090 Exchange Invest Weekly Podcast April 17th, 2021

TRANSCRIPT

This Week in the parish of bourses and market structure:

Warsaw Stock Exchange celebrates 30 years. Coinbase Tops Young's Pyramid (albeit disappointingly), Bernie Madoff dies and Gary Gensler is confirmed SEC Chairman as Coinbase lists on the 301st anniversary of the South Sea stock market bubble beginning.

At least one of these is surely a sign of things to come?

My name is Patrick L Young.

Welcome to the bourse business weekly digest,

It's the Exchange Invest Weekly Podcast Episode 090.

Good day Ladies and gentlemen, this is a very brief reduction of highlights amongst the key headlines from the weekend market structure. All the analysis of the week’s many events and happenings can be found in Exchange Invest’s daily subscriber newsletter, the unique guide to the bourse business sent daily to your inbox.

More details at ExchangeInvest.com

Plaudits to GPW that's the Polish acronym for the Warsaw Stock Exchange, and particularly its dogged founder Wieslaw Rozlucki who pluckily plonked a stock market in the former headquarters of the Polish Communist Party 30 years ago this week. The last time I passed by that former Communist HQ housed Warsaw's Ferrari dealership -now that's what I call karma.

Congratulations to Wieslaw Rozlucki who is now retired, and the entire current Warsaw Stock Exchange team as well as its forebears on this incredible milestone.

April the 14th marked an incredible day the South Sea bubble anniversary met Coinbase. Wednesday 14th of April marks a day when the world of finance has changed in 1720, it was the day when the South Sea company first sold stock to the public. On that day, 2 million pounds worth of stock was offered at 300 pounds per share, the issue sold out within an hour.

Sales were especially brisk thanks to investors only needing to pay a 20% deposit with the remainder due in instalments over 16 months. The only problem lying ahead was that the South Sea bubble burst before the stock was fully paid up. In the wake of that bubble bursting, fortunes were lost, politicians were amongst the many disgraced and the British economy suffered a colossal tumble.

Wednesday, April 14 2021 may equally have marked an incredible turning point in the world. The only question is precisely what that turning point was?

Building on the South Sea Bubble anniversary some who read the runes are suggesting the omens were not propitious. This theory gained further currency as news emerged from the USA that the ghastly Bernie Madoff had died in US custody while serving 150 years for fraud.

However, the news media frenzy of April 14 2021 has focused on the NASDAQ listing of a remarkable company. Coinbase arrived in public trading as immediately the largest exchange group in the world. Yet it lacks the same form of regulatory status as the legacy bourses it displaced at the head of Young's Exchange Pyramid, which measures the relative size of the world disparate exchange operating companies. Indeed at $100 billion on opening trades, Coinbase amounted to more than $25 billion more value than the previous pyramid leader Hong Kong exchanges.

It's rare for an exchange to be listed and simultaneously launched into the top tier of the publicly traded exchanges. It's unprecedented for what is a de facto exchange, but de jure more a collection of disparate licences than a fundamentally regulated entity to be so richly valued, that it becomes the biggest exchange of all by operating company valuation on its stock market debut.

The fuel which helped deliver a billion-dollar value to Coinbase is Bitcoin, that ei-money curiosity currently swept up in a vigorous bull market (some might say bubble) despite being invented by Satoshi Nakamoto, a figure who may not even formally exist.

The vagaries of Bitcoin are legion but at least it has achieved one thing - it amounts to the Ford Model T of digital money. Electronic currencies have come and gone for years (think Beenz in the 1990s) but Bitcoin was the first to actually encourage lasting infrastructure to be built around it. Thus it emulates Henry Ford's best-selling automobile of the early 20th century, which helped energise an economy built around paved roads and with it, the accoutrements nowadays taken for granted by the roads themselves: filling stations, cafes, restaurants, and so forth.

Coinbase was created in 2011 in San Francisco with a mission to deliver “More economic freedom for every person and business”. In less than a decade, during this stellar mission from startup to cento-billion dollar business, Coinbase has placed fingers in many cryptocurrency-related pies. At the core is a modern kind of hybrid variation on the theme of an “exchange” which would actually be prohibited from existing if it were regulated like the NASDAQ Stock Exchange on which Coinbase shares are now traded.

Indeed just last month, the firm paid a $6.5 million fine from the US CFTC “for reckless false, misleading or inaccurate reporting as well as wash trading”.

Without dwelling on the minutiae of each case, let's say this is somewhat akin to having the casino barman serving in a spiked drink while reading your cards and telling the dealer your hand.

       Suffice it to say that the London or New York Stock Exchanges are strictly forbidden from trading against the boss's clients. However, the weirdest element of this case is that Coinbase isn't even directly under the US CFTC remit. In fact, it's not clear just where cryptocurrency lies in US regulation, leading to the curious conundrum that while Coinbase CEO and Co-Founder Brian Armstrong now enjoy a 15 billion fortune (on paper at least) other pioneering crypto exchange founders like Arthur Hayes of BITMEX watched Coinbase stock trading in New York while on a $10 million bail bond.

Away from these puzzling regulatory factors, the question immediately arises as to why Coinbase suddenly found itself propelled to a giddying $100 billion valuation in the midst of the current Bitcoin craze.

There's no doubt Coinbase has grown rapidly, and in its prospectus, it stated some 43 million users. Attaining a client base of more than the population of California is a remarkable achievement - particularly in under a decade. However, its opening trade price: a $100 billion valuation that made each client worth over $2,300.

       Moreover, the prospectus noted that 2.8 million users were active over a month, valuing them, therefore, are a giddy $35,000 each as trading got underway. Saying each user is worth roughly half a Bitcoin in these arguably frothy crypto bull market times may be a mark of rabid optimism in the crypto economy, or it could just prove to be remarkable hubris in the event this is a crypto bubble. History in the making indeed.

Before you rush in to sell while listening to the rest of this podcast, perhaps we ought to remember JM Keynes useful investor maxim “the markets can remain irrational longer than you can remain solvent”.

Peeling back some more layers of the value justification behind Coinbase, there is clearly the core argument that this is ‘a new thing’ and thus Bitcoin represents the future to which we all hope to subscribe, where Jetson life comes to reality or something.

Given I wrote the first bestselling book on the concept of FinTech “Capital Market Revolution” (FT Prentice Hall) which in 1999 outline the likely digital currency future, it is fair to say I am not averse to the ideas of electronic money and all-around digital progress. However, I am left looking at Coinbase admitting the sort of low whistling breath exhalation which can also signify that winter-time plumber perusing your dysfunctional boiler, reckoning domestic central heating service will cost a princely sum to resurrect.

Fair enough Coinbase offered some exciting guidance on their profit and user outlook, but even when we factor these into the model, it's really tough to deploy a coherent risk/reward model and assert that the family fortune ought to be heading into Coinbase stock right now.

Client accounts on the projections of Coinbase are said to be 56 million while the Monthly Transacting Users have leapt from 2.8 million and the declared prospectus to 6.1 million. Then again, even at the relatively subdued first-day closing valuation of a mere $86 billion, that still makes each active user worth around a quarter of a Bitcoin over 14,000 US dollars in old money.

Fair enough, if this business has staggering margins, then perhaps it can justify every client at such an extravagant level but that route reveals some worrying home truths about the cryptocurrency business and particularly the Bitcoin itself.

The driving zeitgeist of digital money, electronic markets and so forth was always about efficiency and scale. Computerisation made markets cheaper to operate, reduced headcount (think of all those people populating vast exchange floors alone) in the past. This can drive down costs for the consumer. By way of comparison, when I worked at the lowest echelons on the floor of LIFFE in Thomas Gresham’s storied Royal Exchange in 1987, we could charge massive multinational banks over $30 per round turn, that's a trade where you buy and sell.

With electronification, you can now buy the same contracts online through a retail broker for under $5. Institutions pay a lot less.

To advance the Coinbase analysis: your word for today in the Sesame Street of financial markets jargon is ‘basis point’. That 0.01% (1/100TH) of a percentage point. In other words, so as we can see above, in the case of a million-dollar futures contract, you can transact a million dollars of Eurodollar interest rates for instance, for less than $5 (buy and sell) as a retail investor - or significantly less than one basis point which amounts to $100. In pure exchange fee terms (i.e. stripping out what a broker will charge on top for their services to give you boss access at all) the transaction cost is generally at most one basis point or as we have seen above, much less than one basis point.

Now, if we examine Coinbase’s financial history and its projections, what we rapidly see is a business, which appears to be charging its retail customers somewhere between 46 to 57 basis points. In other words, easily 46-57 times what exchanges charge for dealing on regulated (and thus one might presume frankly much more secure venues) such as the Blue Riband exchanges of say, London and New York. Of course, they don't trade cryptocurrencies. So clearly, one can argue there may be a premium for allowing people to deal in this new paradigm of assets, but then again…

As I said above, the original point to “Capital Market Revolution!” and delivering more ‘tech’ in finance to achieve FinTech was all about greater efficiency, lower costs and all that...

The problem with cryptocurrency is that while it has a fascinating backbone in the blockchain: distributed ledger technologies, they can have issues when it comes to their being scalable and cost-effective to use. That doesn't apply to all of them, but the problem is the likes of Bitcoin are using the earliest variants of DLT to be found in the wild - which makes it again akin to the Ford Model T. A nifty idea at the time, but soon rather outmoded. In this case, it's more like the way the Ford Model T shares a vast DNA base with your modern hatchback. However, if you're offered the choice of commuter drives, few if any, will long term consider using the pre World War One wheels.

So we might at this stage emit a cynical remark that perhaps Bitcoin isn't actually going to be the long-term solution to anything fiscally significant - and thus enjoy a few days pondering whether they really need social media - while Of course, a bang mob descends on their Twitter feed.

However, the serious point is the way Bitcoin delivers its secure transactional protocols and that's inefficient. AKA is not very scalable for fast, cheap transactions, precisely the site ghost or FinTech. So while you can trade a Satoshi ( a Bitcoin basis point if you will) it's expensive, and when you want to transact on the likes of Coinbase, you're likely to end up paying something like 50x what it would cost for more conventional financial assets. In other words, the old-line legacy financial assets are way more efficient to trade and vastly cheaper as a result per transaction.

Now some have thus argued this is just a growing pain. The “invisible hand” will meet raw market competition destroying down commissions. After all, (admittedly through what amounts to what some might call sleight of hand) US stockbrokers can nowadays offer “free” share trading.

       Presuming even a reversion to the legacy bourse theory is feasible. That doesn't look so encouraging for Coinbase as its valuation of $100 billion is based on the rosy prediction of a minimum profit of $730 million for the year ahead. That's based on an estimate of somewhere around $1.8 billion in total revenues.

However, even a maximum estimated $1.8 billion in revenue is based on charging something up to (if not beyond) 50 times the prevailing legacy exchange fees. Presuming the Coinbase crypto business was transacted at the level of the much more efficient traditional bourses, that would leave it with something like $36 million in revenue. Now, that's not going to pay 1200 staff salaries, (let alone Coinbase CEO Armstrong, who apparently received three times the remuneration of Goldman Sachs as CEO last year)

Thus we see the staggering dichotomy of appraisals around the value of Coinbase stock just ahead of its NASDAQ listing. Pundits on US financial television ranged from $5 billion, pretty much all the way along this spectrum, to Buzz Lightyear’s Toy Story catchphrase “infinity and beyond!”

Clearly, the ‘truth’, sorry fair value, lies somewhere within that wide-ranging 100 billion valuations, but it's very tough to assess that Coinbase is going to be able to grow fast enough to justify its 100 billion dollars first-day valuation without at least a little test of the downside support along the way. This reminds me that in private market trading pre-listing, Coinbase was very patchily traded, even compared with other recent similar US stock market debutants, such as Palantir, Spotify and Roblox, which also enjoyed the vote for “direct listing” (i.e. going to the stock market without selling any new shares to new investors).

I'm not sure it will mollify investors to further consider that they don't even get much say in the corporate governance of Coinbase either. Thanks to a skewed share structure, The Coinbase management and board of directors hold 54% of the votes, whatever the stock price.

Bitcoin may go to infinity. I happen to think like the Ford Model T it will bubble, burst and become a sweet relic for hobbyists and enthusiasts. The “Tin Lizzie” has value today but it's not priced at a staggering premium by vintage car standards. At the same time, markets and economies go in cycles. Betting on Coinbase that you can go from 0 to $100 billion in a decade and expecting the linear trend to continue seems a challenge.

       No Coinbase is in full public accountable view, contrary valuation opinion is an open debate for the market to resolve. Investors can consider the relatively staggering costs of dealing in cryptocurrency, which seem to belie the idea that technology makes the world better, more efficient and cheaper.

Likewise, there is a patchwork of regulation - rather, it's more like a string vest. The cryptocurrency business has some licences, but no coherent overarching regulation. Through these grey zones, the great fortunes of Coinbase and others have been accumulated to date, albeit at the risk of orange jumpsuits being distributed to others who clearly fell off the head of the crypto-pin upon which they danced.

So here's the rub, even if you don't associate Coinbase with the South Sea bubble of 301 years ago, and presuming you don't believe the death of Bernie Madoff is somehow totemic to the whole scenario. There was one other very significant event in the financial firmament on April the 14th 2021.

       Gary Gensler was confirmed as chairman of the SEC - the Securities and Exchange Commission: a regulator of stock markets and more in the United States of America. Gensler previously ran the derivatives regulator CFTC (which fined Coinbase multiple millions last month) with an iron fist during the early Obama administration. The new SEC Chairman spent several years at MIT during the Trump Presidency and his Bitcoin lectures have led many to believe he is a crypto enthusiast.

Perhaps he is. However, the one thing which was clear during the Gensler era CFTC was a ruthless desire to bring anything the chairman perceived as an egregious market behaviour to heal, and an eagerness to close up holes in the financial firmament where regulation was not being consistently applied.

       During cancellers CFTC tenure, a raft of firmly enforced laws transformed the interbank swaps market into a vastly more heavily regulated entity. Who believes he is chairman Gary Gensler won't be eager to bring the cryptocurrency market into a properly coherent regulatory framework away from the current patchwork where the ‘exchange’ can even trade against its own clients?

April 14 likely marked its place in financial history once again this year, time will tell.

If you'd like to know more about the future of blockchain cryptocurrency in the FinTech world. Don't forget to check out not just Exchange Invest - as my daily newsletter, the water cooler at the epicentre of the business of bourses, but also my latest book “Victory or Death” blockchain cryptocurrency and the FinTech world, published by DV books and distributed by Ingram worldwide.

And finally, this week, News reaches Exchange Invests that European Union Co-Founder Robert Schumann is being lauded as having “heroic virtues” which amounts to step three of the sanctification ladder in Roman Catholicism.

He has already surpassed being dead five years (having been born in Luxembourg, died in Scy-Chazelle, in Lorraine in France in 1963.

I must admit I missed the bit where he achieved “servant of God,” which is kind of equivalence with religious practice.

The next step of the ladder to sainthood requires a miracle to be attributed to the former French Foreign Affairs Minister, whose political peak was his role in the May 9, 1950 declaration to create the European Coal and Steel Community.

Looking at the situation logically, if the European Union survives with its implosion until 2035, it ought not to be difficult to attribute that miracle to Schuman, and thus he needs just one more miracle (sustained European Union economic growth, perhaps) to achieve canonisation.

And on that mysterious and magnificent note, ladies and gentlemen.

Thank you for listening to this Episode 90, the Coinbase special of the Exchange Invest weekly podcast.

My name is Patrick L. Young,

I wish you a great week in life and markets.

LINKS:

Coinbase Is Not Worth $100 Billion But Its Stock Could Double On Direct Listing
Forbes

Despite Record 1Q Results, Coinbase's Valuation Remains Ridiculous
Forbes

Opinion: Should You Buy Coinbase? The Valuation Is Ridiculous, Based On This Math
MarketWatch

2 Reasons The Coinbase IPO Is A Risky Buy
Motley Fool

Coinbase's Public Debut Is Set. Should You Invest?
Nasdaq

How The Coveted ‘Coin' Ticker Found Its Way To Coinbase
Nasdaq

Gary Gensler Confirmed By Senate To Lead The SEC, Wall Street's Top Regulator
CNBC