The SEC approved nearly a dozen spot Bitcoin ETFs on January 10 in what was heralded as a “watershed” moment for the crypto industry, opening the door for investors to gain exposure to Bitcoin without directly holding it. It’s widely expected that this approval and subsequent widespread access for institutions and retail investors will shape up to be one of the most bullish fundamental moments in Bitcoin’s history.

We have been anticipating this moment since 2019 when we stated: “One of the biggest hurdles for institutions, however, is not the idea of a world run on digital currencies, but rather the decentralization concept and the need for cryptocurrency storage. Institutional investors need to know the assets are secure, insured, and under the care of a trusted third party, per SEC rules, which requires advisers to keep client funds with a qualified custodian.”

With a first batch of spot BTC ETFs approved, it’s prudent to assess the potential impact to exchanges and platforms, given that exchanges will now be competing on fees with ETFs, while increasing BTC prices and the next halving serve as potential tailwinds for miners.

Trading Volumes Have Declined Significantly for Coinbase, Robinhood

For exchanges and trading platforms, such as Coinbase and Robinhood, that allow direct ownership of Bitcoin and other cryptocurrencies, the ETF approval serves as a double-edged sword. The bull thesis is centered around how the approvals will help usher in a wave to new all-time highs for Bitcoin, and how that could translate into higher transaction revenues (which have declined significantly), while the main headwind and primary story is that the two may now be forced to compete on fees in the long run, which can keep transaction revenues depressed as trading volumes remain far below peak levels.

Coinbase has expressed no desire to change its fee structure to compete with ETFs in the immediate term, per President and COO Emilie Choi’s remarks in its Q3 earnings call:

Q: “Will Coinbase consider reducing transaction fees to make them more competitive with other platforms where ETFs are being traded at significantly lower prices?”

A: “We have no current plans to reduce transaction fees because of ETFs. If you just zoom out a little bit, spot ETF should be a positive catalyst for the entire crypto space. They should add credibility to the market, and we should see increased liquidity and market stability as we’ve seen with other asset classes such as gold.”

Choi’s answer hinted towards a potential headwind to Coinbase’s model – market stability. Coinbase noted that in Q3, “crypto asset volatility, a driver of our trading business, continued to decline, and it reached levels that we haven’t measured since 2016.”

A majority of Q3 witnessed little to no volatility in Bitcoin prices – August saw one decline of more than (10%) and a 6% rise, but aside from that, prices were relatively stable. Volatility heightened in October as Bitcoin broke the $30,000 mark and ascended towards $35,000, while the remainder of Q4 witnessed relatively heightened volatility as well.

Due to stable crypto prices, Coinbase’s trading volume dipped more than (17%) QoQ and (52%) YoY to $76 billion in the quarter, while transaction revenues declined nearly (12%) QoQ and (21%) YoY to $289 million.

Heightened crypto volatility is a primary driver of Coinbase’s trading business, so periods with less volatility, i.e. stability, correlate to lower trading volumes and transaction revenues. Coinbase noted that its October transaction revenue was $105 million (around 9% higher than Q3’s monthly average), but cautioned investors not to extrapolate that figure for Q4. If you do extrapolate that sum, Q4’s transaction revenues would fall between $310 million to $320 million, signaling flat to a low single-digit YoY decline in transaction revenue despite an ~80% rally in Bitcoin.

In a broader view, both trading volume and transaction revenue have declined significantly since peaking in Q4 2021, when Bitcoin made a round trip from $47,000 to new highs above $64,000 before pulling back to $47,000. Trading volumes in Q3 were nearly (83%) lower than Q4 2021, at $76 billion compared to $547 billion.

Transaction revenues similarly are down more than (87%) since then, with five straight quarters below $400 million. Transaction revenues accounted for more than 46% of Coinbase’s total revenue in Q3, so there is heightened risk to Coinbase’s model now that a fee-competitive asset class exists, as it may potentially draw away trading volume and thus transaction revenue via lower fees.

Monthly transacting users have also declined (40%), from 11.2 million in Q4 2021 to 6.7 million in Q3 2023, with the decline accelerating over the past two quarters.

These trends in trading volumes and transaction revenues are not exclusive to Coinbase, as Robinhood is reporting similar weaknesses in both metrics.

Robinhood’s notional crypto trading volume was ~$6.8 billion in Q3, a (25%) QoQ and (53%) YoY decline. Since Q4 2021, trading volume has fallen (85%), interestingly nearly the exact percentage drawdown as Coinbase.

Transaction revenues peaked in Q2 2021 for Robinhood at $233 million, before plunging to $51 million the next quarter; unlike Coinbase, Robinhood did not see a second higher peak in transaction revenue. For Q3 2023, Robinhood reported $23 million in transaction revenue, representing a (26%) QoQ and (55%) YoY decline; unlike Coinbase, crypto transaction revenues are under 5% of Robinhood’s total revenue, so there is less risk from ETFs, as investors could choose to invest in the ETFs directly on Robinhood’s platform.

Robinhood hinted that it is more willing to be competitive on fees, saying that it rolled out some UI changes in Q3 so its crypto customers “can clearly see the spreads that we offer on our crypto transactions. This makes it easier for customers to see their all-in cost of execution, compare it against other platforms and see how great of a deal Robinhood is giving them.” By focusing on offering a better deal than competitors, Robinhood is potentially limiting upside to transaction revenues via a lower average fee – its average fee rate in Q3 of 0.338% was more than 10% lower than Coinbase’s average fee rate of 0.380%.

With a basket of ETFs now approved, Robinhood and Coinbase will have to compete on fees, as certain classes of investors are likely to choose ETFs over directly holding crypto for exposure due to trust. In just the first week after the approval of the ETFs, we’ve seen strong demand for top of the class funds: BlackRock’s iShares Bitcoin Trust has surpassed $1 billion AUM in its first week, a rare milestone that few ETFs share.

This is the first major speed bump for the bull case – how Coinbase and Robinhood can find ways to drive trading volumes higher, while maintaining higher fees than ETFs, to drive an inflection in transaction revenues.

Retail trading accounts for more than 95% of Coinbase’s transaction revenue while accounting for less than 15% of trading volume – this suggests that to drive a meaningful uptick in transaction revenues, Coinbase will need to see strong growth in retail trading volumes. More volatile Bitcoin prices, or a run to higher highs, can serve as a catalyst for higher trading activity; however, Coinbase holds the view that the ETFs will lead to more stability in the market, meaning more investors may choose to buy and hold with less active trading.

Custodial Fee Benefits & Risk for Coinbase

The ETF approvals offer one direct benefit to Coinbase, in that it stands to earn custodial fees by serving as the custodian for 8 of the 11 approved ETFs, including the most popular of the class, the iShares Bitcoin Trust.

Coinbase will be providing custodial, trading and lending services to the ETF issuers, giving it a stream of revenue via fees for these services, but opening up the door to a significant concentration of risk. Custodial fees currently account for ~2.5% of Coinbase’s revenue at less than $16 million in Q3, leaving opportunity for significant growth via ETFs – however, impacts from ETFs will not be visible until Q1 earnings, given the recent launch date.

Serving as the sole custodian for more than three-quarters of the approved ETFs heightens risks to investors, as a security compromise, hack or other operational failure on Coinbase’s part could significantly impact the ETF’s value or increase difficulty in accessing funds.

A multi-custodian approach helps safeguard investor assets by reducing the dependency on a single entity for providing all of the necessary services for an ETF to function. Therefore, it is likely that these ETFs, and other approved ETFs, will diversify away from relying on Coinbase as a sole custodian to having multiple custodians. This could reduce custodial fees should Coinbase lose its status as custodian for more than 75% of spot Bitcoin ETFs.

Conclusion

The approval of the spot Bitcoin ETFs is expected a game-changer for crypto, as it is widely believed that the approval and subsequent widespread access for institutions and retail investors will shape up to be one of the most bullish fundamental moments in Bitcoin’s history.

To attempt to size the demand the ETFs may create, Grayscale has $18 billion assets under management, and iShares has surpassed $1 billion already. If we assume over the long run that these Bitcoin ETFs average $5 to $8 billion AUM, this could add an additional $55 to $90 billion in demand for a limited supply of Bitcoin. As a reminder, Bitcoin is limited to 21 million Bitcoins and the next halving occurs in 2024. Halving can lead to a higher value for Bitcoin as it reduces the number of new bitcoins being generated by the network.

A push to new all-time highs for Bitcoin sits at the core of the bull thesis for crypto platforms such as Coinbase, as higher prices theoretically would lead to higher volatility and thus higher trading volumes and higher transaction revenues. Even with Bitcoin’s 80% push back to the high $40,000 level, Coinbase’s clues suggest that transaction revenues may not meaningfully accelerate in the high-teen to low-20% range.

Given this substantial decline in trading volume and resulting declines in transaction revenue for both Coinbase and Robinhood, the bull case centered around ETF approval ushering in strong revenue growth is weakened. There are many moving parts with how the ETFs will alter the crypto landscape, but unless both platforms witness trading volume more than double over the next few quarters, it is hard to see how this creation of a fee-competitive environment can serve as a tailwind to revenue growth over the short to medium-term.

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