Home Coinbase Deconstructing the 'Coinbase effect'

Deconstructing the 'Coinbase effect'

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Coinbase is often considered the benchmark for a digital asset infrastructure project. Its CEO Brian Armstrong recently topped the first ever Forbes crypto 40 under 40 list (as well as making an appearance on the main list). The company was also reported to have revenue exceeding a billion USD for 2017. Recently, it released a Q2 2018 report detailing a wave of new hires, business acquisitions, investments and products, signalling strong health in the short and medium term.

Coinbase began operations in 2012, initially as a digital Bitcoin wallet. It has since shifted its primary business to acting as a digital asset broker for retail consumers, allowing for easy purchase of crypto with fiat currency. It currently offers its services in 33 countries, spread across Europe, North America, Asia and Australia.

Beyond the brokerage service, and connecting buyers and sellers of crypto, Coinbase also has an inbuilt trading platform, Coinbase Pro (formerly known as GDAX). The trading exchange allows for direct access into Coinbase markets.

In recent times, Coinbase has also expanded into offering custodial services to institutions, and now has other products such as 0x based ERC20 off-chain relay solution, Paradex.

Coinbase is also well known for its selective approach to onboarding digital assets. Coinbase Pro currently offers 12 trading pair options, which is slim pickings when compared to a competitor like Okex, which currently has 511 different pairs listed.

Navigating the barriers to entry

In order to become a tradable digital asset on the Coinbase platform, a blockchain project must go through an exhaustive review process which features a number of stages including;

  • an initial review by Coinbase’s internal asset selection committee.
  • a legal and risk review phase.
  • an approval process from the Coinbase executive committee.
  • a specific assessment of core code and engineering facilities.
  • and a final assessment of the asset’s liquidity capabilities, price stability and financial performance.

Members of the asset selection committee also follow strict confidentiality obligations, and protocol surrounding public information disclosure and trading activity.

The crux of the Coinbase asset selection process revolves around the GDAX digital asset framework. It designates general criteria for; a token’s alignment with Coinbase’s core values, assessments of the network technology, legal and compliance standards, market supply & market demand requirements and crypto economics.

Specific sections of the digital asset framework can at times be difficult to interpret, and appear to be quite subjective. For example, decentralized networks like Bitcoin, Bitcoin Cash or Ethereum, it is likely challenging to make an assessment of the founder’s ability to “articulate vision, strategy, use cases and drive developmental progress”, given that key decisions on these blockchains are driven by community consensus, and anonymous forces operating within those blockchains.

The leadership criteria fits well with recently considered tokens like BAT, which has a visible organisational structure, and an identifiable founder, who is heavily involved in network strategy. However, other recently associated tokens, like ADA or Zcash, operate with flatter governance models. This makes it more difficult to determine who the true ‘leaders’ of the network are and if there is a central ‘vision’ that the blockchains are moving towards.

 

This considered, the digital asset framework nonetheless remains a useful tool, especially for those outside of the Coinbase inner decision-making circle, it provides insight into what a major crypto organisation perceives to be the key barometers for a viable digital asset.

The Coinbase effect

Because of the exhaustive and selective nature of the Coinbase token listing process, a connection to the platform can act as something of a golden ticket for a digital asset, making it part of a very exclusive, desirable club.

When Coinbase integrated Litecoin into its trading systems in early May of 2017, for example, it triggered an immediate surge in the transaction volume and price of LTC. From trading at $24.20 (Index) on May 4th, its price rose to $48.40 on June 18th, a 98.43% jump in less than 6 weeks.

bnc chart 38The graph shows the normalized USD price, and volume, of 5 different LTC trading pairs since April 2014.  LTC/BTC, LTC/USDT, LTC/USD, LTC/EUR and LTC/CNY. The orange line represents an Index of the prices, blue is LTC/BTC, yellow isLTC/USDT, green is LTC/USD, navy is LTC/EUR and LTC/CNY is turquoise. The bar charts below represent total trading volume in USD, with colours corresponding to the lines

The listing was additionally significant because it came after Litecoin integrated the Segregated witness (SegWit) protocol into LTC transactions. The upgrade allowed for a creative method to increase transaction capacity on the network, while retaining 1MB block sizes.

However, the decision to use it was controversial among members of the Litecoin mining community and there was a great deal of back and forth before the Segwit implementation. Coinbase choosing to list Litecoin after had transitioned the network to allow for Segwit transactions, was likely perceived as a substantiated endorsement for this network scaling option.

An additional factor was likely that Litecoin’s founder, Charlie Lee, was also the director of  engineering at Coinbase at the time of the listing. While this does appear to be a conflict of interest, one could argue that a network’s founder is likely to have some of the strongest understanding of its respective pros and cons.

Another recent benefactor of this ‘Coinbase effect’ has been the Ethereum classic token. Since the initial announcement that Coinbase would be adding ETC to the platform, its price has risen from $12.65 to $16.53, a percentage increase of ~ 30%. Conversely, over the same period direct competitor ETH, fell by ~10%.

The price rise can be put down predominantly to speculation. The ETC token is yet to be added to the platform, in fact, a listing date has not yet been announced. The jump has likely driven by short term FOMO buyers, speculating on a potential influx of institutional and casual purchasers entering ETC markets via avenues like the Coinbase broker and custodial services. This means there could be a potential dump once the token actually begins trading on Coinbase Pro, if there is no immediate influx of liquidity from mainstream buyers.

We have seen similar speculative jumps in other tokens which Coinbase has declared an interest in. Stellar Lumens (XLM), 0x (ZRX), BAT, Zcash (ZEC) and Cardano (ADA) tokens have all performed well in recently thanks to the implications of what a Coinbase trading option brings. Prudent Investors should put credence to the idea that many new buyers are not particularly interested in any fundamental or technological factors underlying these projects, and are likely to quickly sell off any newly acquired tokens if there is a reversal in the current positive sentiment.

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