Coinbase Gives $256 Billion Reminder About Agonies of Bankruptcy
Comment of the Day

May 12 2022

Commentary by Eoin Treacy

Coinbase Gives $256 Billion Reminder About Agonies of Bankruptcy

This article from Bloomberg may be of interest to subscribers. Here is a section:  

Coinbase Global Inc., like the rest of the cryptocurrency market, is having a really tough week. Not filing-for-bankruptcy bad, but the biggest US crypto exchange did just mention the B-word in a regulatory filing, giving its customers a painful reminder of how bad things could get for them if Coinbase ever does get seriously distressed.

In its quarterly report, Coinbase added a risk disclosure: if the company were to file for bankruptcy, the court might treat customer assets that the exchange is custodian for -- their Bitcoin, Dogecoin or whatever -- as Coinbase’s assets. And they’d be at the back of the line for repayment, forcing normal people, unaccustomed to the ins and outs of federal bankruptcy court, to claw back their money along with everybody else owed money by the exchange.

It’s a huge amount at stake. Coinbase was custodian for $256 billion of customer money on March 31, according to the filing.

Chief Executive Officer Brian Armstrong quickly took to Twitter to elaborate, saying the company is not at risk of going bankrupt and that users’ funds are safe.

Eoin Treacy's view

Segregated accounts didn’t save MF Global’s clients in 2019. It took six months to get two thirds of their money back and it’s not clear how successful efforts have been to recover the rest. Since the crypto markets are unregulated and Coinbase is an “exchange” rather than a broker, the funds are not truly segregated. The company might not be in imminent danger of going bust, but that only exacerbates the leverage to the bitcoin price. It’s a very binary bet.

The share dropped 88.93% between the November high and today’s low and a deep oversold condition is evident. It is clearly viewed as a high beta play on bitcoin as evidenced by the extraordinary volatility in earnings. The company reported over $10 billion in free cash flow in 2020 and expects a $700 million loss this year. The price to sales ratio has now declined to 1.7 which is unchallenging and considerably less than in other highly speculative companies. 

Bitcoin rebounded from the intraday low today following a brief retest of the 1000-day MA. I have opined that the best time to buy was following reversions to the 1000-day MA. We are there now, and it has historically been a rallying point for crypto bulls. That suggests scope for a reversionary rally.

There are still big outstanding questions about how well bitcoin can perform in a rising interest rate and tightening liquidity environment. Those will be answered in due course. The minimum requirement to suggest demand is returning to dominance will be a sustained move back above the psychological $30,000 level. That would form a failed downside break which is a reliable reversal pattern.

This debate is emblematic of the wider quandary investors find themselves in. This is the point at which a buy the dip strategy would best be deployed. A large number of stocks and indices are testing their respective secular trend means. This is either the end of the 14-year secular bull or multi-year attractive buying opportunity.

Personally, I am troubled by the fact this logic is mainstream. A decade ago, when I talked about a new secular bull market it was like a lone voice in the wilderness. Today, I feel bombarded with podcasts, YouTube videos, analysts and reports telling me about the inevitability of AI and deep learning transforming the global economy.
The reality is bull markets thrive on liquidity. Without it the attractive stories wither. It’s going to be difficult to make a clearly bullish case until central banks relent in tightening. The developing weekly key reversal on Treasury yields suggests investors are coming around to the idea a recession is inevitable if inflation is to be brought under control. Breaking the correlation between yields and stocks is the biggest development in markets this year.

The underperformance of the banking sector and high yields spread breaking out are both representative of tightening liquidity.

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