August 10, 2022 | Issue #231

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Coinbase Lands Partnership with Blackrock

Coinbase (COIN) just secured a much-needed win after the company’s recent regulatory headaches.
As of August 4th, Coinbase is the official crypto provider for institutional clients of Blackrock, the world’s largest asset management firm currently managing a massive $8.5 trillion.
The implications for Coinbase investors, as well as the overall crypto space, are potentially huge.
A Match Made In Heaven
The deal is simple: Coinbase will provide crypto trading, custody, prime brokerage, and reporting capabilities directly to Blackrock’s institutional clients.
Coinbase was selected primarily because of its institutional trading platform, Coinbase Prime. Coinbase Prime is fully equipped with everything an institution could want, including advanced agency trading, custody, prime financing, and staking.
All Blackrock has to do is integrate Coinbase Prime with Blackrock’s investment management platform, Aladdin, and their clients will have direct access to crypto. Not every crypto exchange can offer that ease, and it proved to be a key component for Coinbase in landing this partnership.
The Implications
For Coinbase, this deal is a desperately needed adrenaline shot. It’s no secret that Coinbase has been taking a lick this year. The hits have been nonstop: crypto prices crashing, trading volume drying up, a failed NFT marketplace, layoffs, an insider trading scandal, and regulators breathing down their necks.
The Blackrock partnership is the first piece of good news Coinbase has had in, no exaggeration, months. Hopefully, they don’t have to wait months for more good news because, despite their flaws, Coinbase does have crypto’s best interest at heart. In many ways, their success is our success.
COIN investors might be even happier about the deal than Coinbase. The company’s stock was recently trading at a measly $53 a share, an ~80% drop from its 2022 opening of $250. Since the announcement, COIN has rallied to $90 a share, a robust 70% gain. There’s still a long way to go before COIN reclaims its all-time high ($368.90), but it’s a step in the right direction.
This deal further confirms for crypto that the institutions aren’t just coming, but are already here. This is good and bad. It’s good because there will be more capital invested in the space. It’s bad because the correlation between the NASDAQ and crypto will likely get tighter, meaning that crypto will continue to trade like a riskier tech stock.
Historically, an announcement like this would have led to a nice pump for the crypto markets. This time though, the markets barely responded. This leads us to one of two conclusions:

In any case, this partnership is great news for one of Crypto’s flagship companies.

Coinbase Q2 2022 Earnings: Everything You Need To Know

Coinbase reported Q2 earnings yesterday at market close. As we do every quarter, below we will discuss the good, the bad, and the ugly... Before we get to that though, let's just lay out some key numbers:

Investors and readers should also note that this was a quarter of not only brutal price decreases across crypto, but also multiple blowups and bankruptcies as we have meticulously covered in this newsletter.
With all that out of the way, now let's get to it. Caveat emptor.
The Ugly
🟥 The Looming SEC investigation. Although we covered this extensively in CoinSnacks, we didn't get much more clarity in the earnings call. This was to be expected as it's a relatively new headwind and there probably isn't much the company can say. With that being said, we still want to highlight this as a major potential problem for Coinbase.
Unlike some of the company's main competitors, Coinbase is a US exchange and, therefore, must exist within US regulations. Having to take punches from the SEC early on likely means that the company will be the first to get through any issues and potentially have an actual advantage over other exchanges when it comes to operating in the US.
🟥 Coinbase lost a lot of money. There's no other real way to put it other than... ouch. In Q2, Coinbase's net loss was $1.1 billion. Now, we don't want to excuse the huge loss, but there is a detail that readers should be aware of. The company actually only lost $647 million. That's still a huge number, but much less than the headlines you will see in the media. This is due to two main factors.
(1) The company had to take non-cash impairment charges due to investments it has previously made in cryptoassets. As we have covered in the past, Coinbase has committed to making quarterly cryptoasset investments. And although we can assume Coinbase didn't sell a single token, due to accounting changes that are now required by public companies, they had to report paper losses in their earnings. It's a weird rule but it's the reason Buffett's Berkshire Hathaway, for example, also reported net earnings of -$43.8 billion even though the company didn't sell a share of stock.
(2) Secondly, Coinbase marked down some of its private investments. Similar to the above point, although Coinbase has never marked up their ventures portfolio, they marked it down by $69 million this quarter.
The Bad
🟨 Still retail and US centric. As we have covered over and over ad naseum, Coinbase is a retail heavy exchange. This means that as they fight against other exchanges, they will have to begin lowering the fees they charge retail customers. This eats into their revenues as a result.
With that being said though, the failures at other exchanges and products such as Celsius and Voyager might just actually be a boon for Coinbase as retail users begin to flock towards what they trust. We'll see.
🟨 Expenses are very high but are coming down. Between operating expenses and stock based compensation, the company is blowing through a ton of cash.
In Q2 the company also laid off 18% of its workforce, which we won't see hit the financials until Q3. Furthermore, Coinbase executives in the earnings call claimed that:

"If we have the same size of employee base in 2023, our stock-based comp would come down on a year-over-year basis as we do have some M&A earn outs and other multiyear grants from prior years that are being amortized in this year from a multiyear best schedule.""

We here at CoinSnacks still believe that 3% dilution due to stock-based-comp is too high.
The Good
🟩 The company has a boatload of cash on its balance sheet. We seem to hammer this point home ever quarter because it's so important. Coinbase has more than $6 billion in cash or cash equivalents on the balance sheet. That means, at current prices, Coinbase is trading for ~3x cash.
That said, Coinbase is now sitting in the perfect position to spark M&A activity with struggling or strategic companies. Media outlets, such as the NYT, continue to write about how Coinbase's competitors are beginning to grow as Coinbase "squanders." In our opinion, this is a short-term proclamation. We believe that Coinbase will very soon begin making strategic investments and acquisitions. But don't just take our word for it, here is Coinbase's CFO, Emilie Choi:

"We continue to be active across both ventures and M&A. It's an area that has helped us gain access to the innovation happening in the crypto ecosystem. It helps us strengthen our competitive positioning. It helps us execute against our mission. And crypto winters, we view as builders markets. It's often the best time for us to be greedy when others are fearful."

🟩 Healthy risk controls. For all the hate that Coinbase receives, the company's risk control over the past year has been laudable. As firms such as Celsius, 3AC, Voyager, and others have had solvency concerns, bankruptcies, and client withdrawal blocks, Coinbase has been sitting clean. As stated in the earnings call:

"Risk management is a first principle... We're holding customer assets one to one. We're not rehypothecating. We're not lending any assets without customer consent. What our customers choose to do with their assets is our customers' choice. Coinbase is not making independent decisions of what to do with those assets without customer approval."

🟩 Staking is beginning to make an impact at Coinbase. In 2020, subscription and services made up 4% of Coinbase's net revenue. In Q2 2022, it made up 18%.
Putting it all together, Coinbase is printing money from staking, custodial fees, and interest income. And all signs point to this growing significantly from here on out. Between the recent additions of Cardano and Solana for staking, as well as the upcoming Ethereum Merge , Coinbase is set to radically increase revenue uncorrelated to the rest of the crypto market.

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DEEP DIVES

Scandal: Leaked Document Shows Solana’s TVL Was Faked

It's been an eventful couple of months for Solana, the 5th largest layer-1 blockchain. First, they narrowly avoided a catastrophic liquidation. Next, they announced their Solana phone with mixed reviews. Most recently, they were the victims of one of the most mysterious hacks in crypto history.
However, this new story might take the cake as the craziest of them all.
CoinDesk has revealed that developer Ian Macalinao was posing as 11 different developers in order to create a convoluted pyramid of protocols that would artificially juice Solana's total value locked (TVL), a popular metric among investors for analyzing decentralized finance (DeFi) protocols.
Strap in for the strangest story of the year.
The Plot
Although Ian created a vast web of projects, his flagship project was Saber, a stablecoin exchange. Saber turned out to be very successful, ultimately becoming one of the most popular apps on Solana. It was Saber’s success that would act as the foundation for Ian’s con.
Ian's master plan was centered around TVL. Historically, protocols with a high TVL had high token prices. Ian recognized this and formulated a plan to use Saber to inflate his project's TVL, which would, in turn, increase their token price and, ultimately, Ian's profits.
To achieve this TVL pump, Ian built protocols that would "stack on top of each other, such that a dollar could be counted several times." Basically, Ian would build protocols that recycled money from Saber. This way, the TVL for his new projects would increase without bringing in any new money.
The plot worked exceptionally well. At its peak, Ian's protocols comprised $7.5 billion of Solana's $10.5 billion TVL.
Many Masks
The natural question is, "how did he get away with this?" It's fair to assume people wouldn't be cool investing in a pump-and-dump scheme, so how did he successfully con them?
The key was anonymity.
Anonymity is a core fabric of crypto. Most people in traditional finance would never trust their money to an anonymous person, but it's common practice in crypto.
Ian understood this and took advantage of crypto's comfort with anonymous developers to build his empire.
Closing Thoughts
This scandal is making people think long and hard about TVL as a metric, Solana, and anonymous developers.
TVL has been losing some of its luster recently, with many investors realizing it's a flawed and easily gamed metric. Unfortunately, this scandal just further confirms that sentiment. In fact, DeFi Llama, the most popular TVL tracking platform, has now implemented a "double-count" filter to prevent a scandal like this from happening again. Suffice to say, this is a con that probably won't work in the future.
For Solana, the scandal is another setback that has many questioning its merits as a layer-1 that can thrive in the future. One of the core selling points for Solana was its high TVL, as proponents pointed to it as evidence that the network was popular. This scandal casts severe doubts on those claims, and now the onus is on Solana to prove it can succeed honestly.
Finally, the scandal has people talking about the future of anonymous developers. This discussion has been percolating for years and notably exploded during the 0xSifu Wonderland drama in January. Still, this scandal takes it to a whole nother level. Over the coming months and years, we must decide if anonymity's merits outweigh the drawbacks.
These are the types of discussions that ultimately decide what crypto becomes. We look forward to seeing the answer.

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REGULATORY FRONT

Tornado Cash Shutdown By U.S. Treasury Dept.

The moment that many have feared is finally here.
On August 8th, the U.S. Treasury Department added Tornado Cash to their OFAC list of Specially Designated Nationals and Blocked Persons. In other words, it is now illegal for any U.S. citizen, resident, or company to interact with a protocol currently holding $437 million in crypto assets.
The consequences of this for crypto are downright scary.
The Sanctions
In many ways, it makes sense why Tornado Cash (Note: we would link to the website, but it honestly might be illegal to visit it) has caught the ire of the Treasury Department.
For those unaware, Tornado Cash is a protocol built on Ethereum that enables users to privately transfer funds on-chain. This has made it the go-to option for law-abiding citizens looking to transact privately… and criminals looking to launder money.
Naturally, the Feds ignore the many harmless reasons why one would use Tornado Cash and instead focus on its criminal potential. The main criticism of Tornado Cash from the Feds is that it is used by cybercriminals to launder stolen money. There is definitely some truth to this, with the most infamous example being the North Korean hacking group Lazarus Group using Tornado Cash to move money stolen in the Ronin hack.
This criminal potential was reason enough for the Feds to shut down Tornado.
Rippling Effects
This development is important because it doesn’t only impact Tornado, it also has a rippling effect throughout the crypto ecosystem.
For example, Circle’s USDC stablecoin is one of the two dominant stablecoins currently on the market, along with Tether’s USDT. Some of the most essential DeFi protocols rely heavily on USDC. This means any failure with USDC would come with disastrous consequences for DeFi.
Many have been harping about the risks of hitching DeFi’s wagon to a centralized third party like Circle. The argument is that this gives the Feds an angle to destroy crypto; as we said: a collapse for USDC is disastrous for DeFi.
Although everyone agrees that a USDC collapse would be disastrous, not everyone agrees that it’s something we need to be worried about. Instead, these people believe that the odds of the Feds cracking down on USDC are low, so we might as well use USDC to its fullest until we find a superior decentralized alternative.
Well, it turns out that the Feds pressuring Circle is not some distant dystopian future after all. As of this week, it's our reality.
Following the announcement on Monday, Circle froze 75,000 USDC worth of funds linked to the Tornado Cash addresses sanctioned by the Feds.
Yes, it’s a small amount. But that’s not the point. What’s important is that it shows that Circle can and will freeze funds to comply with the Feds. It was only 75,000 this time. What will it be next time?
Looking Ahead
Although it’s unfortunate for the innocent people who now can’t get their money out without breaking the law, Tornado Cash is a small fish. What makes it so concerning is its potential to be the first domino.
Who’s to say that the Feds won’t move to pressure each DeFi protocol to implement KYC/AML requirements? Or force Circle to blacklist any address that is not KYC’d?
Suddenly DeFi would look a lot like the traditional finance system it was meant to replace.
The path out of this dilemma remains unclear. Maybe the solution is to make a collective effort to focus on lobbying and politics so that we may educate current politicians on crypto and elect more pro-crypto candidates. Maybe the Lunarpunks are correct and we need to double down on building protocols resilient to government intrusion. Perhaps the answer is a mix of both or something else entirely.
In any case, the clock is ticking much faster than we expected. The time to fight for the future of crypto is now.

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