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Code for pulling Coinbase data and replicating my analysis is available here. If this is interesting to you, let me know, and I can do a deeper dive on what the data tell us.
A longer version follows below…
Coinbase’s revenue growth is rumored to be almost historically fast. The widely-reported rumor is that they did $1 billion in revenue last year.(Allegedly the bulk of that came during the price surge in the waning months of 2017.)
With this data point in mind, we can estimate what proportion of Coinbase’s revenue comes from casual consumer speculators and how much is from their more sophisticated professional trading platform. We can then estimate how 2018 revenue is shaping up for the company.
This analysis is possible because data are unusually accessible for a private company: running an exchange, Coinbase’s near-exclusive revenue source to-date, requires publishing price and volume data. These data are key drivers of revenue and therefore give a unique view into the growth of the private company.
Coinbase has never aimed to be only an exchange. Brian Armstrong, the CEO, lays out their broad strategy here. They’ve been aggressively launching and buying products, especially in the past year. In order to be a ≥$100 billion company, Coinbase will need both successful new product bets and for institutional cryptocurrency adoption to happen sooner rather than later. The closest analogy to what Coinbase has to execute over the next few years is Facebook circa 2012–2014: a huge platform shift at a favorable time (consumer adoption of mobile in Facebook’s case, institutional adoption of cryptocurrencies in Coinbase’s), one or more successful bet-the-company moves to capitalize on the opportunity, and possibly homerun product acquisitions (_e.g.,_Instagram and WhatsApp).
On an exchange like Coinbase’s, trading involves matching buyers and sellers. Coinbase takes a cut of each transaction.
Limit orders involve a trader offering to buy or sell as much as a set amount of an asset at a specific unit price (e.g., “I’ll buy as many as 10 bitcoins at a price of $5,000 per bitcoin,” or “I’ll sell as many as 2.5 bitcoins at a price of $5,010 per bitcoin”). Limit orders underlie the market and “give liquidity.” Those who place limit orders are called price makers since they literally name their price. To date, limit orders have been free on Coinbase in order to encourage liquidity growth.
A market order involves specifying a buy or sell against outstanding limit orders. In a market order, a trader specifies an amount of one asset to be exchanged, on the best possible terms, with outstanding limit orders on the other side. For example, “sell 100 bitcoins” results in selling 100 bitcoins to limit buy orders in descending order of price. Depending on the size of the market order, it may fulfil as little as part of one limit order or as much as multiple limit orders.
The fees Coinbase charges for market orders are starkly segmented across what they refer to as retail traders (those who use the mobile app and coinbase.com) and professional traders (those who use pro.coinbase.com, which was formerly called GDAX). Anyone can perform retail trades with the app or on Coinbase.com. To date, the pro platform has also been easy to join. It just has a slightly more complicated interface. (Note: in May 2018 Coinbase launched an institutional trading platform called Prime, but this analysis will not attempt to separate that from Pro as there is no benchmark for how to do that cleanly.)
Retail trades (mobile app and coinbase.com) are subject to a fairly complex fee schedule that can vary with Coinbase’s discretion depending on market conditions when executed (documentation is here). For use in the model, we’ll simplify it to the following:
So, under the simplification above, we’ll assume that for every Z dollars in retail trading volume, Coinbase generates: Z * (1.49% + 1.00%) = 0.0249*Z dollars in revenue.
Coinbase Pro charges 30 basis points, or 0.30% in exchange fees for price takers. Accounts that trade $10–100m or >$100m over a 30-day period receive a 10 or 20 basis point refund, respectively. (Documentation is here.)
The market data we’ll use doesn’t attribute volume by-trader, so we have to assume the relative proportion of Pro traders’ volumes in order to calculate a mean exchange fee. Because it is very easy to create a Pro account and even the discounted taker rates are prohibitively high for high-volume traders, it seems reasonable to assume that most volume is subject to the full 30 basis point fee. For the sake of easy comparison, we’ll assume the mean Pro fee is 24.9 basis points, or a tenth as much as the Coinbase retail fee.
As the market matures, both the absolute rates and the degree of retail vs. pro price discrimination seems unsustainable. As is, any savvy trader should never use retail Coinbase. To-date, the segmentation has been quite successful, however. Many consumers either don’t realize the difference, or put a big premium on the convenience of the mobile app (as evident by the fact that it reached #1 in the app store for a while in late 2017).
Expect serious downward pressure on Coinbase’s fee rates in the future.
Competitors generally charge significantly lower fees for “Pro” style exchanges. Ceteris paribus, expect pressure towards zero fees for investor-facing exchanges as firms seek to capture market liquidity. Of course, everything else is not equal and being a leader in governmental and institutional regulatory compliance has been and may remain a competitive advantage for Coinbase.
We’re going to make another simplifying assumption that the relative proportion of retail and pro traders has stayed constant because we don’t have better data to suggest otherwise.
Given the assumptions:
we can calibrate the proportion of volume from retail and pro traders as follows: $1 billion = (X * V * 0.0249) + ((1-X) * V * 0.00249) where X is the proportion of volume from retail traders, (1-X) is the proportion of volume from pro traders, and V is the total volume traded in 2017.
Based on Coinbase’s API data, they did about $80 billion in trading volume in 2017. Plugging that into the function as V, we find that X is approximately 50.2%. So, Coinbase appears to have done about half of their volume at retail and half at pro rates. $1 billion revenue on $80 billion in volume.
NASDAQ, the second-largest stock exchange in the world, represents about $12 trillion in market cap. In the first half of 2018, NASDAQ traded $14.777 trillion. They claim to do about 1 in 10 security share sales in the world. Their exchange generated $517 million in trading fees based on this volume (Q1and Q2 financial results), which includes not just cash equities but more expensive products like derivatives. That’s a mean fee rate of about 0.0035%, orders of magnitude less than Coinbase. And, NASDAQ even has the advantage of near-exclusivity for many of its traded assets.
An exchange is a good business, but margins go down as liquidity goes up. In the long run, Coinbase doesn’t want a world in which their current fee rates are sustainable. That is indicative of an inefficient and speculative market, not the frictionless economic protocol they hope cryptocurrencies become.
An exchange simply doesn’t support big tech scale businesses. Put another way, Apple makes more setting the default search engine in Safari than NASDAQ does with its entire exchange business.
This is the cumulative volume traded on Coinbase (note the first years of the company’s existence aren’t shown because you wouldn’t be able to see it anyway):
Annual totals are as follows:
Finally, monthly totals are as follows:
These are some of the reasons my analysis above could be wrong: