TLDR: Coinbase Global, Inc (COIN) did not directly answer the question about a new disclosure: can a bankruptcy filing by Coinbase result in the loss of a customer’s assets?
The Rolling Disaster
I am one unhappy Coinbase (COIN) shareholder. After alternating between buying and shorting COIN at much higher levels, I finally settled on buying and holding (dare I say HODLing?) COIN. I put the stock on the shelf with a plan to check in from time-to-time. The carnage following the Q1 2022 earnings report became one of those (painful) times. I understand this is the wrong time to own such stocks, but a disclosure disaster is too much to take.
The Disclosure That Is Apparently Not A Disclosure
Q1 earnings were bad enough for Coinbase. A disclosure in the associated 10Q sealed COIN’s fate on the day. Upon first (and last) reading, the following disclosure suggests that customer funds could be confiscated in a legal proceeding over a Coinbase bankruptcy.
“…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.”
Coinbase responded to the flurry of concerns by issuing assurances in a blog post and through tweets on Twitter (TWTR). In a post titled “A message to our customers”, Coinbase emphasized in bold:
“You may have heard some noise recently about who owns your assets and what claims Coinbase creditors may have to them. The reality is that your assets are… your assets. Not ours or anyone else’s.”
The company went on to refer readers to an explanatory section from their User Agreement that reportedly supports the claim that Coinbase cannot take customer funds for its own purposes (emphasis mine):
“2.6.1. Ownership. Title to Supported Digital Assets shall at all times remain with you and shall not transfer to Coinbase. As the owner of Supported Digital Assets in your Digital Asset Wallet, you shall bear all risk of loss of such Supported Digital Assets. Coinbase shall have no liability for Supported Digital Asset fluctuations or loss. None of the Supported Digital Assets in your Digital Asset Wallet are the property of, or shall or may be loaned to, Coinbase; Coinbase does not represent or treat assets in User’s Digital Asset Wallets as belonging to Coinbase. Coinbase may not grant a security interest in the Supported Digital Assets held in your Digital Asset Wallet. Except as required by law, or except as provided herein, Coinbase will not sell, transfer, loan, hypothecate, or otherwise alienate Supported Digital Assets in your Digital Asset Wallet unless instructed by you.”
(Potentially interesting sidenote: at least two other crypto players have similar language in their customer agreements: Cryptobucks and Blockquake).
I am no lawyer, but the disclaimer “except as required by law” is a pretty big hole in this agreement. A bankruptcy proceeding is a legal matter subject to laws. Coinbase needed to unequivocally clarify that there are NO conditions, legal or otherwise, under which customers can lose their accounts without a customer causing their own harm. These funds are not insured by any regulatory agency, so customers have no recourse if their money vaporizes into the pit of a legal proceeding.
Coinbase did not directly answer the concern at hand. Is there ANY bankruptcy condition under which customer accounts could be seized from their owners? The disclosure clearly says “yes.”
Communication Fail
The CEO’s tweet did not clarify matters.
Funds may be as safe as they were, but it turns out yesterday’s safety was misunderstood. Something changed. The disclosure causing the “noise” is new; it does not appear in the Q4 10Q or in the annual report. Coinbase needs to explain why it felt compelled to make this new disclosure. The company failed in its communications.
The Cathie Wood Endorsement
At least one person is unfazed by the noise: Cathie Wood of ARK Invest. As is habit, Wood and team reflexively loaded up on more shares right into the teeth of a post-earnings plunge. This Martingale-like strategy is extremely risky. I interpret this behavior not only as an attempt to reinforce bullish convictions over a rolling 5-year period, but also an attempt to use the constant inflow of money to lower cost bases enough to make a return in 5 years possible.
I now await an explanation from ARK about its view on Coinbase’s troubles. ARK sends a weekly email to explain or describe one-day changes of +/- 15% of portfolio stocks. ARK has sent a LOT of these emails over many months.
COIN is the 4th largest holding in the ARK Innovation ETF (ARKK) at 6.1% (before the latest purchase). COIN is the 2nd largest holding in the ARK Fintech Innovation ETF (ARKF) at a whopping 9.0% (before the latest purchase). The post-earnings plunge helped drive ARKF to an all-time low, a major setback given Wood has taken to referencing fund performance since the pandemic lows.
Be careful out there!
Full disclosure: long COIN (perhaps not for long! Ironically, I stopped trading crypto in Coinbase months ago.)