Over 4 million shares: Why Cathie Wood's Ark Invest is so bullish on Coinbase stock

No asset manager has been more bullish on Coinbase stock than Ark Invest.

Coinbase went public on Nasdaq on April 14, listed under the ticker symbol COIN. Since then, Ark Invest has snapped up COIN shares on almost every single trading day.

The firm, whose CEO Cathie Wood was called “Wall Street’s hottest hand” earlier this year by the Wall Street Journal, has bought a total of nearly 4.5 million Coinbase shares, worth more than $1 billion at current prices.

Wood was crowned a star stock picker last year as her funds delivered eye-popping returns. Her two key funds — the Ark Next Generation Internet ETF and the Ark Innovation ETF — each delivered nearly 150% annual returns.

Ark’s COIN shares have been distributed across three exchange-traded funds (ETFs). The Ark Innovation ETF held nearly 3.2 million shares, worth more than $750 million as of June 1. The Next Generation Internet ETF had about 810,000 shares, worth nearly $192 million. And the Fintech Innovation ETF held more than 462,000 shares of Coinbase, worth nearly $110 million as of June 1.

Meanwhile, the stock itself has been dogged by volatility, and its price has fallen nearly 40% since it debuted on the market.

So why is Wood’s Ark Invest remaining so bullish on the Coinbase stock?

Core competency

When Coinbase went public, one of the messages that CEO Brian Armstrong delivered during media appearances was that the firm was on a trajectory to diversify its revenue — a counter to a common argument that the company is too dependent on crypto trading fees.

In the first quarter of 2021, trading fees formed nearly 94% of Coinbase’s net revenue. In absolute terms, the company's net revenue for the quarter was $1.6 billion, of which $1.5 billion was transaction fees revenue.

But Ark Invest likes Coinbase's core business of a crypto trading platform.

Coinbase’s position as a leading crypto exchange operator in the U.S. — it has more than 55 million users, and last month it handled more than $200 billion in trading volume — provides "an efficient derivative exposure" to the crypto market, Ark Invest crypto-asset analyst Yassine Elmandjra told The Block in a recent interview.

Elmandjra expects the crypto market to grow substantially over the next five years.

The current market capitalization of the crypto market is around $1.7 trillion. Over the next five years, it can gain "parity with gold," Elmandjra said. "So, around a $10 trillion market cap. And I think bitcoin could take at least half of that."

Along with the market cap growth, Elmandjra also expects crypto’s trading volumes to level out at around 100% year over year from its current growth of roughly 200%. He thinks Coinbase will continue to command between 10% and 15% share of global trading volume in the years to come. 

Coinbase will "ultimately scale proportional to the crypto market's market cap growth,” Elmandjra predicted.

The DEX factor

The crypto market is notoriously unpredictable, however. Few anticipated the explosive growth of decentralized finance (DeFi) protocols during the past year.

Blockchain-based decentralized exchange (DEX) platforms hosted more than $300 billion in trading volume in May, led by Binance Smart Chain-based PankakeSwap, which saw more than $155 billion volume, according to The Block’s Data Dashboard.

DEX volumes were 15% of centralized exchange volumes in May. One year ago, they were just about 1.5%, per The Block’s Data Dashboard.

While Ark acknowledges the competition from decentralized exchanges for Coinbase, it doesn’t seem concerned.

Elmandjra argues that in fact, DeFi could represent an opportunity for Coinbase, which is aiming to figure out how to be a DeFi onramp and service provider.

“Even if down the line, we are going to see decentralized exchanges take a majority of share, I think Coinbase is very well aware of that and it's going to position itself to be complementary to that service,” said Elmandjra.

But most importantly, institutional investors aren’t yet ready for decentralized exchanges, according to Elmandjra.

DEXs are “just nowhere near mature enough” for institutional investors, he said. Besides the lack of regulatory clarity around DeFi, the protocols also suffer from slippage, which is the difference between the expected trade and the price at which the trade is executed. Slippage on DEXs is “much, much higher on larger scale transactions,” said Elmandjra.

“We are still pretty far away from, say, a pension endowment fund getting their first exposure through a decentralized exchange,” Elmandjra said.

Beyond trading fees

While the competition from decentralized exchanges is real, Coinbase is making efforts to diversify its revenue into non-trading businesses such as prime brokerage and staking, with recent acquisitions of Tagomi and Bison Trails, said Elmandjra.

Indeed, Coinbase CEO Brian Armstrong also recently said that he expects the company's non-trading businesses, such as custody, staking, and debit cards, to account for 50% or more of the company's revenues in the future.

But that would take at least "five or ten years," said Armstrong. Ark has a time horizon of at least five years for its stocks, including Coinbase.

Greg Tusar, former Tagomi co-CEO and now Coinbase's VP for institutional products, recently told The Block that the exchange operator's prime brokerage business is growing. "The trades are in the 10s of millions now and much bigger," said Tusar.

Down the road, Elmandjra also expects Coinbase to serve as an "interesting settlement layer" to send value from any bank account in the world to any other.

If Coinbase were to enter the remittances market, it could be a valuable player, said Elmandjra, adding that he expects firms like Coinbase to take a significant share of that market. Leading remittance provider Western Union generated $5 billion in revenue last year.

Buying the dip(s)

Coinbase's stock has been trading down since its listing, but that clearly isn't a cause of concern for Ark Invest because it kept buying the stock even at dips.

According to Elmandjra, the stock is underperforming because early shareholders of Coinbase are taking profits and rebalancing their personal portfolios.

Another reason for the price fall is that broader tech stocks took a hit last quarter as investors "cycled into value from growth," said Elmandjra.

What would it take for Ark to sell COIN? “That's a very short-term question,” Elmandjra told The Block.

“If something were to happen, that would be something we'd assess as it happens rather than project what might happen,” he said. “The prospects of Coinbase over the next five years seem compelling enough.”

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