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By: Steve Sosnick, Chief Strategist at Interactive Brokers

I become a more popular guy when markets get crazy. I’m not complaining, mind you. I’d like to think that my years of experience trading stocks and options during bull and bear cycles allow me to offer perspectives that are a bit different that are more suited to volatile markets than those that prioritize chasing hot investments. For obvious reasons, many of the recent questions involved cryptocurrencies and the fate of Coinbase (COIN). 

I can’t get too in-depth with comments about a competitor (IBKR also offers cryptos), but let me start by saying that I think the COIN bankruptcy worries are a bit overblown. I’m not taking bankruptcy completely off the table – every company has some risk of bankruptcy, no matter how low — but their recent disclosure doesn’t mean it is more likely today than it was last week. All companies need to disclose all sorts of potential low probability/high outcome events in their corporate filings, and it would surprise me in the least if COIN was relatively lax in its prior disclosures and playing catch up now. It also sounds very scary that customers could be wiped out in a bankruptcy scenario, but that happened to many Bear and Lehman customers as well – at least those with more than the SIPC limit. This is the flipside of extolling the freewheeling, unregulated nature of crypto. People tend to like deregulation on the way up and regulation on the way down.  

As for their earnings and what went wrong – the bloom is coming off the crypto rose, and a company like COIN is especially exposed to that. Again, that was a benefit on the way up, but a problem on the way down.COIN is a company that is dependent upon transaction fees in a specific product space. As that product declines in value and fewer transactions are processed, that hurts COIN’s revenues. Plus, there is fee compression in their space. There are cheaper alternatives to COIN (*coughs* like IBKR *coughs), so as the industry matures, they face tighter margins that are not being offset by sufficiently higher volumes.

Unfortunately for COIN investors, the market is punishing unprofitable companies. After being rewarded handsomely for showing exceptional earnings in the past four quarters, they are getting pummeled for their most recent miss.  We recently discussed the problems involved when growth stocks no longer show growth or actually shrink.  In this respect, COIN is now part of a large club that includes Amazon (AMZN), Netflix (NFLX), Carvana (CVNA), Peleton (PTON), and many more

As for crypto overall – I was fairly consistent in drawing parallels between the crypto craze and the internet bubble at the turn of the century. In August, we posed this question: “Blockchain : Internet :: Bitcoin : ?” My answer was Cisco (CSCO), which was a backbone of the internet, just like bitcoin was blockchain’s proof of concept. The unfortunate part of that parallel is that CSCO was unable to top its 2000 peak until the end of 2021. In February, we asserted that the numerous crypto ads during the Super Bowl were reminiscent of the internet ads that peppered the 2000 event. And now, the collapse sadly seems to echo the market events of 2000 as well.

Like crypto, the internet was generational – twenty-somethings figured it out first, then the masses followed. Despite the fact that the wildest early predictions about the internet largely proved true, only a small fraction of the late ‘90s winners proved to be profitable over time. The same seems true about blockchain and cryptos. Twenty-somethings figured it out first, and I have no reason to doubt that blockchain will ultimately prove to be a useful methodology, I’m afraid however that we will look back at the glut of secondary coins, oddball NFTs, and untested Web3 promises with a similar view. Cryptos benefitted enormously from the easy-money post-Covid environment. If real interest rates are negative and the government is heading out free money, why not take a flyer on crypto? And this goes for the venture capital funds that backed all sorts of schemes – some sensible, some dubious. But Federal Reserve tightening is forcing all types of investors to reassess risk vs. reward. Non-economic cryptocurrencies are suffering the fate as stocks in companies that don’t make money. 

Every financial innovation faces its day of reckoning. This is crypto’s. How it ultimately fares remains to be seen.                                                                           

(Btw, over the past two years, Bitcoin is still up about 3X, and Ether up about 10X. The early adopters are still doing great. The latecomers, not so much.)