COIN — Based and redpilled

Will Caiger-Smith

9 December 2022•6 min read

It’s hard to be a crypto stan these days. The flaming dumpster fire of FTX has many feeling like Larry David was right all along. We’re not the first to make that joke, and we won’t be the last, but the point stands: these are dark times for digital currencies.

They are also dark times for all those who create them, trade in them, and the exchanges they transact upon (at least, those that are still standing).

Coinbase is one such exchange. Like many of its peers, it has attracted celebrity endorsements and regulatory scrutiny; unlike many of its peers, it has publicly traded equity and debt, so we can track investor sentiment in real time.

We’ll cut to the chase in a second. First, here’s a quick update on that sentiment, courtesy of Coinbase’s senior unsecured bonds:

The chase

Even before the collapse of FTX and its founder’s public self-immolation, the onset of so-called crypto winter had already pushed Coinbase’s debt to distressed levels. In our analysis back in July, we concluded that cold, hard fiat currency might be a big factor in the company’s future.

But with crypto winter threatening to become a cryptocalypse, Coinbase’s sizeable cash reserves (at $5bn as of the third quarter) have again become the subject of debate. Some observers, for example, think these cash reserves make the bonds a buy.

“The reason to be long Coinbase debt is if you think this management team is a rational actor and they do the intelligent thing here and delever the balance sheet,” said John McClain, a high yield portfolio manager at Brandywine Global.

“Management says they are no longer modeling out profitability,” he added. “I say if you are not doing that, and if you’re not generating cashflow, the best use of your capital is not investing in the business — it is retiring debt.”

Others think the company should conserve its cash, partly to reassure those who trade on its platform that it can provide liquidity and avoid leaving customers high and dry in the same way that FTX did.

“If I were them [Coinbase], I wouldn't be letting any cash go out the door,” said Pete Duffy, senior portfolio manager at Penn Capital. “Liquidity is of the essence, and if you want to continue as a business, the first question your clients ask is, 'How's your liquidity?'”

“I don't think they would like to see them buying back their bonds. I think they're going to have to prioritize keeping the business first.”

The rebase

Aside from liquidity, another thing Coinbase has going for it is the relatively low cost of its debt. Gross debt is $3.4bn (alongside its SUNs it has $1.4bn of convertible notes maturing in 2026 — see our cap table here) but the company’s annual interest expense is only $89m.

This is partly down to timing. Whether by accident or design, the company’s bankers at Goldman basically called the bottom of the market in September 2021, pricing Coinbase’s debut bond deal back when the high yield index was at 3.96%. Remember those days?

In that sense, it might be wise for the company to hold onto its existing debt rather than retire it. That kind of pricing is unlikely to come around again any time soon.

But then again, what use is all that debt at the moment? All the growth potential it was meant to fund has evaporated over the past 12 months.

Coinbase executives have forecast awful earnings this year. Revenues will be down hugely, and the company is deeply unprofitable — as of September, LTM EBITDA was negative to the tune of more than $1bn.

Today, Coinbase is in the opposite of growth mode. It dithered for a while, but is now cutting headcount. It is widely judged to have massively overhired during the pandemic, so there is probably a lot more cutting to come.

Meanwhile, it is sitting on bucketloads of cash and its bonds are trading at half of their face value. Financial leverage has crushed some of Coinbase’s competitors — might it be wise to use some of that cash to buy back debt and derisk the balance sheet?

Contrarianism

There’s headline risk on both sides here.

Firstly, if Coinbase announced it was spending billions to buy back debt, the public might be alarmed by the high upfront cost and its impact on liquidity (even though it would leave the company with tons of cash to spare).

Yes, delevering the balance sheet does reduce risk in the long term. Maybe the share price would pop. But FTX’s downfall accelerated when customers realized it was running out of cash — surely Coinbase would want to avoid the possibility, however remote, of a similar perception forming around its own liquidity.

Secondly, any fund manager buying the bonds right now is walking into a world of pain, both financial and emotional. Yes, there’s a theoretical upside case, but right now, most debt investors are running away from Coinbase, and indeed crypto in general. Pitching it as a long sounds like crazy talk — your boss might think you’ve been redpilled.

For the company, buying back debt could risk coming across as sign of desperation, an admission of how bad things have got; for investors, holding the bonds basically makes you a social outcast, not to mention opening you up to significant financial downside.

On both sides, such a trade would take conviction and fortitude and fly in the face of majority opinion. The kids have a word for this: based.

Cryptopianism

The bigger question for Coinbase is whether there is a long-term future for crypto.

Does the collapse of FTX, which pitched itself as a safe and responsible actor within an industry with a reputation for shadiness and rug-pulling, spell the end of digital currencies? Or does it lead to a radical overhaul of risk practices and regulation, and make crypto safer?

Unsurprisingly, people who work in the industry think it’s probably the latter.

“Is this the Hindenburg exploding, or the Titanic going down?” said an associate director at a blockchain analytics firm. “When the Hindenburg blew up, we stopped using hydrogen blimps. When the Titanic sank, we just put more lifeboats on ships.”

Crypto insiders say the industry moves in dog years, so if FTX was going to blow up the space, it would have happened by now (as an aside, some of them also say Coinbase is a boring, stable cashout with no edge; one told us it was “the Jay Leno of crypto”).

There’s no shortage of arguments for and against whether blockchain technology and cryptocurrency has a viable future. To immerse yourself, we’d recommended Matt Levine’s history of the space and Dan Olson’s video ‘Line Goes Up — The Problem With NFTs’.

We’re not here to make a call on the future of digital currencies. There may be something to the argument that if it was all going to collapse, it would have done so already. Then again, the failures are piling up — maybe it could be death by a thousand cuts.

All this is coming as analysts forecast corporate deleveraging on a massive scale. “As the new reality of high coupons on debt for a long time sets in, we expect issuers to focus their capital allocation priorities on delevering their balance sheets,” wrote BofA’s HY researchers today.

Clearly, what this all means for Coinbase is up for debate. But we would point out that the firm is publicly traded, with an actual board and corporate offices that aren’t a Margaritaville in the Bahamas. It is an actual company. (For what it’s worth, Coinbase declined to comment).

You might think crypto’s a ridiculous clown show, but at least some of the actors in it are wearing serious makeup.