Coinbase Global, Inc. (NASDAQ:COIN) Q3 2023 Earnings Call Transcript

Coinbase Global, Inc. (NASDAQ:COIN) Q3 2023 Earnings Call Transcript November 2, 2023

Coinbase Global, Inc. beats earnings expectations. Reported EPS is $-0.01, expectations were $-0.54.

Operator: Good afternoon. My name is Sarah, and I will be your conference operator today. At this time, I would like to welcome everyone to the Coinbase Third Quarter 2023 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Anil Gupta, Vice President, Investor Relations. You may begin your conference.

Anil Gupta: Good afternoon, and welcome to the Coinbase third quarter 2023 earnings call. Joining me on today’s call are Brian Armstrong, Co-Founder and CEO; Emilie Choi, President and COO; Alesia Haas, CFO; and Paul Grewal, Chief Legal Officer. I hope you’ve all had the opportunity to read our shareholder letter, which was published earlier today on our Investor Relations website. Before we get started, I’d like to remind you that during today’s call, we may make forward-looking statements. Actual results may vary materially from today’s statements. Information concerning risks, uncertainties and other factors that could cause these results to differ is included in our SEC filings. Our discussion today will also include references to certain non-GAAP financial measures.

Reconciliations to the most directly comparable GAAP financial measures are provided in our shareholder letter on our IR website. Non-GAAP financial measures should be considered in addition to, not as a substitute for GAAP measures. We are once again using Say Technologies to enable our shareholders to post questions. In addition, we will take some live questions from our research analysts. With that, I’ll turn it over to Brian and Alesia for opening comments.

Brian Armstrong: Thanks, Anil. Let me start with a provocative statement. Onchain is the new online. The Internet was and is a game changing technology that redefined our modes of communication, business and social interaction. It broke down barriers, democratized access to information and made knowledge universally accessible. Blockchain and crypto are doing the same thing today with a redecentralization of the web and the introduction of a new building block ownership. Instead of just reading and writing on the traditional Internet, Onchain, you can now read, write and own. Onchain is about digital assets, broader access to financial services, and even changes how we think about identity, governance, artwork, and non-financial services.

Crypto creates a level playing field where everyone, irrespective of their socioeconomic status or geographic location, has access to more robust and transparent systems. Crypto creates a world with fewer middlemen, lower fees, faster transaction speeds, and greater protection and control over one’s digital assets and identity. It is for all of these reasons that we believe that crypto is the greatest tool, increasing global economic freedom. We also think that Onchain will be as essential and impactful as the Internet is today. If we look back to the early years of the Internet, the companies that ignored the noise and built for the future of the Internet now stand as tech giants. The Onchain companies of today will be the tech giants of tomorrow.

Coinbase stands at the forefront of this technology and continues to build a responsible, compliant, trusted, financially strong and innovative business that is building those linchpins products. Speaking of financial strength, Q3 has been another strong quarter for us. In Q3, we delivered positive adjusted EBITDA for the third consecutive quarter and demonstrated continued operational discipline. In fact, we are on track to deliver meaningful, positive adjusted EBITDA this year, which reflects the direction we set at the start of this year to be a company that can generate adjusted EBITDA in all market conditions. We thought it may take us more time to get here, but through operational discipline, rigorous cost management, and more favorable interest rates, I’m very pleased with the results we’ve delivered.

Our balance sheet remains strong and our financial position enables us to continue to invest in the future and deliver products and services that expand the utility of crypto, which brings me to what we’ve built this quarter. We’ve obtained licenses that enable us to access new markets, continued to drive toward regulatory clarity for crypto and build innovative products that expand the utility of crypto. This continues to be a year of international progress for Coinbase, starting with international expansion here. In 2023, we officially launched three key Go Deep markets, Brazil, Singapore, and this quarter in Canada. Country launches are a significant investment for Coinbase. When we launch in a country, we hire local leadership, we work with local regulators, and we establish new payment rails to enable seamless fiat to crypto transfers.

In Q3, we also obtained key licenses or registrations in Singapore and Spain and continue to pursue and obtain licenses and registrations where it’s clear that we need them to serve our customers. Speaking of licenses, let’s talk about derivatives. Unlocking the ability to offer derivatives products to users is a huge opportunity for Coinbase as the global derivatives market for crypto represents 75% of all trading volume. Trading volume that up until now was largely going through unregulated offshore exchanges. Derivatives products are an important tool as the ability to trade crypto using margin essentially giving traders the ability to use margin, increases our capital efficiency and access to the crypto market with less upfront investment.

In Q3, Coinbase International Exchange received regulatory approval from the Bermuda Monetary Authority to enable perpetual futures for eligible non-U.S. retail customers, which we began offering just last month. And Coinbase Financial Markets also received regulatory approval from the National Futures Association to offer futures to eligible U.S. customers via advanced trading. And as of yesterday, we now offer regulated futures to U.S. customers via Coinbase Financial Markets. Customers seek to do business with trusted counterparties when they trade complex levered products such as derivatives and perpetual futures. And Coinbase Financial Markets and Coinbase International Exchange are best positioned to be that trusted partner. We are just getting started and plan to roll out additional products and expand to more markets over time with derivatives.

Speaking of launching new products, in Q3, we launched our new Layer 2 solution called Base. As I touched on last quarter, most blockchain transactions today are happening on what are called Layer 1. And Layer 1 networks are slow, they are inefficient and expensive to use. Think of the jump from L1 to L2s as the jump that the Internet made when it went from dial-up to broadband. Layer 2s are built on top of Layer 1s to make them faster and more efficient, and they result in lower transaction costs and higher confirmation speeds. Our Base platform enables developers to harness the full power, efficiency and cost savings of a Layer 2 network with the convenience of it being built in right into the Coinbase ecosystem. In August, we moved Base on to Mainnet, which means it’s now available to everyone.

And to celebrate the launch, we created an Onchain movement this summer for developers in the crypto community called Onchain Summer. During that campaign, we saw over 10 million NFTs minted across more than 1 million wallets on Base. This momentum helped drive rapid growth of Base, including more than $500 million in assets that are now on the platform. While early, we are encouraged by the early utility of Base and are optimistic about the role Layer 2s can play not only for Coinbase, but also for the growth and development of the entire crypto economy. Finally, I just want to touch on how Coinbase is driving regulatory clarity for the industry. One of the biggest items holding back adoption of this technology is the lack of clear rules and regulation, most notably in the U.S. We are actively involved in U.S. legislation with a variety of bills that are in development and we are still confident that the U.S. will get this right, embrace innovation and propose clear rules.

American crypto holders are owed clarity and they are an increasingly expanding voter base. There are 52 million crypto holders in the United States. To put that into context, that’s more than the owners of electric vehicles and more than all collective members of U.S. Unions. The American people are embracing crypto as more Americans grow unhappy with the traditional financial system. Only 9% of those surveyed say that they are satisfied with the current U.S. financial system, and only 22% of people think that it’s better than any other countries and nearly two in five younger people that’s 38% say crypto and blockchain can increase economic opportunities for them in ways traditional finance can’t. To aid in the mission of driving for crypto regulation, Coinbase is a proud supporter of an independent movement known as Stand with Crypto that now has more than 100,000 advocates and continues to stand with the American people to drive towards clarity in the U.S. While the U.S. continues to struggle to keep pace, the rest of the world has made great strides in embracing crypto and Onchain technology with clear legislation.

We are seeing global efforts to bring crypto into regulatory scopes as 83% of the G20 nations are adopting crypto regulations. Most recently, we’ve seen this with MiCA legislation in Europe, and it’s incredibly encouraging to see that now 27 countries stand together with one unified set of rules for crypto, something the U.S. desperately needs. In response to this groundbreaking regulation, Coinbase moved quickly and recently announced that Ireland will be our MiCA hub. We continue to work with regulators around the world on laws for cryptocurrencies and act quickly to embrace new regulation when it’s developed. In conclusion, although we continue to be in a down market with volatility, the lowest we’ve seen in years, Coinbase is financially healthy with our third consecutive quarter of positive adjusted EBITDA.

Meanwhile, we have the most trusted brand and the easiest to use products and continue to build innovative key technologies that expand the utility of crypto and best position Coinbase to take advantage of the next bull market. We continue to do the work of running a trusted, secure, and compliant crypto platform, and this is our competitive advantage. We have a long-term focus on building and on following the rules, which has proven to be the right strategy. We believe Onchain is the new online, and that Onchain technology represents the same opportunity that the Internet did before it. With compliant and responsible companies like Coinbase leading the charge, Onchain applications are set to become the foundational pillars of the future financial system and more.

With that, I’ll hand it over to you, Alesia, to tell us more about our Q3 performance.

Alesia Haas: Thanks, Brian, and good afternoon, everyone. As Brian shared, Q3 was a strong quarter where we saw the efforts of multi quarter initiatives come to fruition. Further, we continue to make progress on building an increasingly efficient and financially disciplined company. Let’s dive right into our Q3 results, and I’m going to start with transaction revenue, which was $289 million, down 12% quarter-over-quarter. In Q3, crypto asset volatility, a driver of our trading business continued to decline and it reached levels that we haven’t measured since 2016. As a result, total Coinbase trading volume declined 17% quarter-over-quarter, which outperformed the global spot market, which declined 24% quarter-over-quarter. The blended average fee for consumer was higher in Q3 as compared to Q2 and was again driven largely by the mix of simple versus advanced trading volume in the quarter.

We continue to experiment with our pricing models for both our consumer and institutional products, and price changes may impact future quarters, but that was not the case in Q3. Turning now to subscription and services. Revenue was $334 million, essentially flat quarter-over-quarter. Overall, we saw inflows of native units in custody. We saw an increase in staked balances and we saw growth in USDC on our platform. However, offsetting this unit growth were price effects as crypto market cap declined approximately 9% quarter-over-quarter. Now shifting to expenses. Total operating expenses declined 4% quarter-over-quarter to $754 million. Technology and development, general and administrative and sales and marketing were collectively $654 million down 1% quarter-over-quarter.

Expenses did come in at the low end of our outlook, driven primarily by a shift in timing of certain legal and marketing expenses from Q3 to Q4. Net loss was $2 million and adjusted EBITDA was $181 million. Our Q3 net loss benefited from two transactions. First, we completed a debt repurchase in the quarter, which had a favorable impact of $82 million. Second, we had a $50 million gain on strategic investments. Both of these items were recorded in our other income. Additionally, in the quarter, we increased evaluation allowance on deferred tax assets, which contributed to the higher tax rate. You can read more about our effective tax rate in our shareholder letter. Now I’d like to turn to our outlook for the fourth quarter. In our letter, we noted that October transaction revenue was approximately $105 million.

We are expecting subscription and services revenue to be approximately flat with the Q3 levels, and this assumes no material change to crypto asset prices or market conditions as compared to the month of October. In terms of expenses, we expect technology and development and general and administrative to be between $525 million and $575 million, which is lower compared to the Q3 levels. A key driver of this decrease quarter-over-quarter is lower stock-based compensation in Q4 as compared to Q3, which as we have previously shared, has a non-linear expense recognition timing. We are expecting sales and marketing expenses to be between $85 million and $95 million, slightly higher than Q3 levels due to the shift in timing from Q3 to Q4 for certain expenses that I noted earlier.

Just as I noted that Q4 is lower than Q3 for SEC, when we look ahead to Q1 of 2024, SEC will be sequentially higher than Q4. As Brian mentioned, we expect to deliver meaningful adjusted EBITDA in 2023, which I want to note is an improvement from our prior goal of just improving adjusted EBITDA in 2023 as compared to 2022 on an absolute basis. To close, Q3 was a strong quarter for the business despite the low volatility environment. We are pleased with the revenue performance as well as our ability to grow our USD resources, while opportunistically reducing our total debt. As we look ahead towards next year, we see a wide variety of positive catalysts for the crypto industry on the horizon, as well as potential risks. We are closely monitoring these inputs as we plan for the coming year and we will share more with you next quarter.

A – Anil Gupta: Thank you, both. So with that, let’s turn to shareholder questions. We’re taking the most upvoted questions as determined by the number of shares, and we might combine questions that touch on the same themes. First question is, will Coinbase consider reducing transaction fees to make them more competitive with other platforms where ETFs are being traded at significantly lower prices? Emilie?

Emilie Choi: Sure. Thanks for the question. So to answer it directly, we have no current plans to reduce transaction fees because of ETFs. If you just zoom out a little bit, spot ETFs should be a positive catalyst for the entire crypto space. They should add credibility to the market, and we should see increased liquidity and market stability, as we’ve seen with other asset classes such as gold. ETF should expand the pie and bring new people and institutions into the crypto economy. One stat that I find really powerful is that 52 million Americans own crypto today despite the current regulatory overhang. So imagine what will happen once ETFs are introduced and widely available. RIAs, retirement funds, other institutions that have been precluded from this asset class historically will gain access to crypto for the first time, and that’s very powerful.

In terms of economic impact, as we’ve said before, the primary way that we’ll monetize ETFs directly in the near-term is through custody fees. And Coinbase is very proud to have been selected to partner with the majority of the potential issuers who are among the world’s most trusted financial institutions. Over time, we think there will be other ways to monetize, but that’s too early to get into those now. And we also believe that the approval of these products will renew interest in crypto generally, and that we would benefit from increased demand and trading volume as a result. Operationally, we are set and ready-to-go and once approval arrives, we are ready to hit the ground running.

Anil Gupta: Second question, when do you see Coinbase with positive earnings per share? Alesia?

Alesia Haas: Let’s dial back. Looking back the last several years, we were actually net income positive in 2021 in the midst of a bull market. That changed in 2022 as the market turned. We are in a nascent industry and what we like to do here at Coinbase is we balance our investment growth in product innovation and profitability. You may recall that we pivoted in the middle of last year to evolve from a company that is profitable through a cycle to one that can generate positive adjusted EBITDA in all market conditions. And that was a very deliberate shift in our strategy. We are focused on that as our goal at this time, generating positive adjusted EBITDA in all market conditions. And year-to-date, we’ve made significant progress towards that goal.

You’ve noted that this is the third consecutive quarter that we’ve had positive adjusted EBITDA this year, and all of those were in excess of $100 million. And as we said earlier in this call, we are on track this year to deliver meaningful positive adjusted EBITDA in 2023. And all of this is in a down market at a level of multi-year low levels of volatility. As a result, we believe we have a strong position to enable us to continue to invest in the future in our strategy to bring new product innovation to the market during this challenging point in the crypto market cycle. We have a strong balance sheet with over $5 billion in U.S. resources to strength, and we further strengthen the balance sheet this year as we repurchased debt and so with that, that is our focus.

Adjusted EBITDA, investing in the future in trusted products and services to expand the utility of crypto.

Anil Gupta: Next question. How is Coinbase handling and preparing for the challenges around the IRS proposed regulations on reporting of digital assets? Alesia?

Alesia Haas: Well, this is a great question, and we’re spending a lot of time working on this internally. So I’m glad we had a chance to highlight some of the work here. First, I want to share some background for those who are unfamiliar with the proposed regulations. The IRS recently proposed rules that would require Coinbase and other crypto platforms to report every crypto transaction of our U.S. customers. When I say every transaction, that includes those Onchain transactions related to payments, NFTs, everyday applications, for example, using crypto to buy a cup of coffee becomes a reportable transaction. This means for Coinbase alone, we could be required to report billions of transactions to the IRS each year. The IRS has admitted that it will receive 8 billion reports, that is more than all current tax reporting combined.

This creates a huge compliance burden for us, for the industry. And importantly here, it threatens our customers’ privacy and ultimately, we believe, would impede the adoption of crypto. I want to state that we have long supported broker reporting of transactions on our exchange on par with the reporting requirements for traditional finance. But we believe these proposed rules are unworkable and impractical because they reach far beyond that objective. They set a dangerous precedent for surveillance of non-financial transactions and could lead to the invasion of privacy for American people. So we’ve been very active here. First, we filed a comment letter introducing our concerns and highlighting the challenges raised by the proposed regulations.

We are actually preparing a more detailed comment letter to be submitted shortly with further observations and recommendations regarding the proposed regs. We’re also preparing oral testimony on our perspective and concerns at an IRS hearing scheduled for November 7. And lastly, we’re working with trade associations and peer companies to provide industry-wide perspective. We’ve made public aware of these proposed rules. We’ve mobilized with gain with crypto to encourage public comments to the IRS and proud of seeing tens of thousand comment letters be submitted so far. So while we think these proposed regs went too far and unworkable, we think a staged approach to broker reporting is the correct path with the realistic targets and effective dates for the industry, and we remain committed towards transparency and working towards this objective.

Anil Gupta: Thank you. So with that, Sarah, let’s switch and take questions from our analyst, please.

Operator: Thank you. Your first question comes from the line of Ken Worthington with JPMorgan. Your line is open.

Kenneth Worthington: Hi. Good afternoon, and thanks for taking the question. I wanted to dig in further on derivatives. So you got your FCM license and you rolled out derivative trading on your website. I guess, importantly, when does Coinbase start to launch on mobile, and how are you thinking about marketing and growing that? And then more broadly, as we think about derivative growth for Coinbase inside and outside the U.S., how much of a void is there in derivatives given the FTX blowup and the pressure on Binance and how challenging might that volume be to pursue?

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Q&A Session

Brian Armstrong: Yes. Thanks for the question. I can start off. So I think the first part of your question was really about rolling out derivatives on mobile. And while I don’t want to give any kind of like launch dates on the call here, you can imagine that’s one of several things that we’re working on, which would improve people’s access to it, both for retail and institutions actually. And so there’s still a lot of work to be done to fully integrate our derivatives products into our other products, both Coinbase Prime and our retail app. I do think that we have a big opportunity to essentially go out and provide some trusted infrastructure around this. As I mentioned in the opening statements, people really care about their counterparties in this market.

And I do think Coinbase has the best reputation out there in terms of being trusted and we can be an important player by providing this infrastructure in a way that’s regulated and compliant and has our long track record of cybersecurity, for instance. Just a few pieces of data that we haven’t shared, I think, before. So we’ve done about $10 billion in notional volume in Q3 on derivatives, which is – that sounds like a big number, but in the derivative space, it’s actually – it’s a good start, but it’s still relatively small. We’ve also been really increasing the number of institutions we’ve been onboarding. So in Q3, we now have over 100 institutions that have been onboarded. So with our launches that we talked about, we’ve got a lot of work in front of us, but we’re making really good progress on that.

And I can’t really predict what percentage of the derivatives market would come over. But I know it’s important for the space to have trusted infrastructure, and that’s what we’re going to go build.

Operator: Your next question comes from the line of Devin Ryan with JMP Securities. Your line is open.

Devin Ryan: Thanks. Good afternoon. Just want to talk a little bit about Base and the adoption that you’re seeing. You guys gave a few stats there. It sounds like off to a really good start. So just maybe want to talk about what you guys think are going to be some of the biggest applications that are going to be on Base? What makes it attractive relative to other Layer 2? And just for Coinbase as this starts to become hopefully a bigger contributor for you. How should we think about kind of the ability to monetize and also just geography where kind of that shows up? Thanks.

Brian Armstrong: Yes. So I can start off with some of the applications, then I’ll turn it over to Alesia to talk about monetization. So look, I think if anybody was sitting there kind of when broadband was first introduced on the Internet, and they tried to predict what the use cases would be. There’s probably some good video clips, we can go back and look at people predicting that. And I’m sure they look a little bit silly because it would have been hard to predict Uber and Netflix and all these kind of things that were enabled. So there’s a little bit – I don’t want to make any kind of firm predictions here, but I can definitely say that one area we’re excited about is payments, for instance, just because if you think about – on Layer 1 today, if it costs between $1 and $15 or so to make a transaction, and it takes anywhere from minutes to an hour to confirm that could be serving these use cases around trading because people don’t necessarily do trading every second.

They might need to do it periodically. And so L1 has served use cases like trading well. But if you’re trying to build a global payment network, it really benefits everyone to have that happen fast and cheap. So for instance, if you’re at a merchant and you hit send, you want the kind of confirmation to show up ideally within a few seconds. You don’t want to be sitting waiting around for 20 minutes or something like that. So payments – and by the way, payments could be a whole variety of things, right? It could mean sort of commerce-type applications. It could mean peer-to-peer. It could mean B2B. It could mean remittance. It could mean payments in third-party applications that are like these new types of Dapps that are being created. So I made this analogy at one point in the past, but what we saw the friction was reduced from sending a text message to sending a WhatsApp message is it went from like $0.25 to send a text message to being free on WhatsApp.

We saw in order of magnitude more messages sent every day. And I think if you bring down the friction of payments or transactions on these Layer 2s, you could see an order of magnitude, more transactions happening on these chains. Now we don’t know exactly all of the things that it will be used for, but we are seeing good early adoption of Base, as I mentioned. So we’ve had more than 1 million transacting wallets over the last month, for instance, and Base is still quite new. 10 million NFTs got minted during Onchain Summer. $500 million in assets have been locked up on the platform already. So that’s a great sign of adoption. Hopefully, this new kind of – this new efficiency that is introduced with Layer 2 creates thousands of different types of applications, and we’ll see which of those rise to the top.

Alesia, do you want to talk about monetization?

Alesia Haas: Yes. I’ll just quickly add on here Brian. So based on monetize both directly and indirectly. On a direct basis, we do earn sequencer fees. We are reporting those as transaction fees, and today they’re included in the consumer transaction fees in our financial statements. It’s very early, they’re not material enough to break out, but over time, as hopefully they grow, we would provide more disclosure in the future. But more importantly, I think are the indirect opportunities. Whereas Brian said, if we see the proliferation of opportunities for apps on Base, this will provide opportunities for our wallet product for more money to come from traditional fiat into crypto. And we are on on-ramp to that overall economy, and so we can see opportunities to earn revenue in many of our existing products as well.

Operator: Your next question comes from the line of Mike Colonnese with H.C. Wainwright. Your line is open.

Michael Colonnese: Hi. Good afternoon and thank you for taking my question. Question for me around the spreads. So retail spreads have consistently increased for four quarters in a row now, which I know you guys have attributed to the mix shift towards higher yielding, simple trading volumes. And now looking back, you’re about a 100 basis points higher than you were back in 2021 when trading activity was certainly a lot more robust on the platform. So if you can help us to understand what spreads could look like when the mix flips and advanced traders become more active again and could we get back to 2021 type levels or will some of these pricing changes allow spreads to be above those type of levels? Thanks.