Here are the biggest risks Coinbase investors face

James Royal, Bankrate.com Analyst and Author of “The Zen of Thrift Conversions”, joins Yahoo Finance’s Kristin Myers and Alexis Christoforous to discuss the volatility in cryptocurrency.

Video Transcript

ALEXIS CHRISTOFOROUS: And certainly, investing in Coinbase is not going to be for the faint of heart. Whether you're an institutional investor or a retail investor, for sure, the business and the stock are expected to have some pretty dramatic swings.

Here to talk about that now is James Royal, analyst at Bankrate.com and author of "The Zen of Thrift Conversions." James, thanks for being with us. Can you lay out for us some of the biggest risks you see for investors getting in on Coinbase at this point?

JAMES ROYAL: So I think with the Coinbase IPO, you've got at least a few major categories of risk. You can think about valuation risk here, fundamental risk, and then some risk just to do with this direct listing, right? We're going to have a relatively limited number of shares here. So the market's going to be relatively thin in comparison to a traditional IPO. And so you might-- you may see demand outstripping supply by significant amount, especially in the early days. And so that could create a lot of volatility here, both positive and negative, as sort of people race for shares or are looking to trade the pop or, you know, all these sort of investment strategies here.

So those are some of the issues with the direct listing. And of course, the direct listing doesn't have the support, you know, as the stock would in a traditional IPO, right, where you've got the roadshow and the hype from the investment banks and whatnot and, you know, just the fact that you're sort of setting a psychological price target with your-- with the IPO price.

But those are issues with the direct listing. If you want to look at valuation, though, you know, Coinbase looks great in terms of growth on traditional metrics, right? You had 2020 sales grow nearly 140% over 2019 sales. And if you make it more granular than that, if you look in the first quarter of this year based on their reported figures, you see sales up 10 times over the prior year quarter, right? So that's absolutely phenomenal on those traditional metrics.

And if you looked at the-- if you annualize those first quarter earnings, it looks like the stock might be at 30-- at that $100 billion mark, where we're sort of trending now. It looks like the stock might be 33 times earnings. But there's a big assumption built into that, right? And that's where some of the fundamental risk is-- comes in, right?

Will Coinbase be able to maintain that level of revenue? And that relies a lot on the price of the cryptocurrencies itself because it takes a cut of those. And it relies also on volume, right? And so those are some of the fundamental issues. Is this going to be-- become more widespread or is interest going to wane? And thinking about those issues--

So those are three categories here. And investors really need to look carefully at all the risks here.

KRISTIN MYERS: James, I want to bring up that point you're mentioning, at least about cryptocurrencies themselves-- are incredibly volatile, which, of course, could cause huge swings when it comes to the revenue for Coinbase itself. How much, you know, caution should, really, investors approach with this IPO given that fact, especially as, in the background, we frequently hear folks, at least when talking about Bitcoin, saying that the higher that the price rises, the more stable that cryptocurrency becomes, which should, of course, give perhaps a little bit-- alleviate some fears for some folks, especially as we're seeing, you know, Bitcoin right now up over $63,000 for one coin. So how should folks approach that?

JAMES ROYAL: Yeah. I don't know that you could say a currency that's completely electronic and has very limited practical use-- the fact that it's risen six to seven times in a year-- that strikes me as tremendously volatile. I think Coinbase is doing a good job here in thinking about their IPO, selling while those cryptos are at a tremendously high price, you know, at all-time highs. And so I think that that's quite beneficial for the stockholders who want to sell out at this price. They're really taking advantage of the market here.

ALEXIS CHRISTOFOROUS: All right. We're going to ask you, James, to please stick around as we wait for Coinbase to finally start hitting the tape here and trading on the NASDAQ. So do stay with--