Coinbase: Convienience for a Cost

Coinbase Can be Costly

The alternative title for this post was set to be “Coinbase: Spread ’em!”, but its probably best to tone it down.

Whats Coinbase?

For those in the US, Coinbase is arguably the most convenient and mainstream way to purchase Bitcoin, Ethereum and Litecoin. They link to your bank account and will allow you to buy and sell crypto with the click of a button. They offer relative security in that they have “grade A” investors like the New York Stock Exchange. (This would be in comparison to some non US exchanges owned by…???) I personally use Coinbase and have recommended them to friends.

Coinbase Exchange
Coinbase Exchange Logo

Coinbase is superficially a retail application that routes orders to their exchange, GDAX which offers more advanced functionality.

According to CoinMarketCap, GDAX is the 7th largest crypto exchange by volume.

With the recent price explosion in crypto, CoinBase has had many issues with downtime. Often when markets were at the jumpiest users would see the following screen:

Coinbase Exchange Down
Coinbase Error

This is obviously quite unsettling if you need to sell. Coinbase claims to have been getting slammed with new users claiming to have added 40,000 users in one particular day in May. I think they can be a bit forgiven for underestimating just how fast things would escalate going into June.

Uptime aside, I think its important for users to really understand the price they are paying for this convenience and security.

How [I Speculate] Coinbase Works

Coinbase does not give users the ability to place limit orders – for that you have to use GDAX. Coinbase gives you a live price at which you can buy or sell the crypto of your choice. That price comes from GDAX, and that is where they “source liquidity” (i.e. actually buy or sell). When you buy they then pull money from your bank account or credit card. This opens Coinbase up to two principal points of risk

  1. Price Risk – Coinbase guarantees you a price for a few seconds, during which the actual price could move. Coinbase still has to grant you the quoted price, even though the price may have changed between when they quote you and when you click “Buy”.
  2. “Funding” Risk – Your crypto is not available under Coinbase has received the funds from your bank. However you could probably find ways to cancel the funds transfer and stick Coinbase with the crypto you bought. This leaves them with unwanted inventory and the associated risk. Coinbase caps how much you can buy or sell, and you need special permission for higher levels to greatly mitigate this risk.
Coinbase Order Screen
Coinbase Order Screen

This risk is baked into the price when you receive a quote and pay their fee. It appears in two places:

  1. Transparent Fees: 1.49%-3.99% in the US
  2. Crypto Pricing (Not Very Transparent): They “spread” you, meaning they increase the price over (buying) or under (if selling) where the actual market is trading. For example, the actual mid point price for Bitcoin might be $2,000, but Coinbase will sell you Bitcoin for $2,010. Note that if you use GDAX you can place limit orders and have better control of your price.

I surmise that when markets get really crazy, spreads widen out. Meaning the price Coinbase is quoting you will be father away from where actual market is trading. This is what happens in stock and options trading: market makers widen their bid/ask quotes to reduce their risk.

Here is a real time example using Coinbase on iOS:

Buy 1 Bitcoin:

Coinbase Offer Price: 2284.65

Coinbase Fees: $34.04

Total: $2,318.91

Simultaneous market on GDAX:

GDAX: Bid $2,268 x Ask $2,273

Therefore Coinbase is going to sell me 1 Bitcoin at $2,318.91, then simultaneously buy on GDAX for a worst case $2,273. They clear $45 from the trade or about 2%. For the security and convenience of using Coinbase, I’d argue thats not a terrible price.

Its possible that they also have a matching engine which would pair or match my buy order off against another Coinbase user that is selling. This means that they could fill both of our orders “mid market” (halfway between the GDAX bid/ask) which would be a price of $2,270. That adds a few more dollars of profit for them.

Not a bad business.

The Flash Crash

Last week Ethereum [ETH] prices “Flash Crashed” on the GDAX/Coinbase exchange. Price went from ~$320 to $0.10 and then back to the $300’s in seconds. Heaps of money were made and lost, and Coinbase is sorting it out trying to make it right. Clearly, this was not a good thing. Yet, even “mature” exchange (like the NYSE) can flash crash and have outages. The important thing is that Coinbase is trying to make it right and that in the end will build trust. How did it happen? From Coinbase:

On 21 June 2017 at 12:30pm PT, a multimillion dollar market sell was placed on the GDAX ETH-USD order book. This resulted in orders being filled from $317.81 to $224.48, translating into a book slippage of 29.4%. This slippage started a cascade of approximately 800 stop loss orders and margin funding liquidations, causing ETH to temporarily trade as low as $0.10.

Our initial investigations show no indication of wrongdoing or account takeovers. We understand this event can be frustrating for our customers. Our matching engine operated as intended throughout this event and trading with advanced features like margin always carries inherent risk.

We are continuing to conduct a thorough investigation and will keep customers updated with any resulting actions. With that in mind, it is important to note that these trades are final in accordance with our GDAX Trading Rules (Section 3.1). Honoring properly executed orders is critical to maintaining the integrity of an exchange.

In response to the large price movement we decided to temporarily halt trading of ETH-USD. Once we confirmed all systems were operating correctly, we restored trading in accordance with our Downtime Process(Section 5).

Because there really isn’t a linkage between global crypto exchanges I think the fallout was pretty minimal. Had other exchanges traded more in lockstep with GDAX we may have seen sustained issues from this event.

Conclusion

For US investors and those abroad with access to Coinbase I think they are best of pure from a purely “retail” or buy and hold (HODL) perspective. For active traders or those a bit more technologically inclined GDAX is a better alternative. Gemini is another US exchange which merits mentioning here as a US based competitor to GDAX. These platforms offer better security and a more regulated environment than not US competitors and while that may come at a slight cost, its valuable insurance.

Crypto Prices & Froth

Bitcoin, Ethereum, Crypto: Prices & Froth

What has been happening recently in Bitcoin, Ethereum and the cryptocurrency space has been nothing short of incredible. Prices went parabolic producing once in a lifetime returns (and wealth) for many lucky individuals. I suspect the recent price declines have stripped many of their savings, but you tend to hear less about those guys.

Before I continue: Let me emphasize that what follows is not investment advice. I am completely unqualified to offer investing or trading recommendations. What follows is pure guesswork and speculation. Trade and invest in Bitcoin, Ethereum or any of the other cryptos at your own risk.

Where Have Crypto Prices Been

Ethereum [ETH] which many view as the future of crypto is up several thousand percent this year (and we’re only 6 months into ’17!).

Ethereum Price Rise

Justified? Maybe. Too much too soon? Quite possible. I think incredible things exist and are coming in this crypto, but prices that go parabolic tend to correct.

ETH launched on July 30th, 2015 which was roughly 700 days ago. Below is a chart of Bitcoins [BTC] first 700 days:

Don’t misinterpret this chart as an indication from me that ETH prices will decline, I have no idea.

There are several reasons why this specific comparison may not be valid – I could easily place charts comparing tech stocks in the 2000 or tulip prices in the 1600’s. Prices can often move too far too fast regardless of the validity of the asset itself.

Bitcoin in 2013 was the first major crypto currency and people had to wrap their heads around the entire concept.  Often Mt. Gox gets solely blamed for the 2013 price bubble, but pure speculation was also a participant. Obviously Bitcoin is now trading well above the 2013 peak, just as many tech stocks are at highs today.

Ethereum is a new player to a more understood field and therefore open to faster adoption which could justify the rise. The last several months saw several exchanges come online, many new technology developments and a large jump in media coverage.

There are some signs for caution – much of the Ethereum technology is still in very early development, despite attracting large investment. Bitcoin is wrestling with its blocksize issue which may resolve in the next several weeks (segwit August 1st). There is lot happening very fast and its easy to let hype drive emotion.

Whats Ahead for Bitcoin & Ethereum

Somewhat akin to the theory of Diffusion of Innovation early adopters have come quickly into the space. While money is flooding into cryptos (Just look at the ICO or Initial Coin Offering  market) the doors to huge assets doesn’t appear open yet. Anecdotally, it seems like Venture Capital is just catching on to the hundreds of millions being raised. (Here is a great Tim Ferriss, Nick Szabo podcast). Wall Street still hasn’t come on board if the SEC initial ruling on Bitcoin ETF’s are any indication. The lack of regulation (part of what some say is great about crypto) is a hindrance for government regulated entities. Additionally, for large entities there are massive issues in crypto when it comes to custody of funds and the like. I’d speculate that both sentiment and technology will grow, and open the doors to much larger pools of capital.

What tends to get lost in all of the price speculation is the technological revolution thats arrived. Today, with Bitcoin you can move millions of dollars globally, at an instant, for pennies. In Germany the Ethereum network helps charge up electrical cars and collects payment. Many think this is all leading towards “Web 3.0” which will decentralize the internet making it more efficient.

Regardless of current trading level amazing things are happening. As the innovation continues value will grow, and price will follow.