Does Coinbase Have a Diversification Problem?

Coin Metrics latest “State of the Network” report takes a deep dive into Coinbase’s revenues, a perennially interesting subject for those looking to understand the crypto exchange market in the U.S. According to the latest figures, Coinbase has seen cash inflows diversify away from trading fees, which for years accounted for upwards of 90% of the exchange’s revenues.

Looking at its most recent quarterly earnings report, Coinbase reported revenues of $707 million with $327 million coming from spot trading. While still the largest source of cash flows, fees now account for just 77% of its total revenues. Other business lines including subscription fees for a pro product as well as wallet, staking and on-chain scaling services are an increasingly large share of the pie.

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Why not milk the cash cow forever? Well, Coinbase has historically been able to charge above-market trading fees as perhaps the most trustworthy U.S. exchange and because U.S. crypto users are not really supposed to be using cheaper, overseas competitors.

This situation isn’t exactly about to change anytime soon – even despite the firm’s ongoing U.S. Securities and Exchange Commission’s (SEC) lawsuit (then, what fintech hasn’t been dinged by the SEC?). But it does mean Coinbase has limited runway for growth, which is concerning considering its global expansion has been hit or miss and recent rollbacks in markets including Japan and India.

There are still plenty of Coinbase bulls in the world, not even counting the firm’s largest stock holder Cathie Wood. The Coin Metrics folks seemed to end on a positive note, including thoughts on a number of potential business lines with growth potential including a tie up with MakerDAO, revenues from USDC as well as its nascent derivatives push.

But in face of the growing narrative around Coinbase’s seemingly successful push towards diversification, I want to bring in a dose of reality: Coinbase’s total revenues from trading fees are down because trading fees are down. Period. If this were a year as frenzied as 2021, I’m sure the seemingly growing sectors like sequencer fees and staking-as-a-service would be a pittance in comparison.

Let’s not forget the realities that tether Coinbase to its U.S. customer base, which is the same reason why CEO Brian Armstrong’s threats to move overseas fall hollow (and why Coinbase’s media team tried to roll back the tape). I believe Brad Garlinghouse when he said he would take Ripple overseas, because he’s a madman who plays with fire like selling hundreds of millions of dollars of XRP in transactions that clearly resemble (but are not always) securities offerings.

But is Coinbase trapped? Can it grow or acquire its way out of its current situation?

Here’s a non-geographical non-growth story: Despite there now being over 600 asset pairs on Coinbase, Coin Metrics found that coins and tokens listed earlier in the company’s history – like bitcoin and ether – still account for the bulk of volumes.

“[S]imply adding new assets isn’t a guaranteed way of generating trading fee revenues,” the researchers write.

Depending on how you look at it, this could be ominous for Coinbase’s future growth or simply a matter of common sense. ETH and BTC are the two largest networks, but that hasn’t prevented, say, Solana from finding a user base. Not every token will be a winner, but presumably unless something catastrophic happens recent launches like Sui and Aptos will find uses and users too.

And it’s not like “adding more tokens” is really a game plan for dealing with a protracted bear market. The issue isn’t the coins, but the lack of users – hence Coinbase’s drop in relative trading fees.

Thankfully for the company, attempts to expand into staking as well as L2 rollup operations via its recently launched Base has seen early success. For Coin Metrics, this bodes well for the future of on-chain activities. Better yet for Coinbase is the extractive returns it earns on staking commissions, used by retail and institutional traders. Ethereum staking accounts for over 13% of the exchange’s net revenues, and it’s all essentially passive income after the initial software and hardware costs.

To be fair, Coinbase’s staking operation is flying in the face of the U.S. Securities and Exchange Commission’s (SEC) “Wells Notice” and legal concerns meaning it could one day be unplugged.

I’d reckon similar risks stand for the Ethereum scaling layer Base, which is fully monetized by Coinbase as the only validator earning sequencer fees for validating transactions. While Base is not yet a target for Gensler’s SEC, it is becoming a money-maker for Coinbase in part because of the surprising success of the social-media platform Friend.tech.

But Base comes with clearer expenses, like the data rollups to mainnet Ethereum, which sometimes, amazingly account for over 1% of all ETH fees paid per day.

Are all of the business lines Coinbase is or could conceivably become involved in pyrrhic? Somehow, yes. For instance, Coinbase is being tapped for a number of bitcoin ETF proposals that, if approved, could eat into its bitcoin trading market.

I’m mostly kidding about that last point, and Coinbase is still sitting pretty on a massively successful exchange business, nascent staking platform and backer of USDC (which literally prints money via interest earned on deposits).

But considering the restrictions on its possible growth, it’s no surprise that Brian Armstrong is spending his free time thinking about hail mary startup ideas like “on-chain ads,” putting the real world on-chain and something called “flatcoin.” I mean, it’s not exactly like innovation investor Cathie Wood is going to hear that Coinbase’s business plan is essentially “mess around, find out” and be upset.