark in the Crypto based payments domain, CoinBase even launched a Visa Debit Card Program in October 2020. It promised crypto cashback on every transaction, as well as wide spread acceptance thanks to being a part of the Visa network. The promise was that your rewards too would grow as the crypto market size grew. I guess they failed to account for the crypto winter back then! Cynicism aside, I still think the value proposition they had in mind has a lot of merit. Especially given the way my Diners Black seems to be Cutting back on my rewards and benefits year after year! Given a chance, yes, I would like to see my reward points grow in value.

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Coinbase Product offerings and customer Segmentation

So, now that we have seen how Coinbase was formed, and their growth trajectory in the initial years, let us dive into their product offerings, and the various customer segments they cater to, before we answer the question of how is it that they earn from all of these varied lines of business.

CoinBase for Individuals

?Let’s jump into the shoes of Kam now. She is a young corporate employee, looking to diversify her means of earning a passive income. During her research she comes across something called Crypto Currency, and allured by its promised future decides to put into a small chunk of her monthly salary into crypto assets. For Kam, CoinBase offers an easy way to Buy and sell Crypto currencies, as well as track her portfolio through her mobile app. This is the first use case that CoinBase solves for through their Exchnge product.

Now Kam would also like to ensure that securely store all her crypto assets in one place, for which coinbase offers their Wallet services. She can in this instance opt either to secure her assets using CoinBase’s custodial services, or also use a secure key for the self custody of her wallet. Either ways CoinBase has her covered.

CoinBase for Businesses

Ok so next lets take a look at Kam Fintech Club Inc. If this company were to set up a payment mode of accepting cryptocurrency for their goods or services, CoinBase provides their Commerce services. You can setup the checkout option in under a few minutes, and start accepting payments in any crypto currency of your choice, be it BitCoin or Ethereum (Psst, if you are enjoying my newsletter thus far and would like to sponsor an episode, then do reach out. Yet to set up Crypto payments, because you know Indian Regulators, but Rupee/Dollar are equally welcomed). The advantages are that you can now circumvent a dozen middlemen if you have customers placed across the world, and accept international payments in a decentralised currency (provided your government allows you to do so), and easily convert it to a currency of your choice. Much cheaper and faster than taking the traditional routes.

Kam Fintech Club could also sell their NFTs and other Digital Collectibles on their Asset platform. And if their treasury also had crypto reserves COinBase’s business model allowed for them to enlist their custodian services to buy, sell, stake, lend, borrow digital assets while providing the company with adequate liquidity and leverage(more on this later).

But what if Kam Fintech Club instead was an investor in the Crypto/ DeFi space? CoinBase covers them too through their Data Marketplace and Investor’s platform. The Data Marketplace provides insights using the exchanges information on tickers that are trading on the platform, plus on chain analysis if the ivestor is looking to invest into a particular blockchain project. ?(Let me know in the comments if you’d like to know more about some of the key metrics to look at for a crypto project like Hashrate, inflow versus outflow, whales versus shrimps, Gas Fees etc. I’ll do it in my next LinkedIn Live Episode of Kamversations)

CoinBase for Partners

Finally we have the developer community and creators, core to everything crypto , DeFi and Web3. For them CoinBase provides APIs and SDKsto built their web3 apps or DApps, integrate wallets, query the blockchain, integrate their solution to a blockchain and so much more.

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How does CoinBase Make Money?

?So now that we know the three business verticals it makes a lot of intuitive sense to understand where the revenues for coinbase comes from.

When it comes to retail users it is their ability to charge them for every transaction they do on the platform, i.e. Transaction fees which is a tiered structure for them but averages out to 4% of the trade volume. Now this means the higher number of new users signing up, and more active monthly users the better. On that front they sure have done well. ?

The other metrics to track their top line performance would be Trading Volumes, and Assets on the platform, both of which have had stupendous outcomes

Next, lets look at their subscription revenue, how much it grew and what fraction of their overall revenue does it contribute towards.

Here, I do have some concerns because this to me indicates a huge dependence on trading to drive their revenue. And since 2021 was a great for crypto economy in general, with most cryptocurrencies touching their all time highs in November, implying the fees from transactions too have hit their all time high on platform. So, this means this year we can expect terribly muted performance of their revenue numbers.

How about their enterprise business? As of the end of 2021, Enterprise trade made up about two thirds of their trade volumes, which is still a good indicator, and probably shows they are somewhat prepared for a crypto winter, assuming they can cross sell their Enterprise solutions to these client base.

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What is the Coinbase Business Model?

?Given that we now understand the levers that drive business for CoinBase let us try to answer the question of what is their Business Model and how will they evolve in the future?

And no, it isn’t that they act as an exchange, while that may be their primary line of business at present. Or that they provide the tools needed for the creators of tomorrow to capitalize on their creations. Or that they could help all enterprises to become a Crypto Company. These are all on the surface. Let's go a few layers deeper. (BTW, I'll admit at this point this is my conjecture basis their Investor reports and press releases that I read)

Instead it is, yet again, their ability to use the vast volumes of data flowing into their systems, to gauge and predict the sustainability of the numerous crypto projects that are rampantly sprouting up every other day.

Armed with this not only could they provide advisory services to crypto companies, but they could potentially be involved in policy making as well, giving them unprecedented power in a decentro world.

They could also use this to scale their business by investing in projects that are showing great potential, while also performing due diligence on it , and in a way ensuring project governance as well.

What is more, they could provide an easy interface for people to expand their wealth in the Metaverse as well. Using the analytics and insights they’ve built from their core business they could expand that to serve customers in the Metaverse as well.

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What are the Risks with Coinbase’s Business Model?

Crypto Economy

CoinBase grows as the Crypto economy grows. Which is why the last few months, and possibly the next quarter too, have been especially hard at CoinBase, that forced them to layoff 1,100 employees in one shot. In a manner that incited a lot of backlash on twitter and LinkedIn.

Also, their revenues are highly correlated to the price of Bitcoin and Ethereum, as these arr the most popular digital currencies in terms of both value and volume traded across all exchanges, not just at Coinbase. For example, the first quarter of 2021 saw a 11% increase in revenue, the following quarter declined by over 30%, and then a 9% increase. All thanks to the volatility in Bitcoin and Ethereum, which btw accounts for 45% of their trading volumes. Which means the next BitCoin halving cycle and Ethereum Fork will drastically impact their top line.

Can CoinBase de-risk this? Sure, but for that they’ll need to grow their subscription services, and provide better quality add on products they can cross sell to their exchange bases users.

Unbundling of DeFi services

Competition for CoinBase is closing in from almost every corner, thanks to unbundling of crypto services, and several new startups receiving massive funding for their chosen niche, despite the funding winter. Now, obviously since these are growth stage, they’d offer their consumers better pricing, which means this will strain CoinBase’s margins drastically.

Issues with Governance and Compliance

When it comes to fintech, the Regulators hold the last word. No arguments there.

And this can be a major hindrance to the growth plans that CoinBase has, as well as become a damp squid to their expansionary plans. I mean quite recently, Charles Schwab had to pay a hefty fine for their robo-advisory product, so if the incumbents aren’t spared, Crypto companies are definitely well inside the firing range.

Not only that, sometimes complying with the state’s laws can turn out to be a costly affair, just as expensive as it would be to operate within the grey areas of the Land’s regulatory purview.

How can they de-risk? I would place my bets on Joint ventures and strategic acquisitions.

In fact I wouldn’t be surprised if their Europe expansion includes some expensive shopping around for a decent early stage startup. ?

Cybersecurity and its impact on Exchanges

In October 2021, 6000 accounts on Coinbase were compromised and hackers made away with a chunk of their crypto assets. This hack was attributed to their Multi factor authentication flow which had a vital flaw in it.

Such hacks questions CoinBase’s credibility in securing the assets of their users, and will harm their top line .

To make their systems more secure Coinbase has a very expensive bounty program. Recently they paid out $250,000 to an ethical hacker when they found a security bug in Feb’22.

These costs in my opinion are set to go up only in the future, as they start bringing out more newer features and hackers start using more sophisticated system and enhance their algorithms to attack CoinBase’s system. Btw, this isn’t something that is unique to coinbase alone, so I am hopeful that there will be a startup that comes up in the future that will help companies like coinbase outsource their cybersecurity to them. So in the long term thanks to disruptions and technological prowess this may no longer be a risk item.

What role will CoinBase play in the Decentralised Finance World?

While all of the risks mentioned above are legitimate, they are still ones that CoinBase can work around and de-risk.

But in my head, I have this whole other existential question for CoinBase. In a decentralized world, what role pray tell me can a Centralised Exchange have ?

And this especially pertinent, since even in TradFi we have seen the likes of Zerodha, 5Paisa in India and RobinHood in the US come in with their Discount Brokerage model, and cut away at the margins of regular Exchanges and Brokers. So in such a situation why would I need to pay a hefty cut to Coinbase for my trades, when in essence a Decentralized Protocol can take its place for much much cheaper ? And also give me much more control and transparency in the process??

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