How to price shovels in a gold rush

Plus translating Vitalik from the native cryptolese.

In this issue:

  • How to price shovels in a gold rush (reader submitted)

  • Translating Vitalik’s essay on Legitimacy (reader submitted)

How to price shovels in a gold rush

“I would love to read your thoughts on Coinbase's valuation and future. Something like the bull vs. the bear case?” - LB

For folks new to the newsletter, Coinbase is the largest US cryptocurrency exchange and will likely be the first to go public - it is currently aiming for a mid-April IPO and a valuation north of $100B/share, which would make it one of or perhaps the highest valued tech IPO of all time (current record holder Facebook debuted at ~$104B). According to Coinbase’s S-1 the volume-weighted average share price in Q1 of 2020 was ~$343, shares are currently trading for ~$458.

First some useful context for my biases: in 2014 I was offered but ultimately declined one of the first Product Manager positions at Coinbase. I was tempted but ultimately decided that (a) the role I had on Chrome at the time was very exciting and I was growing a lot, (b) Coinbase and I weren’t quite a culture match, especially regarding altcoin philosophy and (c) I felt like a direct bet on Bitcoin made more sense than Coinbase equity. In retrospect I learned a ton on Chrome and loved my time there and Coinbase pivoted heavily towards altcoins - but Coinbase equity has gained value even faster than Bitcoin itself, at least so far. Two out of three ain’t bad.

Anyway, here is how I see the Coinbase IPO:

The Bull Case: Coinbase is by far the most successful retail cryptocurrency exchange and they show no signs of giving up ground in that competition. The set of people who own cryptocurrency already is very small compared to the set of people who could own cryptocurrency, so if you are bullish on crypto generally it is hard not to be bullish for Coinbase specifically. Their S-1 filing shows extremely strong evidence of growth among both retail and institutional customers. They became profitable in 2020, which was a good year for crypto but not the explosive bull run that 2021 has been. Coinbase has a strong regulatory moat and strong brand recognition in a space where trust is an important competitive advantage.

The Bear Case: The best argument against buying Coinbase’s IPO is less an argument against the underlying business than that overhype has carried the valuation out beyond what the fundamentals of the underlying business actually support. Investors who want exposure to crypto but are a bit too squeamish to hold crypto directly may very well place a premium on the ability to own exposure to Coinbase, much as they placed a premium on the GBTC fund over the value of the underlying BTC it represented. That would diminish the case for buying the Coinbase IPO without necessarily reflecting on Coinbase the business.

The Philosophical Case: Coinbase reflects a fairly specific view of what cryptocurrency technology is for and how it should evolve. They are in many ways a traditional bank and have a bank’s approach to regulation: they are meticulous about it and tend to view having navigated it as a competitive defense. That makes them pretty far removed from the cypherpunk roots of cryptocurrency.

Coinbase also makes money when people trade between currencies, so they profit the most in a world with lots of different cryptocurrencies people want to trade. As a result they put a lot of emphasis on "educating" new users about different smaller cap cryptocurrencies. Different people can have different views about the value of that kind of education, but I find it to be a bit predatory - like touting the potential healing properties of untested supplements.

Finally, Coinbase’s corporate culture is very specific and often polarizing. CEO Brian Armstrong wrote this post after a number of employees quit citing issues related to workplace diversity and the Black Lives Matter protests.

My personal investment stance is that I think Coinbase is a promising investment but not as promising an investment as just owning Bitcoin directly. On the other hand I made the same bet in 2014 and here we are. This is why I don’t give financial advice.

Translating Vitalik’s essay on Legitimacy

"I feel like one of the things Something Interesting does for me is translate from crypto gobbledygook to human language - would truly appreciate if you could filter Vitalik’s post about legitimacy through that lens. I "get" a lot of his points, but I feel like I’m losing the forest for the trees." - IS

Vitalik Buterin (founder of Ethereum) has a firm standard in his writing that he will never use a sentence where three paragraphs would do. I actually think this is one of his more legible essays! But it is still pretty dense. Let me try and roughly summarize.

He starts by talking about the transformation of Steem-It to Hive as an interesting case study in the power of user driven forks. We first talked about forks back in January. If you’re not already familiar with them its probably worth starting there, but the basic gist of it is anyone can make copies of any cryptocurrency and change things about how it works - those copies are called "forks" because they share a common history but after the fork is created there are now two independent chains.

From a technical perspective, there is no way to know which of the two chains after a fork is the 'real' chain, because 'real' is a social definition not a technical one. The analogy Vitalik uses is driving on the left or right side of the street. Nothing technically distinguishes the two options - social consensus is what makes driving on one side of the street legitimate and driving on the other side reckless.

Vitalik then enumerates some of the mechanisms that he sees as driving legitimacy and references the BitShares consensus model to propose a kind of community powered legitimacy granting foundation dedicated to funding public goods and research for the Ethereum ecosystem.

The idea is that new projects would tithe resources of some kind to the foundation in exchange for official blessing. The community would find projects that had properly contributed to be more legitimate, so they would adopt and use them more readily. The foundation would then use the donated resources to fund public goods for the Ethereum ecosystem like infrastructure and research. In Vitalik’s estimation that would create a flywheel effect: new projects would help fund public goods, public goods would cause more new projects to be more successful.

I think a good comparison would be American Humane, the organization that grants the "no animals were harmed in the making of this production" status to films. AH charges movie companies, supervises their productions and uses the funds raised to advance their cause of animal actor safety. Movie makers pay AH because film-goers prefer movies they can be confident are ethically produced.

Vitalik then specifically proposes NFTs (which are almost pure consensus and nothing else) as a market with both a lot of resources that could be tapped into for public goods and also one in significant need of legitimacy providers. So he proposes a foundation that (for a fee) would vet NFTs as being socially desirable by some definition and then use that fee money to pay for Ethereum development.

Personally, I thought the essay was interesting but I’m not convinced there is actually a market for Vitalik-and-friends-approved NFTs. I also find it lightly amusing how many of Vitalik’s proposals amount to him accepting donations on behalf of Ethereum.

On the other hand I certainly wouldn’t rule it out. If I had a nickel for every time my predictions about crypto were wrong I’d probably have more nickels than I would ever have predicted.

Other stuff happening right now:

  • As a general rule, I don’t make price predictions. Banks do, though!

  • You think you know fear? Watch this guy livestream as the price of Bitcoin plummets down to $0.01/bitcoin. 😬