Coinbase Global, Inc. (COIN) Earnings Call Transcript & Summary

Thanks for joining us. I'm Michael Grimes from Morgan Stanley, and really pleased to have Alesia Haas and Brian Armstrong from Coinbase. So we've got safe harbor statement and disclosures on the Morgan Stanley website in here. So, please refer to those for appropriate disclosures, and that we're going to go ahead and get started. So I don't know which he wants to take this, but we're here to talk about, in part, our financial system, and we know there's parts of it that work, but parts of it that are dated. One of the simplest ways to illustrate that is we want to send money to someone, your choices are Venmo, Square Cash, Apple Pay, PayPal, we can only use them super convenient, but it takes a little while to get through the system and free or if we want to do it fast, wire transfers are expensive.

People know the systems need updating, where can blockchain and crypto, make whether that use case or other use cases more efficient to make the financial system more efficient, is question one. And related to that, how would Coinbase be part of that.

Yes. Well, thanks for having us here, first of all. And happy to talk about some of the use cases. But I think you laid it out well, 80% of Americans today, they feel the current financial system is not serving them. So it takes too long. The fees are too high. It's not serving everybody equally. And cryptocurrency is one of those technologies that can really update the financial system. So whether it's every time you're setting a payment, why isn't it as fast and cheap and global as sending a text message or WhatsApp message, right? Why is it, that every time you swipe your credit card, you're losing 2% or at least the merchant is. Or similarly, we talk about T+2, T+3, settlement, why can't that be instant and just eliminate an entire category of risk in the financial system. So a lot of these tools that we're using, they're based on code that's 40 years old, running on these cobalt mainframes and the laws are sometimes 100 years old or more. . And so cryptocurrency is really a way you can think of it to create new financial infrastructure that's more efficient and global and fair and free. So you asked about what is Coinbase's role in this? I mean -- well, we really have -- we have a role to play as the primary financial account for people engaging in the cryptoeconomy using this new technology. And, we also have a role to play as the most trusted and compliant player in the space. I think, recent events and this increased regulatory scrutiny are really -- I believe, there are going to be a -- there is going to be a net beneficiary of that environment because for the last 10 years, we've been following an approach that is compliant, it is trusted. It sometimes caused us to move a little bit slower, but we're doing things for the long-term game here, and we want to make sure that this company is around for many generations to come.

So you mentioned those recent events pretty eventful, hard to overstate the events of FTX, Luna, et cetera. And yet you have messaged your customer assets, save the entire time. You've had a set of seismic events that didn't really affect your customers. You've been through cycles. Is that what helped there? How did that come to pass? And, how do you take that compliant the mechanisms you've developed there, and take them to the next level, given that you have been the strongest on that in the space?

Maybe I'll start off there. So, I think what we view is the event to 2022 are not crypto-related events. Yes, they happen to crypto companies. But the events there were tried and true risk management practices that we've seen, [indiscernible] on the time. So FTX was fraud. Pure and simple fraud. Terra Luna was bad asset liability management. We saw concentration risk. We saw poor credit underwriting, these are just standard ways that we've seen hedge funds fail, banks fail, et cetera, since the [ Donatime ]. So what's different at clean base is that we recognize those are the types of risks that we could have engaged in, and we structured our products to be very risk conscious. We've hired risk professionals. We focus on asset liability management. We focus on holding assets one for one. We take security very seriously. And so we were able to bypass and navigate through these events because that is not how we've ever approached our business. It sounds pretty simple, but we believe...

Have you seen it coming or you just knew that was the right way to operate the business?

We one saw that there was 4 risk management practices in the industry. We did not see fraud coming at FTX like, we were very shocked by that. We didn't think they were operating as cleanly as we were, but we did not see fraud. So with others, we definitely saw -- people are offering unsecured lending in crypto to -- without underrating their counterparties. When you offer unsecured lending and you don't enter your counterparty, you're at high risk of loss. That is a very basic fundamental truth. So, we knew they are bad practices, we do not engage in those practices. We structured our lending products to have collateral to have liquidation right to not concentrate with any single counterparty. These are how we navigated the event in 2022.

Yes. And we shouldn't underestimate just the basics. I mean, Coinbase is founded right here in the United States. Some of our biggest competitors were not -- we became a public company, with audited financial statements. We've approached regulation by seeking it out. We've run towards regulation and thought out to get licensed in any way that we possibly could. We have a variety of licenses just in the U.S. but across all the jurisdictions. So in Q4, we actually saw an increase in the number of institutions onboarding, to Coinbase prime or prime brokerage, I think, because they said, this is -- if we're going to...

This is the one.

Yes, this is the one. I mean, so I think as long as we can continue to scale up our compliance and our regulatory efforts, it's going to be a major advantage for us over time.

So let's talk about regulation, since that's the theme. What are the initiatives that you're behind on federal or other legislation to modernize regulation, as you've suggested, is necessary to be able to have crypto safe and secure, and regulated in a way that protects the consumer and has the regulators in a place that makes them content?

Yes. So our policy effort is really my top priority for this year. And I've been spending more and more time in D.C. Now there's a lot we can get done with the current rules and laws that are on the books, which are really around how traditional financial services is regulated. And, for a lot of our business as a custodian and exchange, we can -- we've built our business today, and we feel very comfortable continuing in that vein. But it would be very helpful to have additional clarity from the regulators, or new legislation that's passed by Congress, as we've seen happen in EU with the MiCA legislation, comprehensive legislation around crypto that just got passed or we just saw the same thing in Hong Kong. The U.S. Congress is continuing to become more and more interested. There's maybe three different groups we're aware of that are drafting different bills in Congress there's strong bipartisan support for this. Now it takes -- the stars have to align any time, new laws become actually enacted through the various branches of government in the U.S. But, I do think that's an important area to push on. Now separate from that, there's a lot of other things that we can do. One thing we're doing is we're trying to organize the base of customers out there who have used crypto. About 20% of the United States citizen...

Organize them politically kind of lobbying.

Exactly. Yes. So 1 in 5 households in the U.S. have now used crypto. I mean, it's about 50 million Americans. So it's a massive group. And what we're doing is we launched something called Crypto 435. It references the 435 congressional districts. And for a lot of these 50 million people or at least, let's say, at least 1 million of them crypto is almost like a single issue. There's a single issue voter on that.

How many of those districts would they be in, by the way, those 20%? Are they in all 435?

Yes. crypto is widely distributed across...

Is 435 not concentrated in certain spots?

No. I mean I'd say the largest demographic is 25- to 35-year-olds, but in every jurisdiction. And, so I think that we need to make sure that in upcoming elections, we see candidates that are pro crypto and say, I want the crypto vote. And, so in America, the government is a representative of the people in any democracy, right? And so the people want this. And eventually, that's going to have to make its way into government.

That could be a campaign theme, I want the crypto vote. So you've talked about international. You mentioned Hong Kong, EU..

I mentioned one of the things that's -- okay. Yes, sorry. I mean so while a number of us on the executive team are really focused, and we have an amazing Head of Policy who we hired from Goldman Sachs. And many of us are focused on the policy efforts. But, I want to make sure one of the things I'm really pushing on as CEO is that we can't let the whole company be focused on this. We also need to keep innovating, and we'll talk about this later, I'm sure, but there's a number of really important technological innovations we're building, just to drive the utility of crypto in the meantime. We can't just be a 100% focused on policy.

On policy and regulation. So, you mentioned international, EU, U.K., Hong Kong, where else -- where do you see things headed regulatory-wise internationally, reducing friction while also putting in safeguards what's happening internationally that's different than here in the regulatory regimes?

Yes. So Alesia, I don't know if you want to add anything to. But for instance, in the U.K., Rishi Sunak, the PM is very pro crypto, right? Singapore, when I go there to meet with their folks and government, they're saying, we want to be a web 3 hub, right? Hong Kong just did the same thing. And then we saw this legislation passed in the EU. So basically, every financial hub in the world is saying, we're open for business. We want crypto companies to be built here. And the U.S. actually, strangely, they're not really thinking very much about FTX in those regions. It's sort of -- it's not in their collective consciousness maybe as much as it was here, in the U.S. So the U.S. is a little behind here, but the types of legislation that we want pass, it's actually -- it's nothing rocket science. It's really just taking some of the best practices and applying it to crypto, whether that's let's make sure we have audited financial. Let's make sure that customer funds and corporate funds...

[indiscernible] stable coins.

Have a great AML KYC program, avoid wash trading. Some of these really basic controls that we can get -- now. There's things we could do beyond that, like if we had more clarity about what is a commodity, what is the security, what is the stable coin, et cetera, in crypto, that would be even more beneficial, but that might take a little bit more time. Anything you want to add?

That's right. But, I think that meat is an important one because MiCA did recognize that crypto assets are distinct that they do have consumptive use. And that is really the key here that crypto has consumptive use in a way that a traditional bond security doesn't have. And, I think, that's the nuance that we're trying to tease out in the asset taxonomy and clarification.

And that's what is at the core of some of these international regulations on the consumptive side, some of them.

Some of them.

So if you had -- if you had someone playing devil's advocate, that said, take your scale, compliance, KYC, AML advantages, which are significant. You've built them up. You were ahead of some industry turmoil. They powered you through it, as a strength and ran further towards existing regulation just as a devil's advocate and said, go meet the SEC where they are on existing rigs on registration complexity and all. What would you say to that hypothesis is a different way to go at it, than either waiting for or precipitating new legislation, which would certainly clear things up. But, what if they don't get cleared up, could you meet them where they live somehow to current regulators?

Yes. We're definitely trying to do that. And we're spending an inordinate amount of time with the SEC, the CFTC, various other state regulators, et cetera, doing exactly that and saying, we've heard the message that coming in register. Here's something we'd like to register. Here's another thing. Here's another thing, right? By the way, the things that are commodities, we don't think we're going to register those in securities, but I don't know, Alesia, what -- you've gone through as we both...

I wish it were so easy. I wish, we could just show up and register and be done and move on with our lives and grow crypto. It's a bit complex. And what's complex is today. We do think there are cryptosecurities out there. We have not listed those on our platform because we are not a registered securities exchange. And we believe we have listed utility tokens that have consumptive use. And I think that there is agreement, Bitcoin is not a security. We've everyone's heard...

Uniformly agreed.

Uniformly agreed. But you're not allowed to trade a nonsecurity and security on the same exchange. That's prohibited. So you would have to then come up with, are we going to have Bitcoin-only exchanges out there? What are we things that look like Bitcoin, are there other things that are sufficiently...

Where do you draw the line.

Where do you draw the line. Absolutely, security tokens should trade on a securities constraints. We agree with that. But, we think that a lot of crypto that exists today that are the biggest cryptos are there for consumptive use. And you don't need to call those a security because you can use those in the protocol. They are there to actually exchange for goods and services of the underlying protocols. So, you don't even Apple stock to use your Apple phone. You either Disney stock to go to Disneyland. You do need to have a Sirium to send a transaction on the Sirium protocol to pay, the gas fees. Those are different things that we have to address that are not so clear in the existing rules. So yes, we should run through the rules. But we also need to recognize that these rules are written before the advent of blockchain, and that we need to have finding some ways to meet the spear of the law with a different execution of those blocks.

Okay. So the two paths are policy and legislative change, and then where you can the -- existing regs and working with the existing regulators as best you're trying to do, so that one way or another to close the gap and then use your KYC AML, compliance mindset and processes in either version of the world that plays out.

That's right. Yes. I mean I think we have a lot of mutual goals with the regulators, which is let's bring this within the regulatory perimeter and make sure there's strong consumer protection. And, so we are creatively looking for any kind of win that we can give them to fit it within their system just to kind of advance the conversation one step further, and we'll keep doing that. .

Thank you for that. So, on the financial front, you've had a lot of growth, and you've had the turbulence. And now you're talking about EBITDA in all market conditions, tell us about that change?

Yes. Well, when we went public, I mean, we really wanted to make clear on the S-1 that crypto has gone through these cycles. And our trading revenue has been relatively volatile in these markets, where it goes up and down. We've now shifted more and more to subscription and services revenue, and we shared in our Q4 earnings that 47% almost half of our revenue now is from subscription and services, which is more predictable. That's going to allow us to be kind of an all-weather company, if you will. But we realized kind of in this down market that the market conditions had changed, and we needed to change along with it. And so we've now moved to this posture of wanting to be able to generate adjusted EBITDA in any market environment. You saw us kind of take really strong actions to reduce our operating expense and our costs with the layoffs that we did in January. We did one actually last year in June as well. So those were 18% and 20%, respectively. And then we also started to focus a lot on stock-based comp as a very real expense. I know, many people are talking about that now. And we believe that actually between Q4 and Q1, we'll have our stock-based comp reduced about 50%, and we did that with both the headcount reductions and also some changes around compensation within the company. So we're definitely making a big effort to have -- be able to generate adjusted EBITDA in any market environment.

I'd add two things. So one is we're not going to be able to do this overnight, that this is the goal to grow more subscription and services such that our subscription and services cover all of our OpEx. And that means we will still see volatility in transaction revenue, but that will change profitability up and down at the bottom line, but all of the costs will be covered by more particular revenue streams, and that's what we're building towards. . The other thing, I wanted to say that I think changed last year is in the event of 2022, is we saw a lot of companies go bankrupt and that shook consumer sentiment. And what's important for Coinbase is also the market has changed, but also we want to make sure that our customers never have a doubt about our financial strength, and our ability to navigate these market conditions. And so we also believe that this will help give that customer confidence in us that we are profitable in all market conditions. And, so I think it's a change in both.

I see. And then as a step towards that One River and asset management in this sector because that can be a source of recurring revenue and increase that percentage. And we talk about that acquisition.

Thanks to the reason that, Michael, yes, this week, some of you may have seen, we did a small acquisition. We announced that we bought One River Asset Management, which will be our first kind of step into asset management, which is another type of revenue stream that is asset based. It's more predictable revenue, and we'll have less volatility than our trading revenues. And so one, we think this builds out our product portfolio in a way that's really a nice adjacency for our -- especially for our institutional client suite and gives us the ability for that more predictable future revenue stream. It is small. We're going to grow. This is not necessarily impacting today's revenues. So, I think it sets us up nicely for the next.

Directionally, on that recurring revenue. So let's talk I feel like we're in Steve Ballmer mode, developers, developers, developers. Let's talk about your focus on developers. So, the monthly active developers on the blockchain have increased despite all the recent turbulence and you've got a couple of initiatives going on now, a big one with base. And now, I think Wallet as a service in the last 24 hours. Talk about the focus on developers and those 2 initiatives.

Yes, actually. So if you look at the number of developers working on crypto currency and blockchain projects, you can get this data by looking at GitHub and things like that. The number of developers has roughly doubled since 2020. So it's continuing to increase. I think that's a great indicator of where the future is going, and what the smartest young people, the engineers are working on. So Coinbase has been continuing to innovate in this market, as I mentioned earlier, in addition to focusing on policy. We launched a product today called Wallet as a Service. This basically takes all of the core technology that we've built that integrates with the blockchain stores crypto securely, and exposes this as an API through our Coinbase cloud product to any company in the world who wants to integrate crypto into their offerings. So quite as cloud is a little bit like our Amazon Web Services product. There's another developer tool we released very recently as well, called BASE, which is a layer 2 solution. The simple way to understand it is that crypto is still not very scalable. We need to get these layer 2 solutions kind of like moving from dial-up to broadband on the Internet. It's going to allow us to scale up the number of Ethereum transactions, for instance, that we can do. Get the cost down to under $0.01 per transaction, hopefully get it up to hundreds of millions of billions of people someday. So these are examples of really powerful innovation that Coinbase have been able to drive in this environment. And helps grow the ecosystem around crypto as well and drive those use cases.

And you launched BASE with dozens of developers, if I remember correctly, I mean you said a whole bunch, what are they building?

Well, there's a number of things that can be built with it. We launched it actually in partnership with a firm called optimism. Yes. It's built on the optimism stack. So it's probably far more than dozens at this point. But just to give you an example of the kinds of things that we could more vertically integrated into our product. When we have a layer 2 solution that we have some influence over is, for instance, with USD coin, which is our stable coin in partnership with Circle, we could make those payments 0 fee, for instance. With our NFT platform, there's still a lot of work.

Pause there, and say what that means. Like do you see global instant settlement in the U.S. dollar. Like that's what this enables. That enables faster, cheaper than any existing payment rail and crosses borders. So you're not having to now move money between the U.S. payment system and the European payment system, and like having your dollar touch multiple intermediaries to settle, if I want to send an overnight payment in India. This is now peer-to-peer cost-free instant settlement in the U.S. dollar.

It's a big deal. That's a big deal.

It's a big deal. It's a really exciting use case. Use case for crypto.

Any other site without it knows it's a big deal.

Right.

I mean that's a great example of updating the financial system.

Update in the financial system. .

Yes. I mean another example where we can leverage bases with Coinbase NFT, for instance, there's kind of a complicated -- if any of you have tried it, it's pretty complicated today. You have to buy a crypto and Coinbase and then you have to bridge it often to an L2, so that you can get your NFT and some kind of self custodial wallet in a chronic. It's a way to complicated.

Oh, my grandmother just did that. She did exactly that.

I was really amazed in the 2021 period, I was like -- how many people are using this thing and it's that complicated. So that just tells you a little bit of the potential. I mean imagine if we'd actually made it easy to use. So the vision here a little bit with Coinbase is like, oh, if you already have your crypto on Coinbase, one click and now you have the NFT in your wallet too. So that's the kind of thing we can start to just make it just work underneath with we have these kind of solutions like BASE.

Go ahead.

We talk a lot about this 3 pillars. We need scalability, which we worked on with BASE. So it's more scalable, faster. We talked about usability which is then making that wallet and then it's regulatory clarity. Those are the 3 things that we need to focus on to really unlock the doors of a crypto's credential.

You speed in there and scalability that means scalability with speed.

Volume and speed.

And that's how you did it by taking the layer 2.

Yes.

Yes. The confirmation times improve, all that stuff.

So let's up level now. The -- what you've been through from start-up phase through go-go growth through the turmoil and everything went through. What did you learn with all of these lessons and how are you applying those?

Lots of things that we did well, some that we probably could have done better. I mean, one that we learned is it's never as good as it is -- as it seems in crypto and it's never as bad as it seems. When things were -- I mean in 2021 was a crazy year. I mean our revenue grew 600%. We did $4 billion of positive EBITDA in a year. The biggest issue we had as a newly public company was, there was a line out the door of people who were begging to onboard to our platform. And, we were just trying to grow -- I mean 600% at scale is crazy. I mean everything was breaking, like systems processes, we were trying to scale, as fast as we could. And then, of course, 2022 was a massive correction. And so how do you actually grow and manage our business responsibly through those kinds of periods of volatility. So it's basically don't grow as fast as you think you do during the period. Still keep investing in the down period. They don't fall prey to despair, right? Make sure that we're investing in these down periods in the infrastructure around compliance and cyber and it's just literally scaling the server and the application, so that in the next upswing, we'll be ready to grow even better. And so, I think the strongest companies get even stronger in down periods. The herd gets a little bit thin. And that's been the best thing that we've -- it's allowed us to achieve success over the last 10, 11 years is just long-term focus, don't get too excited in the period, don't get the spare in the down period and you're going to end up in a really good place.

So where is that? Let's get before and then audience, you can do some questions in a moment if you have any. What's -- where is that place you end up? What's the long-term vision? What's true north for you for Coinbase?

Well, okay. So the mission of the company is around increasing economic freedom in the world. And I think it's going to be a little bit like the birth of e-commerce. Back in 2020, we were probably sitting here early Amazon or whatever, and it was what percent of global GDP was e-commerce at that time. It was probably 0.1% or something, right? And now sitting here today, it's probably almost 20%, right? And so what happened over that 23-year period. Well, basically all the tools had to get better. We had to have broadband proliferation. We had to get the payment infrastructure to work a little better. All these little pieces had to fall in place, and it eventually started to work. So fast-forward from here, where do we want to end up. We want to have a more global fair free financial system, where cryptocurrency has now updated it in a massive way. We think that there's going to be hopefully 1 billion or more people accessing the system. And everything from earning money to borrowing and lending to sending remittance payments. These things will all be more efficient. But there's lots of nonfinancial use cases as well in crypto. If you've heard about Web 3, we're seeing people create decentralized identity systems, decentralized social networks, new kinds of business models for creators. We're seeing central bank digital currencies come online. Probably in the next 5 years, we'll see more countries actually adopt crypto as a legal tender, kind of like we saw with El Salvador, is like a very early one to start, but others may happen in the future. So these are all things that are on the horizon. And our goal is basically at Coinbase, we want to be the primary financial account for people in the cryptoeconomy.

Terrific. Anything from the audience? Right here in the front.

So my question is bright, Coinbase and you are the [indiscernible]. Unfortunately, there are a lot of bad players. And FTX is one of them. And, I suspect there are other bad players haven't been caught yet perhaps the biggest of them all. Now every time these bad things happen with FTX, Luna, Terra. The regulators they zoom in probably, because they want to stand whats going on. They don't understand crypto because some people have lost so much money. So my question is, what are you doing to proactively educate these regulators in next chart, that the laws and regulations are passed, will enable to equip the industry to grow in a productive way and not react to negative publicity like FTX another player blowing up in the future.

Yes. Great question. So you're correct. There have been some bad actors in crypto, no doubt. And, although it gathers a disproportionate amount of the headlines, there are many legitimate companies in crypto. I actually just hosted a dinner in New York, I'm going to host on tonight in the barrier, I'm basically getting together with all the legitimate companies in crypto and saying like, let's build back this industry better because anyway, we don't want to let a few bad apples gather the biggest mind share. But, I think the core of your question was really how are we educating regulators and policymakers -- and the way we're doing it is. So one thing, I'm just showing up a lot more in D.C. So as our policy team, so as Alesia. So it's everybody on our team. We've also done things like we've drafted a set of principles. It's really -- it's a binder that we basically give out to people in Congress, when we meet with them. And it's just our friendly suggestion about here's some of the challenges. Here are some potential solutions. We don't want to overstep because I think there's a way we could send the wrong signal and say, "Hey, we drafted something for you. I mean, it's their job to do it. We're here only to help, if asked. So we want to do it respectfully. We also filed a petition with the SEC kind of articulating it's public on their website, if you want to look at it, sort of articulating some of the challenges in the existing regs, and how they could potentially be solved. There's a lot of education that can be done, but it's a lot of it is just you got to show up over and over again and help that happen. Do you want to add anything?

We have white papers on stable coin regulation. We have white papers on how the SEC could think about securities versus nonsecurity tokens. And, so a lot of it is drafting and policy influence with we have Coinbase scholars that we have engaged in these topics that have conferences. We do a lot of like hands-on technology learning with members of staff of lawmakers, as well that go really well. But yes, it's education.

What about [ 4 million ] items [indiscernible]?

Yes. Well, we were a founding member of the Crypto Council for Innovation, CCI, we've worked with Block Chain Association. Yes. I mean there are a number of industry groups for crypto. I think, that we could probably do even better on that dimension as an industry, frankly. I don't think -- we've looked a lot at what the banking industry has done from a lobbying efforts or oil and gas or these different industries. And I think -- there is a professionalization effort, if you will, that's emerging in a lot of the dinners and conversations I've been having in the crypto world. I mean, donations is another key piece of this, right? There's kind of the hard money, soft money, there's the packs and then there's also just there's 50 million Americans who have used crypto. So many of those people, they're going to want to donate $100 are up to the -- even if it's $5,000 or whatever the max is, they're going to want to donate that to pro crypto candidates. And so that also obviously influences the -- the policy cycle. .

Last question?

Do you guys have a relationship with Silvergate and what's the update there? Any [indiscernible].

We shared last week that we don't have material exposure.

Question was on Silvergate and the answer is...

No material exposure.

No material exposure. We will wrap on that note. Thank you all for joining Brian and Alesia and Coinbase. Thank you.