Notes 7/18: Problems at Coinbase and Binance

Bitcoin price has stalled this quarter but Coinbase has already won big. Shares for the cryptocurrency exchange, one of the biggest in North America, have jumped by 90 percent in the last month, lifting their price to $105.81 this morning.

Coinbase investors pushed up its stock because they are supposed to be enthused about two recent crypto-related developments that involve the company. First, a spate of spot bitcoin ETF filings named Coinbase Custody as its custodian, indicating a possible future revenue stream for the company.

Second, a recent ruling by a New York court sowed ambiguity in the status of crypto tokens listed at exchanges. A decision categorizing the tokens as securities would have forced Coinbase to delist them and strengthened the Securities and Exchange Commission’s (SEC) case that it was offering “unregistered securities” on its exchange.

Both developments are a temporary respite for crypto. The SEC has not indicated that an approval, after unremitting rejections, of a spot bitcoin ETF is possible. And the agency is likely to appeal the ruling, meaning the regulatory clarity that Coinbase is demanding in a suit against it, is still some time away.

In fact, analysts at Berenger write that the New York ruling puts Coinbase’s Earn program in jeopardy because it clearly states that offering of tokens to institutional investors with the promise of a yield is a security. Coinbase has already shut down its staking program in four states after the ruling.

Fees and Interest Income

The situation does not look too good for Coinbase’s second quarter results.

The company’s revenues were mainly driven by transaction fees and interest income in the first quarter of 2023. Both are expected to fall in the second quarter. While the first quarter witnessed a 70% bump in bitcoin price, the cryptocurrency has eked out a gain of only 8% in the next one. Translated this means lower volatility, fewer traders, and less transaction fees.

The Fed’s interest rate hikes boosted interest income for the company last quarter from Circle’s USDC. But USDC’s overall market capitalization has fallen from $32.5 billion to $26.9 billion. This means there are fewer USDC tokens in circulation and less income from treasury securities.

About the only silver lining in the darkening cloud of crypto markets over Coinbase is its side chain Base. Base is a layer 2 solution on Ethereum that will roll up transactions into batches for confirmation on Ethereum. The chain moved out of the test phase last week and its main network was launched last week to developers. It is expected to become a future source of revenue.

A Sale by Funds

Analyst reports predicting a bright future for Coinbase helped pump stock price for Coinbase. Investors might have done well to take note of actions by funds, who are some of the largest holders of Coinbase stock, from Cathie Wood. ARK funds sold $50.5 million and $12 million worth of Coinbase stock after the recent rally in its prices, signaling a possible slump ahead. Coinbase reports earnings on August 7.

Binance’s Reckoning

While they are mounting, Coinbase’s problems pale in comparison to those of its rival Binance.

The declining market capitalization of cryptocurrencies has unleashed a veritable tsunami of complications in its operations. It had the steepest drop in trading activity, almost 70%, during the second quarter even as Hong Kong opened its doors to cryptocurrency businesses.

Other exchanges based in Asia have garnered share at its expense. For example, Bybit’s share of trading volumes increased from 1% to 8% and OKX surged to 13% of the overall trading volume in June.

Binance is also reported to have laid off 1,000 employees in the last month. [Those figures, however, must be evaluated skeptically since Binance has never publicly disclosed its financials]. The exchange is under a regulatory siege in multiple jurisdictions. And its senior executives are leaving the company.

Accompanying these problems is the rise of TrueUSD (TUSD), a dubious stablecoin that the exchange is promoting as a replacement to its earlier native stablecoin BUSD. TUSD has already lost its peg once and almost all of its trading volumes occur on Binance.

The BNB Problem

However, the biggest problem at Binance currently is that relating to its native token BNB. The Securities and Exchange Commission (SEC) filed a case against the exchange in June, alleging that BNB was a security. [They are correct].

Binance’s financials are a black box. But we do know that BNB accounts for a significant chunk of the exchange’s so-called Proof of Reserves (PoR). The token’s characteristics are similar to those of FTT – FTX’s native token. It was a fire sale of FTT tokens by Changpeng Zhao (CZ), Binance’s CE, that kickstarted FTX’s crash. A similar script is playing out at Binance. Investors have already begun shorting BNB. The question is when will Binance capitulate.

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