Coinbase Global, Inc. Q1 FY2023 Earnings Call

Good afternoon. My name is Christie, and I will be your conference operator today. I would like to welcome everyone to the Coinbase First Quarter 2023 Earnings Call. All lines have been muted to prevent background noise. Following the speakers' remarks, we will have a question-and-answer session. I will now turn the call over to Anil Gupta, Vice President of Investor Relations. You may begin your conference.

Thank you. Good afternoon, and welcome to the Coinbase first quarter 2023 earnings call. Joining me on today's call are Brian Armstrong, Co-Founder and CEO; Emilie Choi, President and COO; Alesia Haas, CFO; and Paul Grewal, Chief Legal Officer. I hope you've all had the opportunity to read our shareholder letter, which was published on our Investor Relations website earlier today. Before we get started, I'd like to remind you that during today's call, we may make forward-looking statements. Actual results may vary materially from today's statements. Information concerning risks, uncertainties, and other factors that could cause these results to differ is included in our SEC filings. Our discussion today will also include references to certain non-GAAP financial measures. Reconciliations to the most directly comparable GAAP financial measures are provided in the shareholder letter on our Investor Relations website. Non-GAAP financial measures should be considered in addition to, not as a substitute for GAAP measures. We are once again using the Say Technologies platform to enable our shareholders to post questions. In addition, we will take some live questions from our research analysts. So with that, I'll turn it over to Brian and Alesia for opening comments.

Thanks, Anil. So I think it's always helpful to zoom out and remind everyone why Coinbase exists with our mission and vision. Our mission at Coinbase is to increase economic freedom in the world. We think crypto is the most important technology out there to do that. Many people today still think about crypto as an asset class that people like to trade, and that certainly is part of it. But it's actually a technology that can be used to update many different aspects of the financial system. We think that's really important because 80% of Americans believe the financial system doesn't work for them. They see issues with it, like it being too slow and too expensive with unequal access. A lot of the traditional financial system is running on outdated code with laws that, in some cases, are 100 years old. So crypto can help improve this. It can make payments fast, cheap, and global like sending an email. It can improve settlement times and reduce fees. It can even tokenize different asset classes to make markets more efficient and help with non-financial use cases like decentralized identity or voting and new ways for artists to monetize their content. Think of crypto as a technology to update the financial system, it's also kind of the next generation of the Internet, or what people are calling Web3. Coinbase has a crucial role to play as people's primary financial account in the crypto economy, making it trusted and easy to use, and we're hopeful we can bring the power of this technology to eventually a billion or more people someday. With that background, I just want to touch on two areas that are most relevant for Q1. The first is about how we've shifted the business to operate more efficiently in this down market by driving positive adjusted EBITDA in Q1. The second is about our impressive pace of product innovation, even in this down market. Let's talk about operating more efficiently. Q1 marked a real turning point in our financial performance. Revenue was up, and costs were down. Net revenue increased by 22% quarter-over-quarter, while we decreased total operating expenses by 24% quarter-over-quarter. The net result is that we had positive adjusted EBITDA in Q1. We're better positioned at Coinbase to generate adjusted EBITDA in all market conditions, as I mentioned on our last earnings call. To cut expenses by 24% quarter-over-quarter, we had to examine every investment we're making, every vendor we work with, and every dollar that goes out the door, including every headcount in the company. We asked ourselves how we could do more with less to be a more efficient company. We conducted a reduction in force in January and reduced costs substantially from our top five vendors by optimizing parts of our technology stack, such as data storage and CPU utilization in the cloud. We also reduced our real estate footprint to achieve additional savings. In general, we took a more scrappy approach with more nimble teams. All this was accomplished while maintaining a strong balance sheet of $5.3 billion in USD resources, and even with this efficient team, we shipped an incredible amount of product. Continuing on product innovation in the crypto space, we've been able to build many new things during this time. In just the last week, we launched our International Exchange to enter the derivatives space. We acquired One River Asset Management, which allows us to dive into the asset management business. I believe this could be an interesting source of subscription and services revenue over time. We also launched our Base Layer 2 solution, which is crucial for scaling blockchain. This will help unlock the next wave of crypto adoption. We introduced something called wallet-as-a-service, which is an important part of our offering and will help businesses integrate crypto custody into their services. So, while crypto goes through many cycles, the best companies, like Coinbase, tend to get stronger in down markets. This is the fourth crypto cycle we’ve been through, and we've emerged stronger after each one. We've built a resilient business by diversifying our revenue stream away from trading fees, and we're in a strong financial position with positive adjusted EBITDA in Q1. With that, let me turn it over to Alesia to discuss our financial results in more detail.

Thanks, Brian. I'm going to start with our market conditions and trading volume in the quarter. Average crypto market cap increased by 16% quarter-over-quarter. Meanwhile, crypto asset volatility increased by 8% quarter-over-quarter. It's important to note that crypto asset volatility remains at multi-year lows. Consumer trading volume grew in line with the overall U.S. spot market by 5% quarter-over-quarter. On the institutional side, trading volume was roughly flat as we intentionally focused on revenue over market share by removing certain discounts. We're pleased to show that trading volume through our prime application reached record volumes in the first quarter. Against this backdrop, we generated $736 million in net revenue, a 22% quarter-over-quarter increase, with revenue growth across the board. Transaction revenues increased by 16% quarter-over-quarter to $375 million. Consumer revenue grew by 14% quarter-over-quarter, and we increased trading volume in fiat to crypto faster than the market. Institutional revenue grew by 67% quarter-over-quarter, driven by our decision to roll back some aspects of our discounted pricing for certain market maker clients. Again, this is an intentional trade-off. Subscription and services revenue grew by 28% quarter-over-quarter to $362 million, which exceeded the high end of our outlook range. This growth was due to increases in market cap, primarily with Bitcoin and Ethereum prices and contributed better-than-expected revenue, particularly across staking and custody. We also saw growth in interest income, especially our USDC revenue, driven by higher interest rates. Switching to the expense side, as Brian shared, total operating expenses declined by 24% quarter-over-quarter to $896 million. This is the lowest level of expenses we've seen since Q1 of 2021. Included in this number are $144 million in one-time restructuring charges related to our January headcount reduction. Looking at recurring operating expenses, including technology, development, general and administrative, and sales and marketing, fees collectively declined by 37% quarter-over-quarter. Lastly, stock-based compensation declined by 54% quarter-over-quarter to $199 million. Combined, these results yielded a net loss of $79 million but we returned to positive adjusted EBITDA of $284 million. As Brian noted, we ended the quarter with $5.3 billion in USD resources. While corporate cash declined by $172 million quarter-over-quarter, this included $204 million in one-time items and we deployed $112 million towards our financing products. We saw inflows of custodial cash and crypto during the quarter, which we believe is a direct result of our trusted brand and ongoing commitment to risk management. To briefly touch on the bank failures in Q1, we maintained operational and risk excellence throughout the banking turbulence, experienced no loss of corporate or customer funds, and largely maintained business as usual operations. As of today, we've replaced lost banking services, rebuilt our layers of redundancy, and restored access to 24/7 instant settlement, which is essential for our market maker clients. Next, I want to discuss our outlook for Q2. Crypto market cap and asset volatility have diverged in Q2 compared to Q1. In April, we've seen average capital market cap up 17%, while volatility was down 25%. This dynamic is reflected in our April transaction revenue, which is approximately $110 million. Again, I need to caution investors not to extrapolate these results. We at Coinbase continue to run scenarios where crypto market cap could increase, decrease, or remain flat from these levels. I want to shift to the more predictable aspects of our business. We expect subscription and services revenue in Q2 to be around $300 million; this decline is largely driven by the USDC market cap, which fell 23% in April from Q1 average levels due to the banking crisis. For Q2, we anticipate technology and development and general and administrative expenses to be between $600 million and $650 million, and sales and marketing expenses to be between $80 million and $90 million. We expect higher general and administrative expenses due to increased legal expenses and a short-term increase in rent associated with lease termination. We also foresee some seasonal spending related to our NBA partnership to boost our sales and marketing for the quarter. We don't anticipate any significant changes to our headcount. Overall, I want to reiterate what Brian mentioned: Q1 marked a significant turning point in our efforts to operate a more efficient company. We're managing what we can control, and we are pleased with our execution and financial results. Anil, back to you for Q&A.

Great. Thank you both. So with that, we'll turn to shareholder questions. We're taking the most uploaded questions as determined by the number of shares, and we might combine some questions that touch on the same themes. So the first question is, is Coinbase planning to build a deck that uses Base, Brian?

Yeah. So for Base, if people don't know, Base is our Layer 2 solution that is helping scale the blockchains and allow developers to build different applications. We at Coinbase don't have any specific efforts to build a deck at the moment. Our main goal is to build the ecosystem and get Base from testnet to mainnet. I want to temper people's expectations a bit; Base is still on testnet, and we're still trying to build it out. I hope that in the future, people can build all kinds of things with it; that's one of many possibilities. This is a great example of the innovation we're doing right now. Base is a very on-chain, crypto-forward effort that is exciting to see come out of Coinbase. At the same time, we've been innovating in our centralized aspects like our international exchange entering the derivatives space. It's great to see this wide breadth of innovation happening in the company right now.

Next question from several shareholders: are we planning to move operations outside of the U.S.? What are the implications? Is Coinbase leaving the U.S.? Are we willing to fight tooth and nail before making a move out of the country? How are you thinking about the prospect of moving operations outside of the U.S. and the implications for U.S. customers, if you did? Brian?

Yes. Let me be clear, we're 100% committed to the U.S. I founded this company in the United States because I believed that rule of law prevails here. This is vital, and I'm optimistic about the U.S. getting this right. When I visit D.C., there is bipartisan support for Congress to create legislation that would establish a clear rule book in the U.S. It's important for America to get this right. Various other countries around the world, essentially all major financial hubs, are competing for the top spot in the crypto space. The rhetoric from the U.K., Hong Kong, Singapore, etc. differs, being more optimistic than the U.S. at this time. The EU has already passed comprehensive crypto legislation, putting them ahead. However, I genuinely believe the U.S. will get this right. We're a global company; we started in America, but we have a mandate to be multinational. We want to serve as many people as we can worldwide. We consider where to allocate our capital every year and look for the highest ROI. The leading financial centers are working to establish responsible crypto rules, and the U.S. will follow suit, I believe.

Next question: when is Coinbase expected to be a profitable company like PayPal or Cash App, Alesia?

Thanks for the question. When we went public, we shared that there is volatility in our business and that our performance had historically correlated with crypto asset price cycles. We have had periods where we've been net income positive and periods with net income loss. Last quarter, we talked about evolving the business to target positive adjusted EBITDA in all market conditions. We believe Q1 was a turning point where we can focus on lowering expenses and operating more efficiently. We're pleased to see our diversification of revenue, continuously investing in that direction. We're seeing these benefits from increased cost efficiencies. We've learned deep lessons from growing too quickly and believe we'll be prudent with our spending going forward. We believe this improved cost structure supports our goal of improving adjusted EBITDA year-over-year.

Next up, several shareholder questions regarding the SEC: if Congress doesn't pass any bill for crypto, how many years do you expect Coinbase to fight the SEC in court for clarity? Will Coinbase operate during that time? If the SEC rules that all tokens other than Bitcoin and Ethereum are securities, what would be the impact on Coinbase, and what plans do you have to protect stakeholders?

Let me start by saying we're committed to transparency about our engagement with all regulators, including the SEC, as much as we can. We want to share information with our customers, stakeholders, and investors as this process unfolds. Regarding the engagement itself, despite our ongoing discussions with the commission, they haven't clarified their specific concerns with Coinbase. Speculating on the timeline for any SEC litigation is hard, as it depends on the type of case and court schedule. Litigation could take a while. However, we fully expect to remain operational during whatever is needed to resolve the matter. The SEC itself doesn't get to decide which tokens are securities; that authority belongs to the courts. The SEC could initiate rule-making to establish standards to determine if a token is a security. We've consistently requested that clarity. Ultimately, these decisions will be made in a court of law. As this process unfolds, we will continue to seek regulatory clarity and support legislation beneficial to both Coinbase and the entire industry, which will ultimately protect the value and investments of all stakeholders.

Maybe I can jump in and discuss the business impact. We've proactively worked to identify and evaluate various scenarios and their impacts on our business in light of the Wells notice. Staking represents about 3% of net revenue, and Bitcoin and Ethereum account for the majority of our trading volume and transaction revenue. Just under 20% of our business is international. While this notice from the SEC is significant, we have various revenue streams we're looking to grow, and we're focused on revenue diversification. We're confident in our ability to operate through these scenarios and meet our financial objectives for the year, improving adjusted EBITDA year-over-year.

Combining a couple of additional questions: what new features are coming down the pipeline, and what's the product roadmap for the next five years?

I can take that one. We try not to preannounce things; we announce them only when they’re ready. I want to focus on how we envision crypto evolving. Initially, crypto started as an asset class for trading, leading to many launched features focused on trading in the spot market and derivatives, as you heard with our international exchange. The second phase of crypto adoption, we believe, will focus on crypto as a new type of financial service, updating the financial system. You’ve seen us launch products around commerce, global payments, staking, etc. Lastly, the third phase of adoption will involve crypto powering the future of the Internet—often referred to as Web3—which includes decentralized identity, voting systems, games, social media, etc. We aim to develop across multiple segments: retail, institutional, and developers. Our goal across all products is to provide trusted and easy-to-use solutions. Trust arises from compliance, cybersecurity, customer support, and design. We strive to be a trusted brand in this space and to make our products easy to use, similar to how people use electricity without understanding the complexity behind it. This is our framework for the product roadmap as we seek to drive utility in crypto and help increasingly large user bases access an open financial system.

So the final prepared question before we move to analysts: any update on crypto regulations?

The general update is that there's broad consensus among financial hubs that crypto is here to stay. It's not going anywhere, and centralized actors in crypto, like exchanges and custodians, must be regulated—common sense. There is a view that new legislation is needed for these centralized players to ensure crypto use is safe. The EU is ahead of the game with their comprehensive crypto legislation called MiCA, which creates a single clear rule book for the entire region. After my recent trips to the U.K. and D.C., I have noted the draft bills centered on stablecoins and market structure. Countries like Singapore, Hong Kong, Australia, and Brazil are following suit. I believe it's a mistake to think that countries must choose between keeping investors safe and embracing this next generation of technology. Even in the U.S., there is bipartisan support for new crypto legislation that protects investors and embraces this crucial technology for upgrading the financial system. Citizens are demanding it; approximately 20% of U.S. adults now own crypto, making it an important electoral issue. The U.S. may lag behind, but I'm optimistic about the direction we're heading. Coinbase is pushing a grassroots effort around crypto advocacy through individuals who want to advocate for sensible crypto regulation. We've launched initiatives like Crypto 435, with 40,000 sign-ups, to boost advocacy across all congressional districts. We've even minted over 100,000 NFTs for our Stand With Crypto campaign. In sum, crypto is here to stay, and every major market is moving toward adaptable crypto regulation.

Now let’s switch to live questions from the analysts.

Your first question comes from the line of Benjamin Budish with Barclays.

Hey, guys. Thanks for taking the question. Alesia, you talked about the divergence between volatility and market cap and retail engagement. I’m curious why Coinbase retail engagement hasn’t tracked crypto asset prices. It seems that trading yields show that simpler traders are more resilient than advanced traders. How sustainable do you think that is going forward?

Thanks for the question, Ben. Historically, our retail transaction volumes and revenues are highly correlated with volatility and crypto asset prices. While we've seen crypto asset prices rise, volatility remains at multi-year lows, which is a factor in the current volume change. However, we are engaging customers in new ways through our staking products and subscription services revenues. We're also excited about our record trading volume on the prime platform in the quarter. Market conditions are unpredictable but impact trading volume from our consumer side significantly. Our focus is growth and engaging customers through new product innovations.

Your next question comes from John Todaro with Needham & Company.

Congrats on the quarter and thanks for taking my questions. Two here, if you don't mind. First, what explains the increase in take rate? Second, how do you reconcile encouraging customers to move more on-chain whilst also competing with decentralized exchanges that may cannibalize Coinbase volumes?

Great questions. Regarding pricing, we regularly assess the pricing for different transaction types. For example, spreads apply to our simple trading experience but not to advanced trading, where customers interact with the order book. We don't have a specific target for spreads; we're assessing the right balance between meeting customer needs and driving our business, monitoring pricing elasticity to ensure we resonate with our user base.

Thanks, John. To address your second question on encouraging volumes to move to decentralized exchanges: I see a significant future for both centralized and decentralized exchanges, and Coinbase aims to operate successfully in both categories. Centralized exchanges have more scalability than on-chain networks, so they’ll continue to exist. Meanwhile, decentralized exchanges present advantages we want our customers to have access to as well. We don't benefit from denying the existence of decentralization. As long as we provide customer solutions, there will be opportunities for monetization on decentralized exchanges.

Your next question comes from Owen Lau with Oppenheimer.

Thank you for taking my question. There are positive developments on regulations, with more crypto bills potentially coming soon—the SEC responding to Coinbase's petition. Could you discuss how the current regulatory regime has impacted your ability to launch new products, both locally and internationally? How has it impacted your confidence in generating positive adjusted EBITDA in all conditions? Thank you.

Our product roadmap hasn't been impacted by the Wells notice. We're excited about our active Q1 product innovations, including launching our international exchange and acquiring an asset management firm. We're building through this winter and feel confident about our various offerings. Presently, we're functioning as usual and believe we can meet our financial goals this year, improving adjusted EBITDA year-over-year.

Your next question comes from Rich Repetto with Piper Sandler.

Good evening, Brian and team. I appreciate you taking my question. On Page 14 of the shareholder letter, you mention that real action on legislation may occur before the end of Q2. Can you provide further details on bipartisan legislation? Have you engaged the SEC since the Wells notice? Additionally, with the Ripple and XRP case, do you think it will set a precedent?

Regarding legislation timing, we can't predict precisely. However, various parties are motivated to establish a clear rule book in the U.S. We remain supportive of these efforts. Paul, feel free to add further comments.

To reiterate, we're seeing bipartisan legislative draft progress in the U.S. and abroad. While timelines are uncertain, progress seems promising, accelerating in various jurisdictions. We remain open to dialogue with the SEC, following the Wells notice. We are committed to defending any potential cases, as crypto as a whole needs clarity for future progress.

Your next question comes from Lisa Ellis with MoffettNathanson.

Thank you for taking my question. I appreciate the summary of your three revenue pillars outlined in the shareholder letter. Could you elaborate on how we should consider Coinbase’s revenues and investments now and in the future across that spectrum?

We are in the first phase—crypto as an asset class—where the majority of our revenue is currently derived. We're actively working to diversify revenue streams through products we've mentioned. We categorize offerings as core, strategic, and those in the interest portfolio. We don't disclose long-term outlooks, but we aim to grow diversified revenue streams over time. As we saw in Q2, subscription and services revenue now accounts for approximately 39% of total revenue. Many newly developed revenue streams have started to contribute, albeit in small amounts. While we can't provide specific numbers, our goal is to achieve a diverse portfolio to reduce dependency on any single revenue source and better engage our customers with various products.

Your next question comes from Kenneth Worthington with JPMorgan.

Hi. Good evening, and thanks for taking the question. Alesia, you mentioned that Coinbase increased spreads on retail trading. How are you determining the right spread for retail orders? What capacity do you have for widening spreads further? For Paul, how does Coinbase ensure that spread adjustments will be accepted by regulators?

We regularly evaluate pricing for different transaction types. For retail orders, spreads apply to the simpler trading experience and not to advanced trading, where customers engage directly with the order book. As we don't have a specific target spread in mind, we continually assess customer needs and business performance to establish the right spread, constantly monitoring pricing elasticity to see what best resonates with our users.

Regarding regulatory assurance, transparency is critical. We commit to being clear about how we operate and ensuring compliance with our terms of service and user agreements. We stay vigilant and ready to respond appropriately to any regulatory inquiries.

Your next question comes from Bo Pei with U.S. Tiger Securities.

Hi, management. Thanks for the questions. Congrats on launching the Base Layer 2 test. Regarding Base, what monetization model do you envision, or do you plan to make it a fully decentralized network? How do you manage risks of running a blockchain as a U.S. public company?

Thanks for the question, Bo. First, regarding monetization, it’s too early to say. Base is still in testnet, and we're primarily focused on building the ecosystem. We have deliberately chosen not to launch a token associated with the blockchain due to regulatory considerations as a U.S. company. We're hoping that Base will evolve into a decentralized chain over time; it's important that it's not solely run by Coinbase. Paul, do you want to add anything?

Brian articulated it well. This project will not be under Coinbase’s control in the long run, as the goal is decentralization. Importantly, we opted not to create a token, which we believe will be favorable as we build the platform.

Your next question comes from Devin Ryan with JMP Securities.

Thanks, everyone. Regarding the international derivatives exchange, could you comment on the addressable revenue market for Coinbase? How much existing infrastructure can be leveraged versus incremental expenses to achieve your goals? Thanks.

While we're not providing revenue outlooks yet, the derivatives markets typically outsize the spot markets in crypto, and they're substantial opportunities. This is our initial launch with two order books, and we’re in the early stages of onboarding market makers. We'll provide updates as the product grows. Expenses needed to operate this platform are part of our current expense base and reflected in our Q2 expense outlook.

Your final question comes from Joseph Vafi with Canaccord Genuity.

I wanted to circle back to your comments regarding financial enablement. Could you give some insight into your initiatives in that area? Also, what's your strategy regarding the Layer 2 rollout?

In my opening comments, I discussed our mission of increasing economic freedom through crypto. There are many people globally without access to good financial infrastructure, which holds them back. Making payments lower friction and allowing efficient settlement of tokenized assets can significantly boost economic potential. Beyond financial use cases, crypto also elevates freedom through property rights. It's immensely significant; anyone with a cellphone and internet connection can access reliable financial infrastructure, which is a powerful global change.

Great. Thank you all for joining us today, and we look forward to speaking with you again in our next call.

This concludes today's call. You may now disconnect.