It would seem only the best and brightest of crypto entrepreneurs would be able to overcome a liquidity crisis in such short order.
Coinbase, perhaps even more than many, seems poised to get caught up in what is likely the largest cryptocurrency-fuelled asset bubble since 2013. At least that much we know for sure right now. But what will happen when it all unwinds?
As far as anyone can remember, this was supposed to be how things went down. As one top industry commentator told Bloomberg recently, the big players (like PayPal) were not going anywhere for quite some time. And I’m sure they haven’t, but it appears they have now joined the ranks of other companies being forced to deal with a massive collapse of investor sentiment when their own portfolios face unsustainable losses.
What happened at Coinbase wasn’t part of any particular theme or cause-and-effect chain of events. It was just an unfortunate coincidence in which the company had been caught up in something completely unexpected and inexplicable at the same time. Of course, there are a lot of factors involved here, including several years worth of investment research on this topic that never really made sense. Or at least didn’t make sense until a few months ago.
This article isn’t about what happened to Coinbase; it’s about why this happened and where we need to go from here. So let’s begin by looking back in history…
Why did Coinbase fail? And how did it all unravel so quickly? Let’s take a look at what led Coinbase into its current situation. Back in 2014, while still trying to navigate a somewhat complicated legal framework around Bitcoin, Coinbase launched its US$11 million Initial Coin Offering (ICO). Some people thought this project would help usher in an age of digital money — something with no clear path to profitability. They hoped it would become the gold standard of blockchain technology and a giant stepping stone toward full adoption. This hope seemed pretty reasonable: after all, if you could create utility for real world value through tokens backed by actual fiat currencies, then surely every organization with a presence on the planet could do the same via coin offerings?
But what Coinbase’s ICO failed to realise, or at least explain how it came to go pear-shaped, was just how risky cryptocurrencies are. Investors expected them to serve as both store of wealth and transfer value in some way. That promise turned out to be false because while most investors anticipated those benefits, most also expected great returns. One report found a median return of 27.8% in 2018 alone. It is hard to say exactly when Coinbase became disillusioned about this expectation, but certainly a lot later than expected. By 2019, investor enthusiasm had waned too. There were growing questions over whether cryptocurrency was actually a good investment at all.
It was then that Coinbase began taking notice. Instead of waiting out the downturn for six or even 12 months, CEO Brian Armstrong decided to pump $25 million towards improving the performance of Coinbase’s native token, USDC. He was well aware of the risks associated with investing in new markets, especially ones he knew would present a significant number of opportunities. But he was also hoping the problems wouldn’t start to affect his business so soon.
This strategy worked, although not without pain. When Coinbase needed cash, it often used leverage against itself: that is, to borrow money from a bank and lend it to another organisation. With USDC, however, the risk was largely mitigated. Its supply was tied to a fixed number of coins produced. However, the price of these coins fluctuated wildly from day to day. Every month, they either increased in value, or they fell. Because Coinbase had invested billions of dollars in USDC, it was always possible that – once again – the coin supply would exceed demand and prices would fall. If that was the case, though, everyone’s bets were off for Coinbase forever. Not only that, but because it was impossible to produce enough USDC to meet consumer demand, investors had to sell at extremely high valuations to recoup the debt. Even worse, if they sold at inflated prices, they had to pay interest. To put that in perspective, Coinbase was making about 5% in coupon payments on each bond issued. Those coupon payments accounted for about 10% or more of annualised revenue from bonds.
Ultimately, Coinbase lost money on USDC loans and suffered serious financial consequences. A report by BNY Mellon estimated that the company’s total combined liabilities totalled over $1b. What was even worse, though, was that the damage done was already complete just two weeks earlier: within nine days of receiving the first payment from the SEC, Coinbase was compelled to file for bankruptcy protection the very next day. Without question, the move proved fatal for the brand.
This crash was unprecedented in terms of scale and impact. Other large entities faced similar scenarios before, but none could go bankrupt like Coinbase in a matter of hours.
And, for those who don’t want me to go on to mention the specific details of what caused this debacle, let me mention some specifics. It started with an IPO in 2015 by Elon Musk’s firm SpaceX, whose stocks rose from roughly $0.03 in October to above $1.00 by November. These meteoric gains gave rise to fears that this type of market structure may threaten competition and stifle innovation, especially given the amount of capital required to create a product in the future.
The problem with startups raised by private founders is that they often lack funding from established corporations. Most typically, venture capitalists are willing to invest in publicly traded tech companies because they understand the potential that exists, rather than because they recognise the fact that most private equity funds simply don’t have as much money as they might be accustomed to spending. As Elon musk tweeted in response to the fiasco, this has become a self perpetuating cycle:
To be fair, though, the reason most private equity firms choose to invest in VC backed startups is more to do with reputation management than anything else. After all, it’s better to be seen supporting your competitor’s success at the expense of your own. Private equity investors simply aren’t interested in building products of equal quality as the public sector is. Hence the tendency of investors in the traditional space who are driven solely by profit maximisation to pursue investments based on perceived efficiency, productivity and speed. Their approach creates unnecessary friction between the parties involved in creating value and dilutes innovation and entrepreneurship.
If you look closely at some of these deals, you will find that the reasons investors invest in these types of ventures aren’t related to any of the fundamental issues of the sector. Rather, they are driven primarily by a desire to build relationships with leaders of companies they believe share their vision and values (often those holding public stock), improve their own bottom line and benefit from seeing others succeed. Once again, investors see themselves building a castle on sand instead of a rock. Perhaps this explains why we heard stories about bankers rushing to sign off on financing deals to allow the purchase of private rockets, but that aside, there’s no evidence the type of money flowing to private rocket developers is coming from the treasury of the United States government.
Now you may wonder why a huge institution like Coinbase would lend money to a group which seemed destined for failure. Why did a single person of immense prestige, influence, power, experience and integrity, decide to throw away hundreds of millions of dollars to try and bring another business into existence? Well, let’s not rush to conclusions at this point, nor should we. What we do know for certain is that investors tend not to make irrational decisions based on pure emotion alone; sometimes, it’s just plain dumb luck or sheer stupidity. We also know that the majority of American traders don’t even consider trading stocks, cryptocurrencies, commodities or commodities derivatives. Therefore, it’s safe to assume that the process behind Coinbase purchasing USDC, if indeed it was purely rational and thoughtful, it probably took place at least initially with sound reasons behind it. And yet, the narrative surrounding this saga becomes murkier. Just how does this phenomenon not fit into the bigger picture of cryptocurrency? Why doesn’t any of this logic justify something as massive and highly liquid as USDC?
This is a difficult question to answer. Maybe this is a lesson we shouldn’t learn the hard way. Perhaps this whole mess could have happened anywhere. Possibly nobody wants to admit to it because they might lose their job or receive hefty fines. Either way, perhaps the problem lies in a misguided understanding of how markets work, and the nature of our universe as a whole. All we can do in this instance is accept that Coinbase failed but didn’t break the law. Still, there is plenty we can learn from the episode. Here are some ideas:
1. Make sure that people are exposed to information on their favourite platforms and apps (and social media).
2. Focus on education, rather than selling you fancy “secrets”. You could always call yourself an expert on something else, but a little bit of knowledge can give you the edge. Also, you don’t really want somebody telling you everything. Everyone has opinions – even if they’re negative– and we all like to disagree and argue. Treat everyone respectfully, regardless of position. Avoid getting wrapped up in personality politics, and look out for patterns. Don’t waste valuable advertising space trying to sell us things we don’t necessarily need. Learn from mistakes, especially bad marketing. Yes, this is ultimately a sales pitch – but it needs to be kept honest, genuine and factual. Don’t focus on