Forget Bitcoin – 5 Reasons To Buy Coinbase Instead (NASDAQ:COIN)

While Bitcoin (BTC-USD) has tremendous upside potential if bullish projections of $500k+ per coin from the likes of Ark Invest’s (ARKK) Cathie Wood play out, we invest for the best risk-reward profile, not simply the best reward potential.

As a result, since we believe that Coinbase (NASDAQ:COIN) offers investors the best risk-reward in today’s crypto market, we would prefer to invest there instead of directly into individual cryptocurrencies in today’s market. In the following paragraphs, we share 5 reasons why:

As a highly profitable business, COIN generates actual cash flow that causes its intrinsic value to grow over time. As a result, it is a true wealth compounder that, assuming the business remains profitable, will result in its owners becoming richer over the long term. Buying and holding shares of COIN is an investment that has the potential to increase the wealth of an individual based on growing cash flows and improving business fundamentals.

In contrast, Bitcoins do not procreate nor generate cash flow. All it can do is increase or decrease in price relative to U.S. Dollars or other assets based on people’s ever-changing desire to own it. As a result, holding it is not an investment, but rather a speculation on the future that Bitcoin will be in greater demand then than it is now.

As Warren Buffett said in his 2011 Letter to Shareholders:

If you own one ounce of gold for an eternity, you will still own one ounce at its end … Owners are not inspired by what the asset itself can produce — it will remain lifeless forever — but rather by the belief that others will desire it even more avidly in the future.

Bitcoin – known as digital gold – could be described very similarly. While we do in fact own some gold (GLD), we also do not view it as an investment but rather as an asset that serves a purpose as an insurance mechanism as a time-tested and inflation-resistant medium of exchange. For exposure to gold in our investment portfolio, we buy gold miners instead. We view COIN as serving a similar purpose in our exposure to the crypto world.

Bitcoin is one of an ever-increasing number of cryptocurrencies that already number in the hundreds. As a result, it faces heavy competition and the constant threat of innovation and disruption displacing it as the leading cryptocurrency and eventually causing its value to fall. Furthermore, it faces regulatory and even ban risks, especially since the majority of its processing power is located in countries that are often considered strategic rivals or even adversaries of the West, including China, Russia, Iran, and Pakistan. Last, but not least, Bitcoin’s price has proven to be extremely volatile, as the last two weeks have made clear:

In contrast, COIN is diversified across over a hundred cryptocurrencies, thereby insulating it against any single cryptocurrency’s collapse. If China were to ban Bitcoin and effectively seize control of most of its mining activity, for example, it would be devastating to the price – and processing power – of Bitcoin. While it would still likely hurt COIN’s cash flows and share price meaningfully, the impact would be much less significant for COIN than what Bitcoin would face and it would be able to move forward with other cryptocurrencies in the place of Bitcoin.

While Bitcoin’s profit-loss proposition rises and falls directly with the price of Bitcoin, COIN’s profits are not tied directly to rising cryptocurrency prices. Instead, it earns the majority of its profits from transaction fees, meaning that as long as there is high volume in cryptocurrencies, they will be making high profits. Furthermore, since it deals in over a hundred cryptocurrencies, it is not reliant on high volume in any single cryptocurrency, but instead profits from the overall popularity of cryptocurrencies.

As a result, whether people are swarming the gate, trying to board the crypto bandwagon, or racing for the exits in a crypto sell-off, COIN is poised to reap massive profits, making it a more defensive and non-correlated asset than Bitcoin. This further boosts its risk-reward profile.

While COIN operates from a similar competitive position as Bitcoin in that it enjoys a significant network advantage and early-mover status, it also faces significant competition from other similar platforms that are constantly innovating and trying to gain an advantage over it. However, COIN enjoys one key advantage over Bitcoin in this arena: it is a business with intelligent management executing a long-term strategy and a small army of highly talented software engineers and programmers, while Bitcoin is a lifeless and static asset.

While this can be a blessing in that Bitcoin does not contain the risk of making any strategic blunders or misallocating shareholder capital, overall we view it as a major negative for Bitcoin because, in a space where innovation is the name of the game, it increases the chance that eventually Bitcoin will be displaced and bypassed by competing cryptocurrencies whereas COIN can continually evolve and pivot at or ahead of the pace of innovation to sustain and strengthen its competitive edge.

In fact, COIN is already aggressively reinvesting its profits into doing just this. While its exchange business makes up the majority of its profits and management maintains that – despite growing competition – the accelerating demand for cryptocurrency means that margin compression on this business is unlikely anytime soon, they do expect margin compression to occur here over the long term as it would in any wildly profitable business without massive barriers to entry.

As a result, management is making multiple investments today in order to grow diverse revenue streams that will lead to more stable and secure income over the long term. Within 5 years, management expects more than 50% of their revenue to come from sources other than transaction fees.

Ultimately, COIN sees itself as a cryptocurrency infrastructure business that offers a wide array of services and tools that enable people to access, exchange, store, and optimize their use of cryptocurrency and blockchain technology. Businesses they are already growing and/or exploring include a cryptocurrency cash back credit card through a partnership with Visa (V), a custody/vault business for institutions that uses proprietary cybersecurity technology, cryptocurrency loans, deposit accounts, and new innovative forms of transactions that are not even on the public radar yet, making them a virtual infrastructure, cybersecurity, exchange, and fintech business all in one.

They are also investing in cryptocurrency startup companies that many of their ex-employees have gone on to found. As a result, they are positioning themselves to benefit from further external innovation in the space while also insulating against being disrupted by new technologies and applications built by former company insiders.

With just 50 million current members and ~1 billion estimated potential users, the growth runway for COIN remains massive and could easily lead to exponential growth in the years to come, especially if cryptos continue to grow rapidly in acceptance and popularity.

Last, but not least, COIN’s ability to generate profits gives it an intrinsic value. While Bitcoin’s true value is ultimately anyone’s guess as it fully depends on speculation, the ever-changing whims of consumers, and the hope that nothing better comes along through the innovation pipeline, COIN brings actual profitability and new business innovation to the table. As a result, we can have a better idea of what an attractive price would be for COIN than for Bitcoin. As value investors, we greatly prefer this method.

As we stated previously about gold, there is certainly a case to be made that popular cryptocurrencies have a place in a diversified portfolio. In fact, we also expect that Bitcoin has higher upside potential than COIN if it can continue to grow in acceptance and utilization by companies and institutions across the world.

That said, as value investors we like to invest rather than speculate and also try to maximize our risk-reward profile. Given that COIN generates actual cash flows to generate long-term growth, it enjoys significant diversification across the broad cryptocurrency space, it is not directly correlated to rising cryptocurrency prices and may profit even during a crypto crash, is diversifying into becoming a crypto infrastructure company, and has actual intrinsic value instead of being a mere speculative asset, COIN is our favorite pick for exposure to the cryptocurrency space.

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This article was written by

Samuel Smith is Vice President at Leonberg Capital and manages the High Yield Investor Seeking Alpha Marketplace Service.

Samuel is a Professional Engineer and Project Management Professional by training and holds a B.S. in Civil Engineering and Mathematics from the United States Military Academy at West Point. He is a former Army officer, land development project engineer, and lead investment analyst at Sure Dividend.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in COIN over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.