Coinbase

by Brett Tejpaul, Head of Coinbase Institutional, and Elke Karskens, Head of EMEA Marketing

We recently won the Best Prime Broker Award in Hedgeweek’s annual European Digital Assets Awards. This success not only underlines the strength of our platform and our integral role within the cryptoeconomy, particularly in terms of further enabling institutional engagement, but also celebrates the incredible talents of our amazing team here at Coinbase.

Over the past three years we have seen widespread adoption of cryptocurrencies across the world. Coinbase now has over 13,000 institutional clients as of March 2022, including a wide range of banks, introducing brokers, pension funds, corporates, hedge funds and asset managers.

Increased adoption of crypto assets by institutional investors follows the wider trend of the asset class becoming more mainstream, underpinned by a belief in the range of benefits that can be unlocked.

The largest and most sophisticated hedge funds in the world have collectively decided that Coinbase offers the best crypto Prime Broker platform because of its extensive product suite and depth of experience in the sector. Our clients trust us as the largest crypto custodian that also combines multi-venue execution capabilities with a strong balance sheet to enable prime financing. Most clients also take advantage of our full suite of services that is completed by best in class data and analytics and staking directly from cold storage. The robustness of our operations is reinforced by our listing on NASDAQ and validated by the fact we are authorised and regulated by the New York Department of Financial Services.

As a market leader we will continue to work with individuals and other stakeholders in the wider financial and political world to shape policy to create a safer and more efficient financial system that’s accessible to all.

We would like to take this opportunity to publicly thank Coinbase’s entire institutional team for their hard work and dedication through an ever-shifting macro environment. We’re just as passionate and hungry as we’ve always been, and will continue to cement our position as the leading prime broker and digital asset custodian supporting institutions of all kinds in their engagement with the world of cryptocurrency.

Coinbase wins Best Prime Broker Award was originally published in The Coinbase Blog on Medium, where people are continuing the conversation by highlighting and responding to this story.

By Paul Grewal, Chief Legal Officer

Tl;dr: Coinbase does not list securities on its platform. Period.

We have said it before, but given today’s events, it bears repeating.

Earlier today, following a Department of Justice (DOJ) investigation into a former Coinbase employee’s misuse of confidential Coinbase information related to listing decisions, the Securities and Exchange Commission (SEC) separately filed securities fraud charges against this individual related to this wrongdoing. The SEC alleges that nine digital assets involved are securities. The DOJ reviewed the same facts and chose not to file securities fraud charges against those involved. As CFTC Commissioner Caroline Pham stated, this is “a striking example of ‘regulation by enforcement’” by the SEC.

We agree with Commissioner Pham and, respectfully, 100% disagree with the SEC’s decision to file these securities fraud charges and the substance of the charges themselves. Let me explain why.

Seven of the nine assets included in the SEC’s charges are listed on Coinbase’s platform. None of these assets are securities. Coinbase has a rigorous process to analyze and review each digital asset before making it available on our exchange — a process that the SEC itself has reviewed. This process includes an analysis of whether the asset could be considered to be a security, and also considers regulatory compliance and information security aspects of the asset. To be explicit, the majority of assets that we review are not ultimately listed on Coinbase.

We cooperated with the SEC’s investigation into the wrongdoing charged by the DOJ today. But instead of having a dialogue with us about the seven assets on our platform, the SEC jumped directly to litigation. The SEC’s charges put a spotlight on an important problem: the US doesn’t have a clear or workable regulatory framework for digital asset securities. And instead of crafting tailored rules in an inclusive and transparent way, the SEC is relying on these types of one-off enforcement actions to try to bring all digital assets into its jurisdiction, even those assets that are not securities.

Just this morning (and with no prior knowledge of the timing of the charges discussed), Coinbase filed a petition for rule making with the SEC calling for actual rule making so the crypto securities market has a chance to develop. We worry that today’s charges suggest the SEC has little interest in this most fundamental role of regulators.

But in the absence of a concrete digital asset securities regulatory framework from the SEC, we remain confident that Coinbase’s rigorous review process keeps securities off Coinbase’s platform. We remain eager to share our perspective with the SEC, especially through a formal rule-making process desperately needed.

Coinbase does not list securities. End of story. was originally published in The Coinbase Blog on Medium, where people are continuing the conversation by highlighting and responding to this story.

TL;DR:

• Coinbase filed a petition asking the SEC to begin rulemaking on digital asset securities.
• The existing rules for securities just do not work for digital assets.
• Our petition calls on the SEC to develop a workable regulatory framework for digital asset securities guided by formal procedures and a public notice-and-comment process, rather than through arbitrary enforcement or guidance developed behind closed doors.

By Faryar Shirzad, Chief Policy Officer

Today, there is a robust crypto market in the U.S. That market includes thousands of different digital assets, crypto companies, and decentralized financial products, and is regulated at every level of government, including by multiple federal agencies in the United States. Yet despite the growth that has happened in recent years, close examination reveals a glaring deficiency in this market. Even with billions of dollars invested toward crypto innovation, and the passage of more than 13 years since the introduction of Bitcoin, there is still no meaningful crypto securities market in the United States.

Many factors can positively influence how a given market develops, but when it comes to crypto securities there is a significant, foundational hurdle that has prevented that market from maturing. That hurdle is the fact that the securities rules simply do not work for digitally native instruments. They don’t work for tokenized debt. They don’t work for tokenized equity. They don’t work for crypto. And that’s a major problem.

The consequence is that the United States is falling behind in digital asset innovation. Most of the digital assets traded today have the characteristics of commodities, and in many instances, were specifically designed to avoid the securities laws. In other words, as the crypto market develops, it is deliberately steering clear of the securities market — one of the principal financial markets in the United States. At Coinbase, we believe that digital asset innovation offers a number of profound, market-enhancing benefits — like real time settlement, the ability to trade safely without needing to go through costly intermediaries, and a transparent record of all transactions. But the full weight of those benefits will not come to pass if they are excluded from a market as big and impactful as the securities market.

Crypto assets that are securities need an updated rulebook to help guide safe and efficient practices. Crypto assets that are not securities need the certainty of being outside those rules. Anything short of that will have the effect of entrenching incumbent technologies at the expense of innovation and ultimately, consumers. That’s why we have submitted a petition to the SEC to request that it develop rules that work for digital asset securities. Here’s a little more on the problem as we see it, and how we hope to work toward a solution:

The Problem

Modern securities law was put into place by the Securities Act of 1933 and the Securities Exchange Act of 1934. The most well-known securities are stocks and bonds, but most other assets that are considered securities are classified as such because they are “investment contracts” or “notes.” The Supreme Court set forth how to determine whether an asset is an investment contract or note in SEC v. W.J. Howey Co. and Reves v. Ernst & Young. The former case created a test for determining whether an asset is an investment contract; the latter created a test for determining whether an asset is a note. These tests play a large role today in evaluating whether a crypto asset is a security.

It is often difficult to determine what a jurist was thinking when they drafted a given piece of law, but I think it is reasonable to assume that none of the authors who drafted these securities statutes from the 1930’s, or the subsequent Supreme Court tests interpreting those statutes, did so while thinking of a day when a decentralized, cryptographically-based, automated financial instrument would be adopted en masse by a millions of people in the United States and around the world.

Put simply — when these authors were writing rules to regulate square pegs, they did not account for how those rules would impact the unpredictable round holes of the future.

Securities law is thus not well-suited to govern digital assets. Attempted application of such ill-fitting laws to crypto creates a number of problems, including:

• Lack of regulation for the subset of crypto assets that are securities;
• So many different steps and intermediaries that there is no way trades can settle in real time;
• It is effectively impossible for individual investors to trade directly, without using a broker; and
• Blockchain technology is not able, under the current rules, to be used as a reliable record of transactions, even though this is the innovation that makes distributed leverage technology so powerful.

The SEC has thus far been unwilling to write new rules for crypto securities. Instead, the Commission recently announced that it will double the size of the enforcement unit that handles crypto and cyber cases. This enforcement-first approach has stifled development of the crypto securities market and prevents entrepreneurs from using crypto to raise money for their companies. It also prevents investors from using crypto to invest in those ventures.

Perhaps worst of all, the SEC’s approach has created enormous risk for investors. We saw this in vivid detail when the Commission brought an enforcement action against Ripple, after years of taking no action against them, claiming that XRP is a security. The value of XRP dropped immediately, costing investors huge sums of money. The XRP case is especially notable because there was disagreement even within the federal government about whether XRP was a security or not: FinCEN had determined it was not a security, and then the SEC said that it was.

If the SEC were to write rules permitting the tokenization of securities, the opportunities for innovation would be significant. The crypto markets could be expanded to offer crypto securities, subject to SEC regulation and governance, thereby giving investors new ways to invest in crypto. And opening debt and equity securities to tokenization would promote efficiency and resiliency in traditional markets.

But the SEC has not done this.

While the SEC has refused to develop new rules for digital asset securities, several governments and other organizations around the world are well on their way to new, workable crypto rules. The list is significant, and includes the European Union, United Kingdom, Singapore, Japan, Hong Kong, Australia, and Brazil. Action taken last month by the EU on their Markets in Crypto Assets (MiCA) regulation, for example, demonstrates the world’s largest economy — made up of 27 different countries — putting in place a clear, comprehensive set of rules for crypto.

We believe the SEC should follow the lead of these jurisdictions by helping to develop a robust and vibrant crypto securities market, with all of the excellent protections that investors have come to expect from American financial markets. That is why we filed our petition with the SEC that requests such a rulemaking to take place.

Coming Up With a Solution

With this petition, we are asking the SEC to start a process where the public and key stakeholders can transparently provide input into the agency’s work on crypto. We also hope the petition will launch a broader conversation where members of Congress — many of whom also see the need for the regulations to evolve — will provide their views. Doing this right will help to avoid one-off, arbitrary decisions that provide little clarity or guidance to the industry, and will instead result in a clear set of comprehensive rules, much like important jurisdictions around the world are working toward.

Coming up with such comprehensive rules will require a genuine examination of how crypto works differently from traditional financial securities and what provisions would actually protect investors who trade in crypto securities.

That examination should look at current crypto trading. Crypto trades differently from securities in a number of ways, and these differences must be weighed when writing rules for crypto securities. Consider:

• Traditional financial exchanges like the New York Stock Exchange and NASDAQ have set trading hours, but crypto trades 24/7/365.
• While traditional financial exchanges require that investors trade through the services of a broker, crypto lets you buy, sell, and trade assets directly, without going through an intermediary.
• Finally, traditional securities exchanges only trade securities; they do not trade commodities or any other type of assets. Crypto investors seek to trade across types of tokens — buying stablecoins to store value, and then buying other crypto with those stablecoins, for example — all on one platform. This kind of trading is not recognized under existing rules for securities exchanges, but could offer tremendous capital efficiency gains.

Another way crypto is different from stock exchanges has to do with custody — or how securities have to be held and kept safe by brokers and exchanges.

Traditional securities transactions are permitted up to two days to settle. This delay is designed to accommodate trades going through a number of intermediaries before the securities are finally in the hands of the buyer, and the cash with the seller. Using existing technology, these intermediaries are needed to help make sure a trade goes through as promised. The buyer must actually pay the money, the seller must actually give up the assets, the trade must be properly recorded, and there must not be any errors or unauthorized actions. The broker also has to hold the securities in a certain way to ensure that it has “possession” and “control” over the assets. These rules ensure that the broker keeps the customer assets safely, and also ensures that the broker completes customer trades appropriately.

This system of intermediaries, and the specific custody rules governing them, fail to leverage the benefit of blockchain technology and do not work for crypto:

• First, crypto investors expect trades to happen within seconds — one of the key innovations of crypto. But the current rules have too many steps to allow for immediate settlement.
• Second, in order for trades to happen that fast, the securities and the money have to be held by the exchange so the exchange can effect the transaction as soon as it happens. But a crypto exchange cannot custody assets the same way that a broker can and still effect an immediate trade.
• Finally, the rules for how to keep assets safe — to show possession and control — are based on how you would keep a stock or bond safe, not how you might hold a private key for crypto securities.

Let’s Work Together on This Solution

Coinbase believes that effective regulation benefits everyone — buyers, sellers, exchanges, and the U.S. financial system. The SEC has a long history of creating and enforcing regulations that have enabled the development of deep, liquid, and transparent capital markets in the U.S. These markets have, in turn, fueled incredible innovation and helped entrepreneurs build companies that have transformed the lives of billions of people.

Thankfully, the SEC won’t have to start from scratch when figuring out how to move forward. We laid out the questions that we think the Commission should be asking stakeholders and itself in determining the right path forward — our petition was written with the input of some of the best securities lawyers and economists in the country. If the Commission starts an open process where all of us can provide input, we look forward to sharing our thoughts on how to answer the important questions our petition raises, and we would encourage others to do the same. We may not agree every step of the way, but it’s critical that this is an open and transparent process, where the public has a chance to offer their views. Policymaking at this level is far too important to be made in a black box.

Crypto represents the next wave of innovation within the markets themselves — and whatever country encourages that innovation while also keeping investors safe will reap enormous benefits. We need the SEC to once again write the rules that will unleash the potential of U.S. capital markets, this time fueled by the benefits provided by crypto.

If they don’t, others will — and the U.S. may not be able to catch up.

The Crypto Securities Market is Waiting to be Unlocked. But First We Need Workable Rules. was originally published in The Coinbase Blog on Medium, where people are continuing the conversation by highlighting and responding to this story.

Around the Block sheds light on key trends in crypto. Written by Connor Dempsey, sourced from the work and insights from the entire team at Coinbase Ventures & Corp Dev

TLDR:

• Coinbase Ventures deal activity reflected the overall pace of the venture landscape, down 34% QoQ. Activity remained up 68% YoY, reflecting the steady growth of our venture practice over the past year
• Among the key trends observed, we believe that Web3 gaming will onboard the next massive wave of crypto users, with experienced founders from Web2 gaming continuing to pour into the space
• We’re excited about Web3 user applications working to upend the captive models of Web2 and give users control over their audiences and communities
• The Solana ecosystem continues to show impressive momentum and developer traction
• Massive UX improvements are coming to crypto that will obfuscate away complexity and deliver experiences on par with Web2
• The United States continues to be home to the bulk of companies in our portfolio, with Singapore, UK, Germany, and India all establishing impressive innovation hubs
• Where CeFi lenders faltered this year, DeFi lending platforms were resilient
• Current price action aside, we remain convinced that the opportunity within crypto and Web3 are far greater than most realize.

The first half of 2022 was turbulent for all markets. The Dow and S&P had their worst first halves since 1962 and 1970. The NASDAQ had its worst quarter since 2008. Bitcoin had its worst quarter since 2011, DeFi TVL ended down 70% from its high, and June NFT sales slumped to levels not seen in a year.

A core part of the crypto market chaos stemmed from the collapse of the $60B Terra ecosystem in May. This contributed to the implosion of a $10B crypto fund (Three Arrows Capital) that had leveraged exposure to Terra along with a few other trades that moved against them (GBTC, stETH). Next, it was revealed that Three Arrows Capital had borrowed heavily from some of the largest centralized lenders in crypto. Unable to recoup these loans, several of these lenders were forced into bankruptcy.

The macro market downturn seeped into the venture landscape as well.

Venture landscape

The broader venture market began to show signs of cooling in Q1, with total funding dropping for the first time since Q2 2019. That trend continued in Q2, with total venture funding dropping 23%, marking the largest dip in a decade. The quarter also saw later stage companies like Klarna raising down rounds; a further sign of the times.

Crypto venture funding still saw a record Q1, but as we wrote in our last letter, we’d already begun seeing signs of a slowdown that we expected to surface in Q2. Sure enough, data from John Dantoni at The Block showed that crypto venture funding dollars decreased 22%: the first down quarter in two years.

In Q2, Coinbase Ventures continued to rank among the most active investors in crypto, but also saw deal place slow, with the total count decreasing 34% QoQ, from 71 to 47. Despite the slowdown compared to the fervent pace of late 21 and Q1 22, our Q2 activity still increased 68% YoY; indicative of the overall growth of our venture practice.

The decline largely reflected the overall market conditions — with volatility in the markets, we saw many founders rethink or put their rounds on pause, particularly at the later stages. We’re seeing that many companies are foregoing a fundraise unless absolutely necessary, and even then, only if they feel confident that they can show the growth needed to justify a new round.

Gloomy macro environment aside, there are still plenty of high quality founders raising at the seed stage, where we’re most active. Looking beyond the price action at the areas that we invested in shows the range of real utility that’s continuing to be built and paints a promising picture of the future: one with a vibrant array of Web3 user applications, improved UX, robust DeFi markets, scalable L1/L2 ecosystems, and all of the tools developers need to build the next killer app.

Here’s how our activity broke down over Q2.

Now, let’s look at some themes that stood out. (* denotes Coinbase Ventures portfolio company)

The coming era of blockchain gaming

With the meteoric rise and subsequent fall of Axie Infinity activity, many pundits have been gleefully quick to dismiss blockchain gaming as a passing fad. As we wrote in September, Axie was experiencing a positive feedback loop that could turn negative should the fervor driving the game die down, which is ultimately what happened. Regardless, Axie posted nearly $1B in sales in a single month and attracted 2M DAUs with essentially zero marketing budget. This put the entire gaming world on notice to the power of this new vertical.

With an estimated 3.2B+ gamers in the world, we strongly believe that Web3 gaming will onboard the next massive wave of crypto users. Web3 gaming remained a sector of heavy investment in Q2, with The Block estimating that $2.6B+ was raised. Our activity over the last few quarters only strengthens our conviction.

As we saw in Q1, founders with strong track records in Web2 gaming continue to embrace this category. For example, Azra games*, was founded by the creators of the $1.4B+ mobile blockbuster Star Wars Galaxy Heroes. Their goal is to build a combat RPG game with a robust in-game economy that can still garner mainstream appeal. The space has also attracted Justin Kan, co-founder of the game streaming platform Twitch, which was sold to Amazon for $1B. Kan’s new company, Fractal*, is building a marketplace for NFT gaming assets.

Companies like Venly* will add fuel to the fire with a suite of tools that let Web2 game developers seamlessly make the leap into Web3. Established gaming powerhouses are even starting to come around, with Fortnite creator Epic Games now allowing NFT based games into its game store.

It will take some time for this sector to mature, but it’s growing increasingly clear that blockchain gaming will be a massive category in the future. Expect an increased focus on sustainable economics and gameplay that infuses NFTs with more familiar Web2 gaming experiences.

Rewiring Web2

Beyond gaming, the next generation of Web3 user applications are working to upend the captive models of Web2 and to give users control over their audiences and communities. One company we’re particularly excited about is Farcaster*: a sufficiently decentralized social network founded by Coinbase alumns Dan Romero and Varun Srinivasan. Their early product resembles Twitter, but with the key difference of letting users own the relationship with their audiences.

Farcaster is an open protocol, similar to email (SMTP). While Farcaster has built the first social app on the protocol, other developers can build competing clients, just like we have Gmail and Apple iCloud. While you can’t take your Twitter followers with you to TikTok, someone could build a TikTok equivalent on the Farcaster protocol, and Farcaster users can take their followers with them to a new, differentiated platform. Not only can users maintain better ownership of their audience, but it also opens the door for more aligned monetization. Where most advertising spend goes directly to Twitter, Instagram, etc, Farcaster users with large followings can monetize their audiences directly across platforms.

Another investment we’re excited about is Highlight.xyz*, which sits at the burgeoning intersection of Web3 and music. Highlight will let musicians create their own web3-enabled fanclubs / communities (no coding necessary), complete with token gating, access to NFT airdrops, merchandise and more. Highlight joins other CBV portcos like Audius*, Sound.xyz*, Mint Songs*, and Royal*, all offering musicians new avenues for connecting with and monetizing their fanbases.

All told, we remain excited about Web3’s potential to reimagine entrenched Web2 models for social media, music, and more, and ultimately return power to creators.

Solana sunrise

Noticeable in our Q2 activity was the continued momentum behind the Solana ecosystem. While Ethereum and the EVM remain king as far as developer traction and compatible apps, we’re noting a clear trend in early teams placing importance on Solana. All in, we did 10 deals building on Solana in Q2.

Given that Solana smart contracts are coded in Rust as opposed to the EVM’s Solidity, founding teams often choose between building in one or the other. Increasingly, we’re seeing teams opt to support both the EVM and Solana from the onset — like recent additions in Coherent and Moralis. We’ve seen others start on EVM and opt to fully transition to Solana while the above mentioned Fractal opted to build on Solana from the onset.

Add in the fact that multiple large funds have publicly expressed support for the ecosystem, and it suggests that Solana’s staying power is real. Chain liveliness however (the ability for Solana to remain online) remains an issue that is paramount for the Solana team to solve.

The UX of Everything

An overall clunky and disjointed crypto user experience has long been a hurdle for adoption. Think of what a user has to do to execute a typical transaction: convert fiat to crypto, transfer crypto to a wallet, bridge crypto to their network of choice, and then finally execute a transaction.

In Q2, we’ve invested in multiple teams (not yet announced) working on streamlining and verticalizing the entire retail transaction journey. Soon developers building in crypto and Web3 will be able to deploy the entire transaction stack with a few simple lines of code and standard set of APIs.

The end result will be a future where, for example, a user can execute a DEX transaction in a single click. In the background, fiat will be converted into crypto, moved to a wallet, bridged to an L1/L2, before executing the swap and custodying the asset in their wallet of choice. All of the complexity will be obfuscated away and we’ll have user experiences on par with Web2 — a massive unlock.

Where are the buidlers?

This quarter we took a look at where the founding teams we’ve invested in are based. While crypto is a global industry, somewhat unsurprisingly, the largest concentration of our founding teams hail from the United States — home to 64% of our 356 portfolio companies; all the more reason for regulators to foster rather than inhibit this fast growing sector.

Singapore has established itself as the base of many of the teams building in Asia. Meanwhile, the UK and Germany are home to growing hubs, with policy makers proactively working towards regulatory clarity. We continue to be impressed by founding teams in India, who we expect to play a major role in the future of crypto adoption (CBV portfolio company Frontier, with 30 engineers in India has built a wonderful mobile-first DeFi aggregator supporting 20+ chains and 45+ protocols).

This quarter, we were also excited to back five teams founded by former Coinbase employees, including the aforementioned Coherent and Farcaster, as well as three others not yet announced. We’re proud to continue to support employees who receive a world class crypto education at Coinbase and go on to found world class companies and projects.

Wrapping up

While there’s plenty to be excited about in the future, there are also plenty of lessons to be learned in the present. The current crypto crises is similar to those we’ve seen play out in traditional finance. The opaqueness that centralized lenders and Three Arrows Capital operated under resulted in an inability for lenders to properly evaluate the risk of their counterparties. Lenders didn’t know how much the others had lent to 3AC, nor did they know how much leverage and risk 3AC was taking on. Investors didn’t know how much risk they were exposed to altogether. When the market moved against both the lenders and 3AC, lenders were left with massive holes in their balance sheets, and investors were left holding the bag.

However in contrast to the centralized lenders facing insolvency, it’s important to note that blue chip DeFi lenders Aave, Compound, and MakerDAO operated without a hitch. Every loan and its terms remained transparently on-chain for all to see. When collateralization levels fell below thresholds, collateral was sold via autonomous code and lenders were paid back. This same code also dictated that Celsius was forced to pay back $400M in loans to Aave, Compound, and MakerDAO — no court order needed (though overcollaterization played a role). All told, it served as a powerful proving point for decentralized finance.

That’s just to say that it may be easy to get discouraged by the current price action while forgetting just how far we’ve come in a short period. When the last bear market hit, the most popular user application was Crypto Kitties. These days, there are more profound, impactful innovations than we can count. DeFi, NFTs, a rich DAO ecosystem, all came about in the last two years, and even came together to make a real impact on the world stage. Meanwhile, layer2 scaling solutions are finally here, and can take us from the dial-up to broadband phase, capable of supporting a rich array of user applications with simple UX to boot.

As in previous downturns, detractors are once again confidently pronouncing crypto dead. However, from our seat in the industry, we’re invigorated by the brilliant founders we see working tirelessly to move this technology forward. As the entire financial system and world digitizes itself, we remain convinced that the opportunity within crypto and Web3 are far greater than most realize.

This website does not disclose material nonpublic information pertaining to Coinbase or Coinbase Venture’s portfolio companies.

Disclaimer: The opinions expressed on this website are those of the authors who may be associated persons of Coinbase, Inc., or its affiliates (“Coinbase”) and who do not represent the views, opinions and positions of Coinbase. Information is provided for general educational purposes only and is not intended to constitute investment or other advice on financial products. Coinbase makes no representations as to the accuracy, completeness, timeliness, suitability, or validity of any information on this website and will not be liable for any errors, omissions, or delays in this information or any losses, injuries, or damages arising from its display or use. Unless otherwise noted, all images provided herein are the property of Coinbase. This website contains links to third-party websites or other content for information purposes only. Third-party websites are not under the control of Coinbase, and Coinbase is not responsible for their contents. The inclusion of any link does not imply endorsement, approval or recommendation by Coinbase of the site or any association with its operators.

Coinbase Ventures Q2 investment memo was originally published in The Coinbase Blog on Medium, where people are continuing the conversation by highlighting and responding to this story.

Tl;dr: In recent weeks, some firms have struggled to remain solvent due to insufficient risk controls. See how Coinbase implements secure and comprehensive risk management practices that enable institutions to successfully navigate the cryptoeconomy.

By Brett Tejpaul, Head of Coinbase Institutional, Matt Boyd, Head of Prime Finance, and Caroline Tarnok, Head of Credit and Market Risk

The shocks to the crypto credit environment over the last few weeks are likely to be a major inflection point for the industry. Solvency concerns surrounding entities like Celsius, Three Arrows Capital (3AC), Voyager, and other similar counterparties were a reflection of insufficient risk controls, and reports of additional struggling firms are fast becoming stories of bankruptcy, restructuring, and failure. Notably, the issues here were foreseeable and actually credit specific, not crypto specific in nature. Many of these firms were overleveraged with short term liabilities mismatched against longer duration illiquid assets.

We believe these market participants were caught up in the frenzy of a crypto bull market and forgot the basics of risk management. Unhedged bets, huge investments in the Terra ecosystem, and massive leverage provided to and deployed by 3AC meant that risk was too high and too concentrated. These events are, unfortunately, more common in traditional financial markets than we would hope. We are reminded frequently of Long Term Capital Management in the 1990s, Lehman Brothers in the 2000s, and even Archegos Capital Management in 2021.

Coinbase had no financing exposure to the groups above.¹ We have not engaged in these types of risky lending practices and instead have focused on building our financing business with prudence and deliberate focus on the client. Now, more than ever, our leading institutional clients demand a high-quality financing counterparty.

Our goal is to be the safest, easiest, and most trusted bridge to the cryptoeconomy. We offer the most secure, comprehensive, and scalable products and services — including financing — and our multifaceted risk management programs are designed to protect our clients, our shareholders, and the broader cryptoeconomy.

Prudent risk management is key to our long-term strategy.

At Coinbase, risk management is a first principle in our product design. We hold customer assets 1:1. Any institutional lending activity at Coinbase is at the discretion of the customer and backed by collateral, which serves as a first layer of protection against potential default contagion. Our standard practice is to require 100%+ in collateral, and we always measure risk against a substantially higher stressed price move.

As a result, we have a record of:

• no losses from our financing book,
• no exposure to client or counterparty insolvencies,
• no gating for client loan recalls or withdrawals, and
• no changes in access to credit for our trading clients.

We use the following principles to understand and manage counterparty credit risk.

This time isn’t different. This environment isn’t different. That’s why we rely on our risk team, which consists of professionals with decades of experience risk-managing financing businesses across a range of economic cycles. Specifically, our team:

Conducts rigorous due diligence. Counterparties are complicated relationships. Financial, business, and structural considerations form the baseline for credit risk management. Beyond that, a company’s behavior and actions must ultimately match their financial statements and stated business objectives. A management team should be experienced and competent and should, critically, implement checks and balances inside the organization.

• It is important to look the team in the eyes — figuratively, if not literally. A company is a group of people; don’t underestimate the importance of trust (but verify).
• Base hits are more sustainable than home runs. Big wins are great, but in another market environment, could those have been big losses?

Stress tests our exposures. Exposures take a variety of forms, so we evaluate them from a variety of perspectives: size, tenor, directionality, volatility, liquidity, concentration, and correlation to our counterparties’ health. We run Monte Carlo simulations to several standard deviations. Further, in a portfolio, assets and liabilities need to be matched together to mitigate liquidity risk and ensure there is no misalignment in the duration of our borrowing vs. loan making. And all this needs to happen continuously as the environment can change. When it does, the risk has changed.

Understands how things go wrong. Every product, trade, and counterparty has at least one potential point of failure. Every single one. We work to find it, calculate how bad it can be, and target our mitigants to the point of failure.

Anticipates internal deficiencies. The information we have about the future is always imperfect. There are no perfect models, and there are no perfect decisions. Reporting can be incomplete. People miss things, or give the benefit of the doubt. Processes fail. We manage our “known unknowns” and keep a buffer for “unknown unknowns.”

Anticipates external surprises. A mitigation plan is critical. As is knowing what might bring you back to the negotiating table. Leave room for Murphy’s law — and limit the size of risk wherever possible.

We think our careful risk management explains why institutional clients continue to diligently and actively explore our financing products, including during the recent market stress.

A healthy and well functioning financing market is essential to the expansion and sustainability of any economy. We believe well-designed risk management programs will help usher in new waves of capital and fuel the next expansion. A leading prime broker, whether in crypto or other asset classes, should understand and effectively manage counterparty and liquidity risk for the safety of their clients, shareholders, and the market. We do.

Ultimately, it may still take time for the broader industry to learn the right lessons from the systemic deficiencies we have seen. If you would like to explore a counterparty you can trust or learn more about our financing products, contact sales@coinbase.com.

¹ While Coinbase does not have counterparty exposure to the companies listed above, Coinbase’s venture program did make non-material investments in Terraform Labs.

Disclaimer: This document is for informational purposes only, and does not constitute the provision of investment advice. For more information, please consult your Coinbase legal agreement and visit www.coinbase.com.

Institutional Insights: Our Approach to Crypto Financing was originally published in The Coinbase Blog on Medium, where people are continuing the conversation by highlighting and responding to this story.

Coinbase secures Crypto Asset Service Provider approval in Italy 🇮🇹

Tl;Dr: By meeting the regulatory requirements, Coinbase will continue to offer crypto services in Italy, and has a clear path to bring new products and features to market in the country.

By Nana Murugesan, Vice President, International and Business Development

As discussed in our recent blog post, Coinbase is committed to bringing the power of our full product suite to customers across Europe. Today, we’re able to announce a key milestone in that journey: securing approval from Italian regulators to provide ongoing crypto services to its residents. The new requirement implemented by the Organismo Agenti e Mediatori (OAM), mandated that all companies offering crypto trading, custody or other services, meet set criteria. We’re proud to be among the first companies to meet these benchmarks.

Coinbase serves customers across almost 40 European countries through dedicated hubs in Ireland, the UK, and Germany. We are in the process of strengthening our presence across Europe and have registrations or license applications in progress in several major markets in compliance with local regulations. In each of these markets, our goal is to grow our customer base by launching the Coinbase suite of retail, institutional, and ecosystem products.

“Building a constructive relationship with regulators in every jurisdiction in which we operate is incredibly important as we march toward our mission of increasing economic freedom in every corner of the world. Gaining this regulatory approval is a testament to our close collaboration and positive working relationship with the Italian financial regulators. As we continue to grow across Europe and other regions, maintaining our strong regulatory relationships will ensure that we will continue to bring to market the products that our customers want, through the most trusted and secure platform in the cryptoeconomy.” Nana Murugesan, Vice President, International and Business Development.

Coinbase secures Crypto Asset Service Provider approval in Italy 🇮🇹 was originally published in The Coinbase Blog on Medium, where people are continuing the conversation by highlighting and responding to this story.

Tl;dr: Perpetuals futures are financial instruments that have become increasingly popular in the crypto space. Coinbase demonstrates a hypothetical simple delta neutral strategy which takes advantage of positively skewed funding rates in the perpetual futures market to achieve a high return on investment.

By The Coinbase Data Science Quantitative Research Team

Systematic Trading Strategy

A systematic trading strategy is a mechanical way of trading that is aimed at exploiting certain aspects of market inefficiencies to achieve investment goals. These strategies employ disciplined, rule-based trading that can be easily backtested with historical market data. Rule-based trading follows strict, predefined trading methodologies that are not impacted by market conditions.

Systematic trading is a fully grown area of investing that spans a wide range of strategies and asset classes. With the ever-growing crypto market, in which thousands of tokens are being traded and derivatives offerings are being expanded, systematic trading will play an important role in goal-based investing with efficient capital allocation and rigorous risk management. In this piece, we explore a delta neutral strategy to demonstrate the basic building blocks of systematic trading.

Spot market and derivative market terms:

Spot Trading: Buying or selling assets that results in its immediate transfer of ownership. For crypto spot trading, one can directly buy or sell crypto assets via centralized exchange, retail broker, or decentralized exchanges. (For example: Coinbase Prime, Coinbase Exchange)

Derivatives Trading: Derivatives are financial contracts whose values are dependent on underlying assets. These contracts are set between two parties and can trade over a centralized/decentralized exchange or over-the-counter (OTC). A futures contract, one of the most popular derivatives, obligates parties to transact an underlying asset at a future date at a predetermined price. Derivatives, such as futures, are highly regulated financial instruments. For example in the United States, the CFTC regulated the derivatives market including commodity futures, options and swaps market as well as over-the-counter markets.

Delta and Delta Neutral: The delta measures the rate of change of the derivative contract’s price with respect to changes in the underlying asset’s price. For the underlying asset itself S, it is called delta one because the rate of change of S relative to itself is 1. Futures contracts that track closely the underlying asset, are approximately delta one. To achieve a delta neutral portfolio, one can take offsetting positions in spot and derivatives markets to construct a portfolio with an overall delta equal to zero. The zero/neutral delta portfolio is not subject to underlying price movements.

Perpetual futures

Perpetual futures have become a popular way to trade crypto assets. Unlike traditional futures that have expirations and associated delivery or settlement dates, perpetual futures don’t expire. These instruments are periodically cash settled with funding rate payment and there is no actual delivery of the underlying assets. Perpetual futures have to be either closed out to exit or held indefinitely.

Perpetual futures have their value closely pegged to the underlying assets they track with a funding payment mechanism built into the contract. It allows investors to easily take directional positions without worrying about physical delivery of the underlying assets. Perpetual futures have several advantages: it’s easy to take long or short positions, contracts can have high leverage, and there is no expiration to the contract — eliminating the need to roll futures.

We will use two scenarios to illustrate how the funding payment mechanism works:

1. When perpetual futures are traded at a premium to spot prices, the funding rate is positive. Long futures traders will pay the short counterparty a funding amount proportional to the funding rate determined by the exchange.
2. When perpetual futures are traded at a discount to spot prices, the funding rate is negative. Short futures traders will pay the long counterparty.

For illustrative purposes only.

As illustrated above, the larger the futures price diverges from the spot price, the bigger funding payment will be exchanged under a clamp threshold from exchanges. It’s an effective way to balance the supply and demand in the futures market and hence keep futures tightly anchored to underlying assets.

Systematic trading strategy with perpetual futures

Based on the above discussions, we explore a systematic delta neutral trading strategy that monetizes the rich funding rate in the perpetual futures market. A one-step setup of initial positions is required and no further rebalance is needed. We first take a long position on the underlying asset, at the same time take a short position on the perpetual future with the same notional. Given that the price of a perpetual future closely follows its underlying asset, the net position is delta neutral and has little exposure to the price movement of underlying assets. The strategy draws its performance from the funding rate payments since it is on the short side of the perpetual market.

Below is how it can be set up with BTC and BTC-PERP on 2x leverage:

1. Deposit USD Y amount as collateral
2. Long BTC with notional 2xY
3. Short BTC-PERP with notional 2xY
4. Every 1 hour, the position either collects or pays the funding on 2xY BTC-PERP position.

Here’s an example of a one period performance:

A trader opens a long position on Bitcoin. The open price was $9,910 USD and position size was 2 BTC. The trader at the same time opens a short position on BTC-PERP at $10,000 and with position size 2*9,910/10,000 = 1.982.

If the price of Bitcoin then increases to 12,500 USD and BTC-PERP increases to 12,613, the unrealized profit from BTC position is 2*(12,500–9,910) = 5,180, and unrealized loss from BTC-PERP position is -1.982*(12,613–10,000) = -5,180. The profit and loss offset each other nicely. During the same period, if we assume a funding rate of 0.3%, we will collect a payment of 10,000 * 1.982 * 0.3% = 59.5. With periodic funding payments, the strategy accrues over time.

In our backtest, we deposit USD $1MM as our collateral and then enter into BTC long positions and BTC-PERP short positions with the same amount of notional. Given the strategy has minimum risk to the underlying price fluctuation, we can leverage up our positions by 10x and the leverage ratio stays stable through the period with negligible auto-deleverage/liquidation risk. With a holding period of approximately 1Y, the strategy performed with a return of ~40%.

Data source: Coinbase and FTX

In order to confirm the achieved performance, backtests with different holding periods and different entry/exit dates were performed: 1 month, 3 months, and 6 months. The table below shows median metrics related to these backtests:

Data source: Coinbase and FTX

From the simulations above, the longer the holding period, the higher the annualized return.

We just demonstrated a systematic trading strategy with spot BTC and perpetual futures. It is a basic strategy that only requires the initial setup of spot and derivative positions; no further active position management is needed before closing out. To make the strategy more robust, one can devise additional trading rules for risk management under market stress scenarios. It will also be interesting to explore ideas on running more dynamic trading rules that adjust leverage ratio to enhance return.

Funding rate

The core of the strategy is funding arbitrage between the perpetual futures market and fiat currency borrowing. Below we take a closer look at the funding rate distributions in the futures market. The rate is concentrated in the bucket around 2%, which can be thought of as a breakeven rate. But there is a long positive skewed tail which contributes to our strategy’s performance.

Data source: FTX

Below we also look at the autocorrelation function (ACF) of funding rate to understand how past observations are correlated to future occurrences. It is clear from the autocorrelogram below that the funding rate itself exhibits serial correlation up to about 20 days.

Data source: FTX

It is also interesting to see how funding rate and spot prices are related. It is evident from the below chart that when spot prices quickly move up, so is the funding rate. And the reverse applies as well.

Data source: Coinbase and FTX

When spots are quickly ramping up, trend followers are chasing the market, possibly with leveraged positions in the futures market. The demand for funding in the futures market pushes up funding costs. When the market takes a downturn, there is less appetite for funding, so funding costs decrease and can even go negative.

Risk analysis

Execution risk for delta PnL offsetting. We demonstrated a delta neutral strategy for which PnL from spot leg and perpetual futures leg offset from each other is expected. Oftentimes, prices between spot and futures could diverge and cause non-trivial delta PnL. This can be mitigated by entering into/existing from the positions gradually in relatively small sizes.

Slippage cost, the effective price paid/received when Coinbase executes orders against an exchange or DEX. When the order size is big compared to order book depth, advanced trading algorithms are necessary to mitigate slippage cost.

Funding rate risk, funding rate is stochastic. It can fluctuate above/below zero. When the rate drifts below zero, the strategy underperforms. Historical markets showed a positively skewed funding rate distribution. However, there is no guarantee of its path in the future.

Leverage risk, auto-deleveraging/liquidation. In order to have a sizable return, the strategy has to be levered up. Given the strategy is delta neutral, it’s safe to run 10x leverage under normal market conditions. However, in a stressed market when spot price and perpetual futures price diverge for a prolonged period of time, the strategy bears risk of auto-delverage or even liquidation, which could result in significant capital losses.

Future directions

We have demonstrated how to run a systematic trading strategy in the crypto market with a basic one-step setup. Systematic trading in crypto is an uncharted territory in which many of the existing strategies in traditional financial markets could be equally applicable. However, with innovations coming from different angles (e.g, decentralized exchanges, liquidity pools, DeFi lending/borrowing) many new opportunities and possibilities arise as a result. We, as part of the Data Science Quantitative Research team, aim to develop and research in this space from a quantitative perspective that can be used to drive new Coinbase products.

You can track crypto spot and derivatives markets with Coinbase Prime analytics, a set of institution-focused market data features that provide real-time and historical analytics for cryptocurrency spot and derivatives markets. Being elegant and user-friendly, Coinbase Prime analytics features provide a comprehensive analytics toolkit built to meet the needs of sophisticated investors and market participants.

The team would like to thank Guofan Hu and Nabil Benbada for their contributions to this research piece.

Disclaimer: This content is being provided to you for informational purposes only. This is not financial or investment advice and the content on this page and any information contained therein, does not constitute a recommendation by Coinbase to buy, sell or hold any security, derivatives or similar financial product or instrument referenced in the content. The hypothetical strategy referenced herein is for demonstration purposes only and is not an endorsement or recommendation of a particular trading strategy . Real trading, including trading in the types of instruments identified in this document carries risks not limited to operational risk, strategy risk, etc and can incur significant loss. Public FTX market data is used for the backtest.

Quantitative Crypto Insight: A systematic crypto trading strategy using perpetual futures was originally published in The Coinbase Blog on Medium, where people are continuing the conversation by highlighting and responding to this story.

By Brian Armstrong, CEO and Co-founder

As companies scale, they usually slow down and become less efficient. It takes more dollars, more people and more time to get anything done. Coordination headwinds increase, vetocracies emerge, risk tolerance fades, and teams become inwardly focused instead of staying focused on their customers.

While this trajectory is natural, it is not inevitable. Every great company, from Amazon to Meta to Tesla, found ways to retain their founding energy in conjunction with appropriate controls, even as they scaled to be much larger than Coinbase is today. Great companies maintain their insurgent mindset, for fear of becoming complacent and irrelevant over time.

That’s why we’re focusing on driving more efficiency at Coinbase. After 18 months of ~200% y/y employee growth, many of our internal tools and organizing principles have started to strain or break. So we’ve been digging in to identify the set of changes we need to make to help us succeed at this new scale.

The first step was significantly slowing our growth, and making the difficult decision to reduce the size of our current team, which we announced last month. Moving forward, we’ll keep looking for ways to make Coinbase more efficient, and to get back to the mindset and approach that made us successful. I believe that these steps will carry us forward.

Push decision making down to single-threaded DRIs

We use DRIs (directly responsible individuals) to help us execute faster. DRIs balance input from the team, and make clear decisions in a timely manner.

But now that we’re a larger company with many products instead of one, we need to adjust how we make decisions — pushing most decision making down in the org, removing bottlenecks and empowering our product leaders.

DRIs often have the temptation to push decision making up the chain when they aren’t sure or don’t want to take risks. Sometimes they’re afraid of being fired if the decision doesn’t go well. That’s why, where possible, we are increasingly focused on identifying “single-threaded” DRIs. Single-threaded is tech jargon that simply means solely focused on a single area. The single threaded DRI is the most senior person whose only job is to run a given product or initiative, this will typically be a product management or engineering leader. They can’t be the single-threaded DRI if they are the DRI of multiple areas.

This may mean that not every decision is perfect. But that’s OK if we can scale our impact and empower subject matter experts who are closer to the products and closer to our customers.

Give product leaders visibility into their P&L

Each of our products have well funded competitors that are dedicated companies. We believe the right way to compete is to incentivize our product leaders to also run their product more like a standalone company. Companies must achieve profitable growth on some reasonable time horizon. Over time, we’ll be able to give product leaders direct visibility into their P&L, so they can move their product toward positive margins and make better decisions around where to invest, while at the executive level we will continue to look at consolidated performance.

Leverage shared services to minimize duplication

While product leaders can operate independently, there are often common elements across products. We have shared services around how customers onboard, manage their accounts, store crypto, add payment methods, trade crypto, and more. Done wrong, shared services can slow down and frustrate product teams. But when they work well, they can create amazing synergies between products, and deeper product integration.

Product teams should not be required to use a half baked shared service. But once a shared service is mature, all products may be required to use it. We’ve found that it often helps to start a shared service with one anchor product in mind. When it becomes clear that we are duplicating effort or creating an inconsistent user experience across our products, services need to graduate into clearly decoupled services that any product can leverage.

Organize teams into small pods

Small teams are more efficient. That’s why it’s important to set a maximum size on teams, so they don’t grow too large and slow down.

We’re beginning to deploy a new concept that we call “pods” to create more structure around the appropriate size of a team. Within each product, we will be defining pods of <10 people working on a specific feature or area. If a pod grows to be more than 10 people, it will be time to split it in two and assign each one a more specific goal or focus. Pods also need to have a focus, and a north star metric that ties into the overall company metrics.

Ship products not slide decks

Inside growing companies, there’s a danger that product and engineering teams start shipping great slides decks instead of great products. It can be tempting to “manage up” and feel like a meeting went great with a beautiful deck shown to superiors. But our customers never see the slide decks we create. They only see the product.

So we’re experimenting with banning slide decks in product and engineering reviews. Instead of a slide deck, you can show:

• A dashboard with your metrics — hopefully your team is looking at this at least weekly anyway
• Figma mockups
• But most importantly….show the product itself and use it live!

It’s fine to include a one page agenda to capture action items, or to link to any pre-reads like technical design documents. But the best use of time in product and engineering reviews is to share your screen and walk through the actual product on mobile or web. It could be the production version, or a staging version. The important thing is to get hands-on with the product, see what the customer is seeing (or is about to see), and make it better.

As we do this, we should avoid spending too much time talking about what’s going well in meetings. We can share what’s going well in the pre-read, and take a moment to celebrate it, but the majority of the time in meetings should be focused on what is not going well, so we can improve the product.

It’s hard to overstate this point. Inside companies, there are plenty of things that feel like work, but ultimately don’t improve the customer experience — from market cycles and negative press, to policy efforts, internal politics/drama, titles, and compensation. We have teams that focus on these areas, so that the vast majority of the company (80%+) can remain focused on talking to customers and building better products.

APIs instead of meetings

Larger companies also get slowed down by endless meetings around prioritization and feature requests. We need to move to a model where all product and engineering teams (not just shared services) publish APIs so that other teams can benefit from what they’re building without ever needing to schedule a meeting. In other words, they need to productize their services and allow other teams to use them in a self-service way.

This requires us to adopt an internal API catalog where any engineer at Coinbase can browse to find an appropriate service. Without this, it’s difficult for any engineer to even know if an API exists, leading to duplicate work. All services need to be architected using “paved roads”, meaning consistent libraries and languages for authentication, logging, instrumentation, etc. Many of these APIs will be surfaced in Coinbase Cloud for external customers as well, making them even more robust.

Maintain an insurgent mindset

Ultimately, a lot of this comes down to retaining the founder mentality inside the company and acting like owners. Most companies start off by being anti-establishment, seeking to right some wrong in the world. But as they grow bigger and more successful, they start to become the new establishment. They get complacent, feeling that they’ve won, and bureaucracy sets in.

At Coinbase, one of our values is repeatable innovation, meaning we always want to be pushing the frontier. We use a 70/20/10 resource allocation model where we invest 70% of our resources in our core business, and 20% in strategic efforts, we also ensure 10% of our resources are always going toward ambitious new bets. And we always try to make products that are the most trusted and easiest to use, so we can bring a billion people into crypto. This is the best way to accomplish our mission of increasing economic freedom in the world.

Conclusion

Coinbase’s success has always been rooted in an ability to operate efficiently with a startup mindset. Now, as we adjust to our new scale, we need to get back to the things that made us successful — to drive more efficiency and shake off the complacency that can creep into a bigger company. We need to empower our leaders to make decisions, and our teams to deliver great products to customers. It won’t be easy, and we’ll need to keep adjusting. But we got this far, and I’m confident that if we make smart decisions now, it will only be the beginning.

Further reading

Companies approach this problem of declining efficiency in different ways, to best fit their situation. We’ve aligned on implementing these changes and tools after doing significant research on how other companies have navigated this. Here are a few great books and resources that helped educate me on this topic:

• Amp It Up: Frank Slootman has a great blog post on this that turned into a book. The core message is that when someone says I’ll get back to you next week, say how about tomorrow. When someone says it will take six months, ask how we would do it in six weeks or six days if we had to.
• Turn The Ship Around: The core message of this book is instead of asking your manager what you should do, tell him or her what you intend to do, and they will edit your thinking if needed. You still need to inform, but it’s your responsibility to decide the best path.
• Founders Mentality: The core message is to maintain an insurgent mindset, with a bias for action, bold mission, customer advocacy, and more. Try the quiz for more details.

Operating efficiently at scale was originally published in The Coinbase Blog on Medium, where people are continuing the conversation by highlighting and responding to this story.

TL;DR — We’ve upgraded Coinbase Prices and rebranded it as Coinbase Explore to provide users with a single platform to research the entire cryptoeconomy

The cryptoeconomy is about far more than buying and selling and assets. But as more people do more with their crypto — earn, lend, collect NFTs, build communities, etc. — they need accurate, actionable information to make sound decisions. Unfortunately, getting that information today is too complicated and time-consuming.

That’s where Coinbase Explore comes in. Coinbase Explore is an upgraded version of Coinbase Prices, which provided users with detailed research on crypto assets. Coinbase Explore will cover much more than asset prices — we’re bringing to market a full-scale, easy-to-use, searchable platform that enables users to research all aspects of the cryptoeconomy in one place.

All categories, all assets

We want to make it as easy as possible for our users to access up-to-date-information, no matter how fast the cryptoeconomy evolves, so they can do more with their crypto, with confidence.

Whether a user is looking for basic educational content, detailed data on DeFi protocols and NFT collections, or to search on-chain transactions and addresses, they need quick, accurate answers.

Coinbase Explore will provide these across all existing and emerging categories of the cryptoeconomy while still providing high quality pricing data for all existing crypto assets.

Further Explore-ation

Coinbase Explore can be found via the “Explore” tab on Coinbase.com. If you were previously familiar with Coinbase Prices, you’ll now find a new, expanded layout where searching for new crypto assets is even easier.

In the coming quarters, Coinbase Explore will include data on DeFi Protocols, NFT collections, and more. We’re excited to continue providing our users with critical tools and knowledge and to onboard the next generation of users into web3.

A research platform for the entire cryptoeconomy: Coinbase Prices is now Coinbase Explore was originally published in The Coinbase Blog on Medium, where people are continuing the conversation by highlighting and responding to this story.

By Cesare Fracassi, Chief Economist, Coinbase Institute

TL;DR: How should we evaluate the recent highs and lows of crypto prices? In taking a market efficiency view, crypto prices are a reflection of the market’s assessment of the future prospects of digital assets. This view can help us understand the historical trends in crypto prices and its correlation with the overall financial markets:

• Over the last 5 years, crypto markets saw very large returns due in part to adoption by institutional and retail investors, and the laying of the foundations of web3.
• Whereas crypto markets were originally uncorrelated to the financial markets, the correlation has risen sharply since 2020. Thus, the market expects crypto assets to become more and more intertwined with the rest of the financial system.
• Nowadays, the risk profile of crypto markets is similar to those of oil prices and technology stocks.
• The recent decline in crypto markets can be attributed for ⅔ to worsening macro-factors, and for ⅓ to a weakening of the outlook for cryptocurrencies.

Introduction

Over the last eight months, the market capitalization of all cryptocurrencies went from a peak of $2.9T to a current level of less than $1T, a decline of over two thirds. This is not unusual in crypto markets: Since 2010, total crypto market capitalization experienced a quarterly decline of 20% or more (a typical measure of bear market conditions) nine times.

Each time a sharp decline in crypto prices occurs, media and expert commentaries usually take one of two forms:

(i) the “Crypto is dead” response, where crypto is painted as a gigantic Ponzi scheme fueled by the desire not to be left out of great returns (Fear of Missing Out, or FOMO in short) followed by anxiety and despair when prices decline (Fear, Uncertainty, and Doubt, or FUD in short). The price drop is the sign that the bubble bursted, and we should run for the exits before prices go down to zero.

(ii) the “HODL” response, where crypto is seen as a groundbreaking technology. Crypto winters and summers are a feature, not a bug, of disruptive innovations, like national banks in the early 18th century, railways in the mid 19th century, and the internet and artificial intelligence in the late 20th century. We should hold and ride through the volatility, as crypto prices will resume their rise in the near future.

However, neither of these explain both the historical trends we have seen in crypto and how we are seeing the correlation with overall stock markets today. But there is a third way to interpret changes in prices, the “market efficiency” response, where prices are a reflection of the market’s assessment of the future prospects of digital assets.

Market Efficiency

Examining the crypto markets based on an understanding of market efficiency can help us interpret the data. For example:

• From June 2017 to June 2022, crypto market cap rose 860%, indicating that the outlook about cryptocurrencies today is much brighter than it was back then: The adoption by institutional and retail investors, and the laying of the foundations of web3 (i.e., decentralized finance applications, non-fungible tokens, decentralized identity solutions, tokenization of real assets, and decentralized autonomous organizations) were part of the reason for these exceptional returns.
• Since 2020, the correlation between the stock and crypto asset prices has risen significantly: while for the first decade of its existence, bitcoin returns were on average uncorrelated with the performance of the stock market, the relationship increased quickly since the COVID pandemic started. This suggests that the market expects crypto assets to become more and more intertwined with the rest of the financial system, and thus to be exposed to the same macro-economic forces that move the world economy.

• In particular, crypto assets today share similar risk profiles to oil commodity prices and technology stocks. Beta is a typical measure of systematic risk for financial assets. A beta of zero means that the asset is uncorrelated with the market. A beta of one means that the asset moves together with the market. A beta of two means that when the stock market rises or falls by 1%, the asset increases or decreases by 2%. The animation below shows that the betas of bitcoin and ethereum have jumped from 0 in 2019, to 1 in 2020–2021, and to 2 today — they are now very similar in risk profile to a more traditional asset, technology stocks. (We wrote about this in our Coinbase Institute May 2022 Newsletter.)

• As the U.S. Federal Reserve and other central banks around the world recently began to increase interest rates, long-term assets like crypto and tech stocks became heavily discounted and their values dropped rapidly. It might be useful to consider how much of the current decline is due to worsening macroeconomic conditions, as opposed to souring outlook specifically for cryptocurrencies, especially considering the crypto market cap declined over 57% year-to-date in 2022. It’s worth noting that during the same time, the S&P 500 declined 19%, and if macroeconomic conditions were the only cause of the decline, we would have expected crypto assets, with a beta of 2, to drop by about 38%. We can thus roughly estimate that two-thirds of the recent decline in crypto prices can be attributed to macro factors, and one-third to a weakening of the outlook solely for cryptocurrencies. This is similar to what happened during the 2000–2001 dot-com recession, where the S&P 500 declined 29%, and the Nasdaq composite index (composed heavily of tech stocks), with a beta of 1.25, declined 70% from peak to trough.

The Future of Crypto Markets

There is one topic that the market-efficiency view is mostly silent about: the direction of crypto prices in the future. The most important pillar of the market efficiency hypothesis is that any traded asset, from stocks to bonds, commodities, and even crypto, incorporates into its price the market’s expectation about the future value of the asset. For example, if the market expects Tesla to sell a very large number of cars in the future, the stock price today will be high to reflect that expectation. If Tesla meets that expectation in the future, its stock price will not rise, because it already incorporated that event into its price today.

Similarly, then, changes in prices occur only when there are changes in the expectation of the future outlook about the assets. Thus, according to the market-efficiency view of crypto markets, only changes in the outlook of the crypto industry relative to what is already expected will bring changes to prices.

NOTE: The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Coinbase or its employees and summarizes information and articles with respect to cryptocurrencies or related topics that the author believes may be of interest. This material is for informational purposes only, and is not (i) an offer, or solicitation of an offer, to invest in, or to buy or sell, any interests or shares, or to participate in any investment or trading strategy, (ii) intended to provide accounting, legal, or tax advice, or investment recommendations or (iii) an official statement of Coinbase. No representation or warranty is made, expressed or implied, with respect to the accuracy or completeness of the information or to the future performance of any digital asset, financial instrument or other market or economic measure. The information is believed to be current as of the date indicated on the materials. Recipients should consult their advisors before making any investment decision. Coinbase may have financial interests in, or relationships with, some of the entities and/or publications discussed or otherwise referenced in the materials. Certain links that may be provided in the materials are provided for convenience and do not imply Coinbase’s endorsement, or approval of any third-party websites or their content.

Coinbase Institute Research: Crypto Prices and Market Efficiency was originally published in The Coinbase Blog on Medium, where people are continuing the conversation by highlighting and responding to this story.