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Coinbase: A Foreshadowing of Institutional Investment Still to Come
It has been said at various points over the past year that institutional interest and investment in Bitcoin and other cryptocurrencies has been one of the primary drivers of the ongoing bull market. The law of supply and demand certainly supports that thesis. Bitcoin’s supply increases at a steady rate and the maximum supply of 21 million coins is known. While not all cryptocurrencies have a hard supply cap like Bitcoin, the open nature of blockchain means that investors can typically get an understanding of the high-level crypto supply on the market. As a result, cryptocurrency prices are overwhelmingly driven by demand rather than by supply.
Institutions can be a source of massive demand given the immense amount of cash that many of them have sitting in their treasuries. For example, the five largest companies in just the United States collectively have nearly $650 billion U.S. dollars worth of cash and equivalents sitting on their balance sheets:
Retail investment has certainly contributed to the growth of cryptocurrency over the past decade. But that contribution in monetary terms could easily be dwarfed if companies around the globe began to put even small percentages (e.g., 5 - 10%) of the cash on their balance sheets into cryptocurrency.
It is for this very reason that many investors within the space have become extremely bullish on its long-term growth prospects. They believe that cryptocurrency usage is about to reach critical mass, leading a large number of companies, big and small, to allocate resources and capital to the industry, driving prices of cryptocurrencies and crypto assets to the moon. As we’ll see below, it would be hard to argue that they’re wrong.
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Institutional Investment: All In On Crypto?
If you spend at least a couple minutes each week reading crypto news, then you’ll probably agree with me when I say that it seems like a new institutional crypto investment is announced every few days. That said, there have been several institutional investments that have gone above and beyond the norm in terms of their positive impact on cryptocurrency prices and development. And yes, these investments primarily dealt in Bitcoin since most public institutional investment thus far has gone towards the king cryptocurrency:
MicroStrategy was not the first company to openly endorse purchasing Bitcoin for its balance sheet, but it may go down in history as the most influential company to do so. The business intelligence firm made waves in August 2020 by announcing a purchase of over 20,000 Bitcoin for around $250 million USD and confirmed the company’s intent to keep purchasing Bitcoin as its primary treasury asset. The company has followed through on that commitment and owns over 105,000 Bitcoin as of June 2021.
It’s no secret that Jack Dorsey, the CEO of both Square and Twitter, is a stalwart proponent of Bitcoin:
It should come as no surprise then that Square, which already enables cryptocurrency trading through its Cash App, purchased over 4,700 Bitcoin in October 2020 and then followed it up with an additional purchase of over 3,300 Bitcoin in February of this year. Square is not content to just own Bitcoin and has already expressed an intent to try and improve accessibility to the space through the creation of its own hardware wallet.
Even your uncle who lives under a rock probably heard about Tesla’s massive Bitcoin purchase in early February 2021. After all, the cryptocurrency’s price skyrocketed by about 20% within twenty-four hours of the purchase becoming publicly known. Tesla followed the purchase up several weeks later with an announcement that the company would accept Bitcoin as payment for its vehicles. However, Tesla’s CEO, Elon Musk, appears to have been misinformed about the true environmental impact of Bitcoin miningand did an about face on accepting Bitcoin payments shortly thereafter. Musk has claimed though that Tesla still holds the majority of the Bitcoin it originally purchased.
Coinbase: “Lead by Example”
The latest institution to make waves by way of announcing an investment in cryptocurrency is Coinbase. Coinbase is one of the oldest and most well-known cryptocurrency exchanges in the world, boasting over 56 million users worldwide. As part of their recent public filings with the U.S. Securities and Exchange Commission (SEC), Coinbase had revealed large crypto holdings of their own in addition to holdings the company custodies for its customers. However, in an attempt to “double down” on its usage and support of cryptocurrency, the company recently announced the following:
We have committed to invest $500 million of our cash and cash equivalents into a diverse portfolio of crypto assets. Going forward, we will also allocate 10% of quarterly net income into this same portfolio. This means we will become the first publicly traded company to hold Ethereum, Proof of Stake assets, DeFi tokens, and many other crypto assets supported for trading on our platform, in addition to Bitcoin, on our balance sheet.
Coinbase’s decision to invest a significant portion of their free cash in cryptocurrency assets makes a lot of sense. After all, Coinbase is a cryptocurrency exchange, meaning that cryptocurrency drives its bread and butter product offering. However, there are a pair of potential benefits that Coinbase could see by increasing the amount of crypto it keeps on hand:
In addition to facilitating cryptocurrency trades, Coinbase custodies a large amount of cryptocurrency, both for investors using its trading service and for institutions that want to have a qualified custodian hold their assets in cold storage. There have not been many large scale hacks against Exchange cold wallets, but hacks do happen elsewhere in the space. Due to the rapid growth in crypto asset values and the risks inherent to holding them, it has been extremely difficult for crypto companies to acquire sufficient insurance to protect their assets under management. Coinbase’s decision to acquire large amounts of cryptocurrency for its own use may be an attempt to increase its ability to self-insure against loss of customers’ assets, especially since the company explicitly stated that its allocation “will be driven by our aggregate custodial crypto balances.” In other words, Coinbase will seek to match its own investments to that of its customers, likely on a percentage basis.
Cryptocurrency prices are well-known for their volatility. As we discussed above, this volatility is driven much more by changes in demand than by changes in supply. In order to increase liquidity and thus help smooth out price volatility, Coinbase may decide to use its own resources as a market maker. Granted, Coinbase’s announcement does state that its own crypto purchases will take place away from the exchange in order to avoid conflicts of interest. However, crypto regulations aren’t currently well established in most countries. If Coinbase can get away with market making on its own exchange while turning a profit, the company may find that opportunity too golden to pass up. Additionally, the announcement did not explicitly say that the company couldn’t use its assets as a market maker on another CeFi or DeFi platform.
The reasons for purchasing cryptocurrency are many and they commonly vary between retail and institutional investors. However, regardless of the reasons that drive an institution to buy cryptocurrency, it seems likely that the trend will continue and accelerate. Cryptocurrency represents a new digital frontier and our world and the companies in it are increasingly looking to digitize. Seems like a veritable match made in heaven, wouldn’t you say?
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This is not financial advice. This newsletter and related content are for informational purposes only. Cryptocurrencies, stocks, and similar assets can be risky. Always do your own research before making any sort of investment.