A few days ago, I wrote about how “[i]f you are an exchange, your core business is essentially getting people to trade more.” Another saying that we’ll surely reference later is “equity markets reflect hope — bond markets reflect trust.” This will be the subject of a future essay on debt, but the point remains that the best barometer of what the market thinks a business’ future prospects at sustaining itself are is reflected by the levels their debt trades at, because that is what the business has to repay first. And boy, COIN’s debt does not look good:
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Issued in September 2021—when bitcoin traded at nearly triple its current price—Coinbase’s 3.375% unsecured bonds due in 2028 changed hands Thursday at around 56 cents on the dollar, according to MarketAxess.
Equity investments are based on prognostication — you think that the future forward earnings of the company will be markedly increased compared to its current day earnings, so you invest. Debt investments are loans — I gave you money to grow your business, so you better pay me back with what you earn over time. It’s the difference between giving your buddy $1k so he can drop-ship some fidget spinners to resell versus loaning your buddy $1k so he can pay his bail from the drunk tank to make work the next morning. The terms of repayment differ — one facilitates equity, the other facilitates debt.
You’d think that with the collapse of one of the largest crypto exchanges in the world, Coinbase would benefit from the turmoil, as the volume would have to redirect somewhere. (Of course, this would depend on people being able to get their money out of the exchange, to some extent.) But even though Coinbase is audited stringently and their financials are heavily documented, when a large chunk of depositors lose faith in the industry, everyone suffers. This was a core tenet of Ben Bernanke’s research on contagion: if one bank is struggling, why wouldn’t the others? This is why a prerogative of the TARP program in 2009 was to not specify which banks were receiving TARP stabilization so as to not terrify the public. (Spoiler — it was basically all of them.)
What this debt movement tells me is that the market expects crypto trading volume to be low going forward. And this makes sense! At least one major market maker and lender are facing troubles, and contagion is leading to bankruptcies everywhere. Furthermore, most bitcoin whales hold their wallets in cold storage and don’t actively trade. Is it any surprise that liquidity is thin across exchanges and people don’t really want to trade?
Coinbase has a bit of a unique model for what is essentially a brokerage in that they don't lend your deposits, meaning that if you put $100 in, it sits there. If you use that $100 to buy bitcoin, of course, they will take a fee. And they will continue taking fees every time you exchange your holdings from one denomination to another. But this differs from, say, a brokerage like Schwab, where your holdings accrue interest or are lent out (to some extent) for income. Coinbase is secure, but if volume goes away, as a custodian, their business is worth nothing.
A bet on COIN stock or debt is a bet that volume comes back to crypto. And, like we were talking about the other day, this requires a catalyst. Without one, you’re at the whims of market beta. Crypto simply doesn’t have the automated inflows that the stock market benefits from, what with 401k contributions, pension fund accrual, and other essentially mandatory inflows that contribute to the upward bias of the stock market. Crypto’s greatest power is narrative (and low interest rates), and until it’s somehow reclaimed from the current FTX drama, I don’t see how trading volumes recover anytime soon. Of course, Coinbase has some time to prove itself, being in a very cash-positive situation compared to other ZIRP companies:
The company had $5 billion in cash and cash equivalents as of Sept. 30, thanks in large part to its success before 2022 and its opportune bond sales last year, which raised billions of dollars at minimal cost. Its nearest-term major debt maturity, assuming it doesn’t convert to stock, is a $1.4 billion issue of convertible notes that isn’t due until 2026. Its $2 billion in unsecured conventional bonds, due in 2028 and 2031, comprise effectively all of its remaining debt load.
You can throw all the quant models at this trade as you would like, but what it boils down to is — do you believe crypto keeps trading or dies out? Take your pick. To me, the bull case for Coinbase depends on the adoption of ETH — as the coin with the most broad utility, if it can retain bid, so can COIN.
Take Another Little Piece of my Heart
I don’t think I need to document how the entire crypto sphere has essentially been relearning the lessons of “traditional” finance that we’ve experienced over the past centuries. But, boy, a massive smile broke out on my face when I saw that the FTX insolvency outsourced OTC distressed debt trading to the internet:
Thomas Braziel, the founder of 507 Capital, who has been active in past crypto bankruptcies, says he’s currently seeing claims being sold “between 5 cents and 8 cents on the dollar” in private offerings.
Far from just involving professional investors, it’s straight up involving telegram groups:
I must admit, truly more and more facets of finance are democratizing as a result of all this nonsense. Absorbing creditor claims and making a calculated assessment of what the payout will be to which level of debt down the road is usually the matter of litigants and professional investment firms. But there is a realistic chance that a lot of these claims could be worth multiples of what’s being offered! (Years from now, but still.) The legality of pursuing it through this channel, of course, is a little suspect, especially given the jurisdictional battle that’s going to happen between Delaware and Bahamian bankruptcy court. Interestingly enough, this all takes places on-chain as well — I am genuinely astonished at the depth of financialization in this ecosystem.
Shaky Ground
A couple days ago, I talked about Grayscale, the GBTC discount, and the relationship between the various subsidiaries of DCG. Well, here’s some topical news:
Cryptocurrency lender Genesis was seeking an emergency loan of $1 billion from investors before it told clients it was suspending redemptions this week… A confidential fundraising document viewed by The Wall Street Journal states that Genesis needed access to the credit facility by 10 a.m. Monday, citing a “liquidity crunch due to certain illiquid assets on its balance sheet.” The firm didn’t get the money.
A constant question when it comes to crypto “liquidity” crises is whether the problem is liquidity or solvency. A liquidity crunch implies that the company is good for the liabilities but for the fact that they simply aren’t able to be paid in the short term. Think of this scenario as too many people clamoring for their money back too soon — you’ve lent it out, you’re good for it, but you just need to be paid back and weren’t expecting to pay out so soon. A solvency issue, on the other hand, is if you don’t have the money to pay back the people demanding their money back. It’s like if you took in money, bought a bunch of Beanie Babies (or FTT or SRM…) with it, and can’t liquidate them for enough money no matter what kind of strings you pull to pay off your debt. Keep in mind that Genesis has already received a $140 million cash infusion from its parent company after it revealed that it had $175 million trapped on FTX. Could we be seeing footsteps to a mass liquidation of Grayscale’s various trust assets (which range up to ~$13 bill of BTC and ~$4 bill of ETH)? Ironically enough, I think the GBTC spread relative to its NAV that I referenced would collapse if it did end up liquidating. As correlated instruments sell off, their corr goes to 1, and it’s likely that BTC would sell off more rapidly than GBTC. I dunno, food for thought, not financial advice. Until I see some bidders enter the market, I can’t help but turn my mind to these scenarios. Stay careful out there.
On another note, I’m trying to use Twitter more! Throw me a follow:
