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How a mature crypto market can hurt Coinbase profits

David Trainer, New Constructs CEO, joins Yahoo Finance to discuss Coinbase’s valuation as it sets to debut on the Nasdaq and competition in the crypto space.

Video transcript

BRIAN SOZZI: All right, let's stay on crypto and get after it on the Coinbase IPO. David Trainer is the CEO of New Constructs, and he joins us now. David, I liked your level-headed analysis on Coinbase. Why are you bearish on them?

DAVID TRAINER: You know, I think Myles is making a very good point. And I think there's an important distinction for the investing public to understand that there's a difference between a good company and a good stock. You don't have to believe that crypto is worth $2 trillion to believe that it's a good product. There's a big difference, right? I mean, you don't pay $5,000 for a pair of shoes, even though shoes are an important product. You got to have them. They're a staple of living in the world today.

So what we're trying to say here with the Coinbase analysis is that hey, this might be a good company. Crypto is probably here to stay. But I don't need to pay 10 times what it's worth in order to get in. Probably better to wait. And we've seen throughout the years, going back to the tulip frenzy, you know, several hundred years ago, that the price of an asset can often exceed its underlying value. Tulips are still around. We don't pay 1,000 bucks for a tulip bulb, right?

So, really, what we're saying here is that Coinbase is similar to what we've seen in other nascent industries, where an early adopter or early company in the industry gives an extraordinarily high valuation, and investors end up losing a lot of money, even though the product, the underlying product is going to be around for a while.

BRIAN SOZZI: Should be known that we're still waiting for Coinbase shares to open, but David, having said that, then, what is Coinbase worth, in your view?

DAVID TRAINER: I mean, I think it's closer to 5-- I think it's closer to $5 or $10 billion and as opposed to 100. You know, look, this is a-- a brokerage industry is not new, right? Coinbase isn't reinventing a wheel here in any way, right? They're just trading a new product. There's no reason that the New York Stock Exchange or NASDAQ, they couldn't also potentially trade crypto also. And by the way, margins in a mature brokerage industry are about, you know, 1/100 of a percent, whereas Coin is getting 46 basis points, right?

So the Coinbase model has margins that are over 40 times higher than their mature colleagues or counterparts. We don't think that's sustainable. We think everybody that can trade crypto is going to want to get in and get a piece of that. You'll see a race to the bottom in terms of margins, just like we saw in stock trading, which is now zero commissions. So, the idea that Coinbase would grow to have revenues 150% the combined revenues of ICE and NASDAQ, while also having margins that are 40 to 50 times higher, we just think that means it's expensive. Not to say it's a bad product or a bad company, it's just a little expensive right now.

MYLES UDLAND: And David, thinking about the path towards that compression on fees, if you look at the Stock Exchange, over time, it gets there. And we can go through the whole history of HFTs and the way that the exchanges were combined, some of those competitive forces. What gets Coinbase from their nice fat-- it's called round number-- 50 basis points per trade closer to the industry norm of a fraction of that? Is it pressure from institutions? Is it pressure from competition for their retail clients? How do you see that landscape for Coinbase?

DAVID TRAINER: I think it's all of it. I mean, I think they look around. And even I think individual investors who are any familiar with stock trading at all are going to say, why am I paying such a large fee? And then their competitors are going to say, look how much money Coinbase is making. We can go in and we can charge 40 basis points or 30 basis points, still make a lot of money, and steal market share.

And that process continues until margins get closer and closer to zero. But, you know, high margins invites lots of competition. This is sort of a law of nature, right? If someone's got a really profitable business and they don't have high barriers to entry, you know, you don't keep people from moving into that business. They come in, in droves, until those margins get competed away.

BRIAN SOZZI: Notable red flags, what are they?

DAVID TRAINER: That there aren't really any major barriers to entry, that there are a lot of competitors on the sidelines, already moving into the business, looking to IPO soon or two. And then I think you've got incumbents, large brokerage firms that have a great-- huge distribution advantage, huge customer advantage over Coinbase that could also look to trade crypto as well. So I think that this business model will be under attack in the not too distant future. You know, hey, also, a super, super high valuation doesn't hurt to attract competition. You get people coming in from all angles. But yeah, I think it's just the basic law of competition. Anybody who can will want to get a piece of this hugely profitable pie.

MYLES UDLAND: And then, David, I guess, thinking more broadly-- and you mentioned in your note a couple of the competitors that are already coming in on the crypto exchange space-- is there a possibility, at least as you see it, that because of the custody issues around crypto, some of the-- you know, it's different than a stock, making sure that you know what address you have, where you're keeping your addresses, who is in charge of all that, that's still a growing and, I think, in some ways, more challenging question.

Is it possible that crypto exchanges end up getting to a more expensive terminal value of 10 basis points, 15 basis points because of those other concerns? Whereas the stock market, with its daily liquidity, you know, that's why it's at 0, because we have massive players who are able to provide that kind of liquidity, such that fractions of pennies actually make good businesses?

DAVID TRAINER: Well, I mean, that's sort of, you know, a contradictory argument, I think. Look, if crypto never gets that big and companies can't get that kind of scale, then you're talking about a much smaller market. If you want to believe the crypto is going to be as big as stock trading, then you got to believe that the players will have the kind of scale that you see in stock trading. So you're sort of damned if you do or damned if you don't.

I personally think that, you know, the crypto trading in the blockchain provides a more efficient system for tracking ownership and tracking shares. It's a digital version. The two-day settlement thing in the stock trading world is what roiled markets with respect to the other meme stock frenzies. By the way, I think Coin is a meme stock. But the GameStop and AMC meme stock frenzy was-- a lot of that was related to the delay of the-- between the trade, the brokerage activity, and the settlement activity because so much of that is still manual, right?

And those are old school companies holding on to a manual business because some folks there are still eking out profits. That, I think, affects-- will eventually be digitized as well. Blockchain's already done that for crypto, in a lot of ways. So it's more efficient. And with a distributed ledger, you don't need the old school kind of manual processes that people have to charge more for, even if they're not making much money. So I think ultimately, crypto is a better way to go in terms of its ability to leverage the blockchain technology.

But I think what people often miss with respect to Blockchain is that this is a technology that is ultimately designed-- by virtue of how it was delivered to the world, right, it is designed for its value to transmit to the users, not to a few companies who are going to be gatekeepers to that technology. The blockchain is out there for everyone. And I think ultimately, the value of that technology transmits to the public, to society at large, not to a few companies who are going to be gatekeepers and try to earn outsized profits leveraging it.

BRIAN SOZZI: David Trainer, CEO of NewConstructs, good to see you this morning.

DAVID TRAINER: Thank you.