The Big Lesson from the Coinbase Chaos

The Money Minute is your one-stop-shop for financial advice. Subscribe to get three articles/week on the best money tips, delivered straight to your inbox. 💸💸💸

Coinbase is a huge name in the crypto space and the finance world in general. If you haven’t heard of it, it’s a platform where you can buy, sell and store crypto securely.

Or, at least, that’s what we thought.

Earlier this month, Coinbase released their quarterly earnings report. Reporters at Fortune read the fine print of this report, and called-out a disclosure that shocked and terrified Coinbase users.

Here's what they found.

The disclosure stated that if Coinbase ever filed for bankruptcy, their user’s assets may be seized. And I’m not exaggerating. This is the exact language from Coinbase: "Because custodially held crypto assets may be considered to be the property of a bankruptcy estate, in the event of a bankruptcy, the crypto assets we hold in custody on behalf of our customers could be subject to bankruptcy proceedings and such customers could be treated as our general unsecured creditors.”

That’s a whole lot of jargon, but the wording that is particularly noteworthy is calling users “general unsecured creditors.” That means that users would be stripped from the right to their own assets. Can you believe that? No one signed up for that!

I can’t even begin to explain how insane that is to me. It would be like your bank saying, “Yes… your money is safe here. But if we ever f*ck up and stop doing our job or make a gigantic mistake, we’ll play responsibility musical chairs and you will become the bank.”

In all my years of reporting on financial news, I’ve never seen anything like it. The next logical question is, of course:

How likely is it that we are going to see this disaster play out?

Coinbase CEO Brian Armstrong says there’s nothing to worry about. He tweeted: “Your funds are safe at Coinbase, just as they’ve always been.” Armstrong also said explicitly that the company is not at risk of bankruptcy, and explained that the company had to add that disclosure in the earnings report because of a requirement from the SEC.

However, Armstrong wasn’t all warm and fuzzy. He also tweeted: “This disclosure makes sense in that these legal protections have not been tested in court for crypto assets specifically. It is possible, however unlikely, that a court would decide to consider customer assets as part of the company in bankruptcy proceedings even if it harmed consumers.”

So, how I read this is that Armstrong is ultimately saying— Coinbase users don’t have anything to worry about… until they do.

But let’s not take Armstrong’s word for it, let’s look at the numbers. On the plus side, Coinbase just became the first crypto company to become a Fortune 500 company. In 2021, Coinbase recorded a revenue of over 7.8 billion dollars, which doesn’t sound like a company on the verge of bankruptcy.

However, in the now infamous earnings report, Coinbase reported a $430 million loss and a 19 percent drop in users per month. Fortune also noted that Coinbase shares fell 15.6% after the earnings report came out, dragging the company’s stock price down to 80% below its Nasdaq debut in April 2021.

Bloomberg has taken some swipes at Coinbase too, calling out that Coinbase took months to launch their NFT marketplace, and now that the marketplace has launched, it hasn’t been very successful. Bloomberg's analysts also expect that Coinbase will lose 1.4 billion dollars this year.

And there are some more signs that indicate that there may be some more trouble ahead. For example, Coinbase is slowing down hiring, which is typically a precursor to layoffs. However, a spokesperson for the company said “While Coinbase may be slowing down our hiring, we have no intention of slowing our pace of product development.”

But even if the company can introduce some major revenue-generating projects, this controversy around the bankruptcy disclosure clause is doing some financial damage that will be hard to reverse.

What is the lesson from this story?

Since crypto has broken into the mainstream, everyone has been figuring out what to call it. And I do mean everyone, including financial institutions like the IRS, has struggled to classify crypto. Is it a currency, like the U.S. dollar? Or, is it an investment, like Apple stock? I argue that this Coinbase story helps us determine once and for all that crypto is an investment, not a currency.

Here's my reasoning. In the US, when you deposit your dollars in a bank, your money is protected by the FDIC (Federal Deposit Insurance Corporation). If your bank fails, the FDIC protects your account up to $250,000.

Coinbase is not offering that same insurance. It's almost like they're offering the opposite: they’re offering risk. This makes crypto much more similar to an investment than a currency. If you’re an investor in a company that goes bankrupt, in most cases, you will lose your investment; there’s no FDIC insurance, in fact, shareholders are the last to get paid in case of a liquidation event— which is just the fancy way of saying that investors typically lose everything if the company they invested in goes bankrupt.

I think this story helps us finally answer the question: what is crypto? It’s not a currency, it’s an investment. And a bad one.