Introduction Coinbase ( COINB ) and its digital asset exchange Coinbase Pro are the most well-known, established and trusted platforms for buying, selling and trading Bitcoin and other cryptocurrencies in the United States. While they have many competitors, the landscape is developing rapidly, and very little differentiation exists. Coinbase has a unique opportunity to leverage its size and reputation to create a lasting strategic advantage against Gemini, Kraken and Bittrex. Vertical integration may be the best way to achieve this lasting advantage, and at the same time remove the threat to their users of being blacklisted by their own financial institutions.
Company Summary Based out of San Francisco, California, Coinbase is probably the most well-known brand in the cryptocurrency space.
Founded in 2012, and funded by Andreessen Horowitz, the New York Stock Exchange, Y Combinator and others, Coinbase became the first company in the space to reach “unicorn” status, by achieving a market valuation over $1 billion . Coinbase serves thirty-two countries and over 20 million customers according to their homepage , and is led by CEO Brian Armstrong .
Coinbase also operates an exchange called Coinbase Pro for professional traders.
Customers can buy or sell cryptocurrency trading pairs in Bitcoin to Ether, Bitcoin to Litecoin, and several others. Customers of Coinbase can move their funds between Coinbase and Coinbase Pro instantly and for free. More advanced users and institutional investors will make use of Coinbase Pro for their zero maker fees, margin trading, and other advanced features.
While Coinbase has only been in business for six years, this is a long time in the cryptocurrency space. The Bitcoin ( BTC-USD )( COIN )( OTCQX:GBTC ) network, which was the first cryptocurrency, only began operation in January of 2009. This first-mover advantage has played out well for them in name recognition and has equated to five million app downloads on Android as of May 2018.
Coinbase competes against other exchanges and cryptocurrency on-ramps in the United States, such as Kraken, Gemini, and Bittrex. Users interact with Coinbase via their website and mobile applications.
Industry Analysis For the purposes of this article, we will focus on the cryptocurrency exchange industry in the United States. There are many exchanges around the world, but the scope of applications, regulations and concerns would be much too broad if they were to be included. In addition to the complications presented by national borders, in the United States, each state has its own hurdles to clear. Some exchanges, Kraken for example, operate in every state except New York and Washington.
Being in the cryptocurrency exchange business is kind of like being strapped to an unstable rocket made by a backyard scientist. The underlying assets have wild swings in value, customers come in a stampede at times that overwhelms most rational understanding of scalability, hackers around the globe will target you constantly, and the underlying security relies on cutting edge elliptic curve multiplication, distributed global peer to peer networks maintained by volunteers, and cold storage techniques, of which there are few experts and massive demand.
Coinbase was plagued by downtime in 2017 as the cryptocurrency markets saw growth of nearly 4,100% in a single year. Massive demand drove Coinbase’s user base to grow larger than that of Charles Schwab ( SCHW ) in late 2017, while the ability of finding qualified employees to hire remained a constant bottleneck.
Cryptocurrency exchanges make their money from the fees that they charge.
Those fees come from maker and taker fee schedules, and the additional fee structure associated with margin trading. As of this writing, there are no publicly traded cryptocurrency exchanges, so in-depth financial information is limited.
When it comes to branding, exchanges seem to compete on a more features based approach. The relevant features are the number of trading pairs, the security of the exchange, the speed of processing, the ease of use, accessibility, and customer service. I would expect this to change over time, as more mature industries compete less on technical capabilities and more on the brand image or relationship.
If we compare cryptocurrency exchanges to traditional financial institutions, such as Fidelity or Schwab, we can see this in action. However, at this point, cryptocurrencies are being treated as a high-tech digital commodity that can also serve many monetary purposes, such as cross border remittances.
Threat of New Entrants
From a strategic perspective, there are many barriers to entry that can play a role in determining the competitive landscape. While trading cryptocurrencies anywhere on the globe is possible and happening now, the choke point in the US is dealing in the US Dollar. This is the largest barrier to entry, as anyone dealing in US Dollars must meet a host of regulatory requirements to be registered as a Money Services Business. Along with this comes the requirements of FINcen , know your customer and anti-money laundering KYC/AML. These requirements are somewhat antithetical to Bitcoin, which was originally meant to provide an alternative access point to the global economy for those with no access to financial institutions.
Supplier Power
The power of suppliers in this industry is a non-starter. Cryptocurrencies are usually open source and available to anyone who wants to use them. So, by definition, any company that wanted (and knew how) to integrate cryptocurrencies into their business platform would just write the necessary code (or hire a firm that does this integration) and that’s it.
The thing being exchanged in this case is permissionless and purely digital. Once the pipeline has been opened, there are no “fast lanes” like we’re seeing with the computers that compete to be closer to the trading floor of the NASDAQ ( NDAQ ) for example (lower latency can mean an order gets executed before a competitor). Decentralized networks have participants all over the globe, which makes this industry unique in regard to suppliers.
Bargaining Power of Buyers
Bargaining power of buyers is a different story, however. While it’s true that single individuals are unlikely to move the needle in one direction or another, interesting things happen when customers work as a unified group.
In 2017, a contentious hard fork (a split in the network) caused Bitcoin to split into two separate entities with a single shared past. This event created Bitcoin Cash ( BCH-USD ), a unique cryptocurrency based on the belief that on chain scaling was a better solution than segregated witness. Initially, Coinbase had said that they would not support this new currency, and users were not happy about this.
What it meant was that users who would have received a new currency in equal amounts to their current Bitcoin holdings, would be unable to retrieve those funds from Coinbase. As pressure mounted from the community, Coinbase decided to reverse its position , both supporting Bitcoin and Bitcoin Cash, while also granting its users their forked coins.
Recently, another class action suit was filed against Coinbase for their handling of unclaimed funds . With external pressures such as these, I must place the power of consumers in the high range. Coinbase does not have the ability to snub its users in the long run. Ultimately, other providers can serve their needs in a similar way.
Complements
Complements are very important to consider in this industry.
They come in many forms, such as:
New cryptocurrencies New use cases for existing cryptos New connections with legacy industry New Cryptocurrencies
This list could get very long, but I will focus on these three for brevity.
New cryptocurrencies are springing out of thin air, and they bring with them a new opportunity for profit. As the cryptocurrency industry is expanding and evolving at breakneck speeds, new coins are coming online in droves. In 2009, there was only one cryptocurrency, Bitcoin . Today, there are over 2,100 that are tracked (there may be many more that we don’t even know about yet), including Ethereum ( ETH-USD ), Ripple ( XRP-USD ), Bitcoin Cash, Litecoin ( LTC-USD ), EOS ( EOS-USD ), Cardano ( ADA-USD ), IOTA ( IOT-USD ), and the list goes on.
If a cryptocurrency follows best practices in the industry, and is a good candidate for exchange (has the necessary volume and stability, etc.), then it’s fairly straightforward to add it to an existing service. From a software development standpoint, the first pair is the hardest, and each additional cryptocurrency added after the fact becomes less and less work.
New Use Case I – The Lightning Network
New use cases for cryptocurrencies are also being discussed and developed at incredible speeds. The idea of programmable money is so mind bending, that it’s not apparent today how this will change our society and the monetary systems of the future.
I’ll just mention two of these new ideas briefly. The first is the lightning network, a protocol layer on top of Bitcoin that will allow scalability to near infinite levels . This routing system will remove many of the pain points of the Bitcoin network by facilitating an additional networked layer of payment channels that can connect individuals and automated systems all over the world.
New Use Case II – Decentralized Autonomous Organizations
The second technology that would provide incomprehensible complementary benefit is the Decentralized Autonomous Organization , or DAO. A DAO is the intersection of blockchain, artificial intelligence, and a decentralized entity living online.
Through a series of interconnected smart contracts, it has been theorized (and attempted in a few cases already) that you could end up with an AI that pays for things it needs and has a life of its own. It could pay for software upgrades from engineers, purchase web servers automatically from AWS, and even operate a real world business like drone delivered soft drinks for example. With the profit it makes, it could return value to stakeholders. All of these transactions could be done with cryptocurrency, so an exchange like Coinbase Pro could benefit from this activity.
New Connections with Legacy Systems
Last year, Fidelity announced that it would allow customers to view their assets from Coinbase on their Fidelity account.
This provided a nice PR opportunity and illustrates how financial institutions may cooperate, now and into the future. After all, the legacy financial system provides the model for the exchanges we’re talking about, but with a new twist. So, legacy providers are keen to test the waters with these new technologies to see if they can benefit (or gauge threat to their existing business model).
Value Chain Analysis Cost Drivers
The total cost basis of Coinbase and Coinbase Pro is not known because they are not a publicly held company. However, we can break down their cost structure into known components and estimate their impact.
The primary cost drivers are most likely highly skilled labor, and high fixed costs resulting from the operations of their technology platform. Top talent in the blockchain space is not cheap, and building a platform that can scale up rapidly is not easy. However, without these components, there’s really no way to do business in this space. Options like outsourcing to software engineers in India are of limited value due to the sensitive nature of the business and the lack of supply of top talent.
Willingness to Pay
Willingness to pay can be driven in large part by the market movement itself.
At times when the market is moving, customers will pay almost any price to get their transaction through to the network. At times when the trade volume is low, they become more sensitive to prices. While Coinbase and Coinbase Pro do not increase their fees during times of high volume, the underlying networks of Bitcoin and Ethereum cause this as buyers and sellers get into bidding wars with each other to have their transactions processed first.
Creating the Wedge
Coinbase has struggled in the past to capitalize on these high volume trading days, when their platform has been pushed to its limits. Many frustrated users found that at the time they needed the platform the most, it was down.
This caused a lot of missed revenue and angry customers. Perhaps the biggest factor in capitalizing on this wedge (the gap between the willingness to pay and the cost of production, which means the strategy is profitable) is simply ensuring that the platform is stable enough to handle a massive traffic spike.
Source: Stanford
We have also seen this play out in other ways, with many sites being so overwhelmed by demand during a big price movement that they were forced to stop accepting new customers. This was the case with many exchanges in 2017, when people were actually selling their new accounts for thousands of dollars on social media (not the coins in the account, just access to an exchange). Proper scalability would have meant capturing many of these unserved customers.
Competitive Advantage Coinbase’s competitive advantage comes from their name recognition and a general consensus of trust among the community.
We can see them leveraging these advantages on their website, which boasts “Secure Storage, Protected by Insurance, Industry Best Practices.”
Source: Coinbase.com
Security is a big deal in the cryptocurrency business, with big named companies of the past having mammoth security breaches. The most well known example is Mt.
Gox, which served over 80% of all trading volume and was hacked in 2013. Many investors lost all their funds, and the legal proceedings are only now beginning to liquidate the seized assets (Kraken, Coinbase’s competitor is actually handling this process). This shocked the market, and sent Bitcoin into an 18-month downward price spiral, in which the price of a single coin went from $1,000 down to about $250. A platform that can make users feel secure has a competitive advantage in this business, and I think Coinbase does the best job at conveying that message.
Coinbase has a referral program, in which any user can invite a friend and earn $10 of Bitcoin. This further leverages their name recognition, and gets their users involved in spreading the word about their business. Many “informative” news articles have a handy link of this sort, which I’m sure has netted them many referrals over time.
Three Alternative Strategic Actions If we compare the strategies of Coinbase, Gemini, Kraken and Bittrex , we notice a few interesting things. First, there seems to be little diversity in the strategies. Granted, we’re extrapolating their strategies from what we can learn on the web, but have a look at the table below.
Company
Coinbase
Kraken
Gemini
Bittrex
Strategic Approach
“Easiest and most trusted”
“The most trusted digital currency platform”
“Secure storage, Protected by insurance, Industry best practices”
“The best Bitcoin exchange”
“Liquidity, reliability, security”
“Security, Liquidity, Trust”
“Custody services, Marketplace, Regulatory oversight”
“Global leader in blockchain revolution”
“Security First, Robust trading, Corporate responsibility”
It’s worth noting that these exchanges are attempting to craft their messages to individuals as well as institutions. So, when we see mentions of liquidity, they’re talking to institutions, and when we see “easiest to use”, it’s clear they’re talking to the individuals (non-professional traders, or traders not familiar with crypto to be specific).
Alternative Action 1
One thing that Coinbase has done is to separate the customer experience between Coinbase.com and Coinbase Pro. This lets them focus on a retail customer with Coinbase and the more advanced users on Coinbase Pro. None of the other competitors have done this.
However, there are some challenges with this approach, namely that some (most?) Coinbase users don’t even know that Coinbase Pro exists.
One strategic action I would recommend is further integrating Coinbase and Coinbase Pro from the UI angle. A link, or some other indicator, would help to raise awareness that Coinbase Pro even exists for the millions of Coinbase users. Then, once the UI has been improved, we could take the relevant verbiage and segment it between the two websites.
For example, if you visit Coinbase Pro and don’t sign in, there’s very little information about what the page even is or does. I think we could gain an advantage by further expanding on the “ease of use” concept and widen the user experience gap by fixing this.
PROS: Further widen the UI gap, differentiating Coinbase from competitors.
CONS: Tech infrastructure is hard, resource constraints exist.
Alternative Action 2
Coinbase has recently been on a buying blitz, snapping up smaller companies and moving to integrate their technology. In April of 2018, they purchased Earn.com, which followed their earlier purchase of Cypher, an Ethereum DAPP browser, just days earlier. The interesting thing about Earn.
com, which was formerly 21.co, was that they piloted a program in which they created and sold “The first Bitcoin computer.” This little device was basically a sandbox for Bitcoin programmers to experiment with the technology and try to understand what it means to program money (image below).
Source: Amazon
This company evolved to create an ecosystem where users could create a page (akin to social media), and allow people to pay to contact you. Users would receive payment in Bitcoin, and had the option to donate those funds to charity if they wanted to.
Where this gets interesting is in being able to make a direct connection with someone and be more likely to get through. This comes in handy in the world of recruitment, where top engineers are rare, expensive, and entire industries are built on tech recruiting.
Source: Earn.com
One strategy Coinbase could use to leverage this relationship is to further integrate with Earn.com.
If even a small percentage of Coinbase’s customers were to use Earn.com, there could be huge payoffs for the charitable organizations being featured. This could create a synergistic feedback loop where community involvement meets tech and charity. This kind of PR would be a lasting and hard to replicate advantage for Coinbase.
PROS: Unique advantage to tap Earn.com network, charity feels good.
CONS: Might confuse users, muddle social and money (complexities arise).
Alternative Action 3
One of the most used features of Coinbase and Coinbase Pro is the on-ramp and off-ramps. Usually this equates to people moving US Dollars into or out of their digital currency wallets.
This has been a pain point as some credit card providers and banks have raised flags for this type of activity (considering it illicit or threatening perhaps). So, why not close the loop even further by purchasing a small financial institution?
If Coinbase bought a credit union, for example, it could create an almost seamless integration between fiat currency and digital currency. If digital currency assets are to be part of the future, then I see this integration as necessary and highly profitable. So, the strategy here would be to become the first vertically integrated crypto behemoth.
Worth noting is that the Litecoin Foundation recently made this exact move by purchasing 9.9% of a bank. Litecoin’s founder is none other than Charlie Lee, who held a leadership position at Coinbase but quit last year.
PROS: Create first seamless user experience from bank to crypto.
CONS: Regulatory hurdles.
Recommendation As a cryptocurrency entrepreneur, I would love to have a bank that’s owned by Coinbase. I live in constant state of worry that my financial institution will block or ban me from banking services. I think I’m not alone, and there are more and more people every day in my situation. For example, my crypto mining company, BTC Northwest, has a bank account at somewhere I shouldn’t disclose. In order to pay our bills, we need to sell Bitcoin at times.
Even though we are engaged in no illicit activity, there is always the risk of being caught in a situation similar to what the marijuana industry is dealing with, where their business is legal in the state, but illegal federally.
Recently, Bank of America (and three other banks) blocked credit card purchases of Bitcoin. Some banks even question new customers about if they plan to deal in cryptocurrency and will reject them if they answer in the affirmative. I think there is a great unmet need for people dealing with cryptocurrency to have a bank that they know will support their use of digital assets. Just speaking for myself, I would move three businesses over to any bank offering this service.
Execution and Implementation In order to execute this strategy of becoming the first digital asset exchange to be vertically integrated with a bank (or credit union), Coinbase would need to follow some discrete steps.
Begin researching regional credit unions that have a strong online presence and would be good candidates for acquisition.
Create a cross functional team to research viability. This team should include, a tech expert, legal council, marketing, and someone with a background in banking at the least.
Require a meeting of stakeholders in sixty days to report to the board about possible candidates and feasibility. If the board approves, move forward. Create marketing plan for roll out. Draft security manifesto. Pilot back end integrations, assign engineering resources and timelines for dark launch.
Clear acquisition with regulators. Consider UI enhancements across all platforms. Allow users to see Bitcoin balances from their bank, allow bank balances to be seen from Coinbase. Add a link to Coinbase Pro to their bank site and Coinbase. Make transfers between banks and digital asset platforms free and instant.
Set hard launch date. Announce launch date. Allow time for soft launch and testing. Go live! Conclusion I hope you enjoyed this strategic analysis of Coinbase.
A majority of this research was done earlier in the year, so I have had to make several updates to make it relevant to today.
This is the first article of its type, where I dig more into the industry itself from a business perspective rather than into the cyrptocurrencies themselves.
Please leave a comment below if you found this useful and would like me to write more articles in this same vein.
Cheers,
Hans
Did you know that the last three Editor’s Picks in cryptocurrency have all been from the same author? I won’t mention any names, but it might rhyme with John’s Toga. This article was submitted first to Crypto Blue Chips . Be the first to get top-tier analysis by joining my marketplace community.
Disclosure: I am/we are long BTC-USD, ETH-USD.
I wrote this article myself, and it expresses my own opinions.
I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article..
