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Coinbase’s Inevitable CME Takeover

By | Jun 10, 2018

Coinbase’s Inevitable CME Takeover

Don’t take your eye off Coinbase – the minute you do, you won’t recognize it when it resurfaces. Despite being only tenth in global cryptocurrency exchange volume and being absolutely dwarfed by pre-eminent power Binance, Coinbase (aka GDAX) is the single most important crypto exchange on the planet and its upside potential recalls memories of watching a young LeBron James play at St.Vincent-St. Mary High School – you knew the kid was destined for greatness and global domination.

I’ve written on this topic before but cryptos move in “dog years” – I stole that line from someone else, but it’s the most apt description I’ve heard yet – so anything I wrote in February on this subject might as well been a decade ago. This is all happening at breakneck speed and the more I follow it all, the dizzier I get. Anyways, here’s my “I-have-no-inside-information-and-don’t-want-any-so-please-for-heaven’s-sake-don’t-make-a-trading-decision-off-this; I-don’t-know-anything!” prediction: (You gotta get those disclaimers out of the way right away): Coinbase will in the next 12-18 months buy the Chicago Mercantile Exchange (“CME”) for a cool, say, $125 billion.

A couple quick points: CME ain’t buying Coinbase. Nope, that would be like Goliath beating up David. “Don’t you know, we’re talking about a Revolution?”

If you don’t know who’s in that picture, please do yourself a favor and Google those italicized lyrics up above

Just because the AOL-TIME Warner merger didn’t work out, doesn’t mean an upstart business with phenomenal technology, a balance sheet bursting at the seams in an industry on fire, with the most ebullient debt and equity markets of all time can’t shock the world with an irreverent, unconscionable and upside-down takeover of its own.

Coinbase can buy the CME, and the probably should by the CME, and I think they likely will buy the CME.

Here’s why: Coinbase is probably worth about $25-30 billion on the open market today, if it were a publicly traded company – in my opinion. Now, we know that in a private, secondary transaction Coinbase was valued earlier this year at about $8 billion, and lots of people laughed and said that’s stupid, and Bitcoin’s a bubble….

And that all kinda makes me chuckle.

I remember when the Ricketts family bought the Cubs for $900 million and super-smart people said “That’s stupid”. And when Uber was valued in a secondary transaction at $50 billion (before the Kalanick fiasco) and people said “That’s stupid”.

In case you’re wondering how those investments have fared, the Ricketts family has probably doubled their investment in a decade (and won a World Series ring in case you’ve been on Mars), and in February, tech insider Recode valued Uber at $72 billion – give or take a few.

What always gets me is the notion that the investors who paid an $8 billion valuation for Coinbase are somehow “Dumb Money”. Um, it’s kind of the other way around; institutional money often comes in late and at a much-higher valuation than in early rounds, but these lofty stocks also – when done right – trade at a valuation that no one will ever get their hands on again. I feel that the $8 billion Coinbase valuation from earlier this year is precisely just that – let me know when Coinbase stock trades at that price again.

Why these two? Good question.

It’s unthinkable that a foreign exchange would takeout CME. Not gonna happen. Cross-border exchange purchases went out of vogue over a decade ago as nationalistic pride throttled a handful of deals from Australia, to Germany to Singapore and beyond.

Just in case you think Binance – which is ten times bigger than Coinbase in terms of daily trading volume – is buying CME, think again

Back home, Kraken is another candidate but the odds of them getting in bed with CME are about 47 trillion to one. Reason: culture clash. Different worldviews – wouldn’t even make it through the honeymoon period.

CME wrote the book on courting Washington as Leo Melamed and every chairman of the behemoth Chicago exchange on down to current chief exec Terry Duffy put politics aside for decades and focused on one mission: working with regulators not against them.

Kraken took that same book and threw it out the window. After former New York Attorney General Eric Schneiderman launched inquiries into several top crypto exchanges earlier this year, Kraken’s CEO Jesse Powell Tweeted: ““Somebody has to say what everybody’s actually thinking about the NYAG’s inquiry. The placative kowtowing toward this kind of abuse sends the message that it’s ok. It’s not ok. It’s insulting.”

“New York – here’s what I think of your $%%$#$#%##%# Bitcoin Licenses” – OK, that’s a made up quote; sorry, I couldn’t resist

Never one to mince words, Powell went on to use some language we can’t print in a family blog to describe the former AG and declared: “Kraken left New York because New York is not only hostile to cryptos…it is hostile to business. Good luck, New Yorkers. (For more on the Powell diatribe, click here: https://www.coindesk.com/kraken-ceo-crypto-exchange-wont-comply-with-new-york-inquiry/).

Please note: I am not taking sides here. But having traveled many times on industry field trips with Terry Duffy, his board and the CME’s biggest clients to kiss rings in D.C., I can assure you that a Kraken-CME marriage could never, ever happen – and that’s perfectly OK, by the way.)

Enough Already, What are the Economics of the Deal?

The CME is worth about $60 billion today on the open market. No one could get it for less than $80 billion or so, probably because no one would know what to do with it. Jeffrey Sprecher’s ICE exchange, which owns the New York Stock Exchange, reportedly made a bid for CME a couple years ago but apparently some feathers were ruffled along the way. Unsolicited, I’ve been told by CME insiders that ICE and CME will “never” merge as a result of CME being left at the altar last time. Or until Sprecher or Duffy are both gone.

And maybe it’s not personal at all. Coke and Pepsi have never merged for a lot of reasons – anti-trust being one of them – but in the end it may be simpler than that: after competing tooth and nail for decades, the two institutions don’t really like each other.

I think grudges are better suited for schoolyards than for boardrooms, and for the right price any business is for sale, so I wouldn’t rule out an ICE-CME tie up. Sprecher is the greatest deal maker in the industry by far – the guy walks on water – so you’d be foolish to count him out, but these two giants merging is about as exciting as AT&T and Verizon – who are currently under federal investigation for collusion – getting together.

Sure, ICE bought NYSE but even so, CME just makes more sense. At the end of the day, ICE will always be a natural gas and commodity exchange while CME is the dominant financial derivatives powerhouse. The client mix at CME is simply a more natural fit – you can’t put a square peg in a round hole.

OK, OK: Let’s get down to brass tacks.

The CME dividend is a paltry 1.64% and it literally might be the safest dividend in America. C’mon, that’s chump change relative to their $4 billion revenue number. If Coinbase offered $50 billion in corporate debt at a 5.5% coupon it would be gone in an hour as every major bank of Wall St. would take a large chunk.

This week Ray Dalio of Bridgewater, the greatest hedge fund manager in the history of the world not named George Soros, announced to the excitement of no one that: “”We are bearish on almost all financial assets” heading into 2019.

What if you listened to him way back when? Psssst: that’s a young Mr. Soros – not a young Mr. Dalio

Yup, a 5.5% virtually guaranteed corporate handout – err, bond – sounds pretty darn good after a decade of non-stop rising equity and real-estate markets. To think that a whole generation of young investors don’t recall ever seeing the stock market go down in a year; well, their poor parents sure do and let’s review the math here real quickly– up 5.5% beats down 20% by……a lot.

(Skip this part unless you’re really an exchange geek: Only CME insiders and traders will know what I am talking about, but the anachronistic membership system at CME – which is frozen in the stone ages – ties up at least a billion dollars in dead capital as members get a discount on trading fees (but no equity in CME shares) in what Mr. Duffy once joked to a roomful of people who owned the darn things (including me) are among the most illiquid financial instruments in the world – which would be sad if it weren’t also true.

The bid-ask spread on a full membership at CME as of Friday was – hold your breath – $184,500 wide. I’m not making this up, friends. Or you can go buy Binance Coin tokens with a dime wide bid-ask and a market cap of $1.8 billion to get fee discounts to trade on the exchange with the same name. I wonder what model crypto traders will opt for in coming years.)

In sports, when you’re playing with a 24-point lead at halftime, you sit on the ball. CME is in a comfortable, almost enviable, position. If you’re sitting in the CME boardroom (which is very nice, by the way) you’re overriding thought must be: “Don’t screw this up.” It’s Wall St.’s version of the Hippocratic Oath – Do No Harm.

What a coincidence, then, that Coinbase announced earlier this year that they were opening a Chicago office. “The talent that’s here in Chicago, you can’t find anywhere else,” said Paul Bauerschmidt, a former CME executive, who is leading the Chicago office. “And especially getting as many of the key staff as we need. It’s really exciting to be able to build it here.”

Coinbase had a billion in revenue last year. As institutional money comes into cryptos, that number will soar in coming years. And in case you’re wondering: that’s already starting to happen. Last week, Fidelity – ever heard of them? – was reportedly said to be “plotting a big move into cryptos”, according to Business Insider.

Based in San Francisco, Coinbase said last week they are seeking every regulatory approval you can think of: FINRA, SEC, broker-dealer, alternative trading system license, registered investment advisor. Have you ever hired and paid a securities lawyer before? I have. That alphabet soup of regulatory hurdles Coinbase just announced they’re going through is not cheap: think of a number; double it; add a zero or two; and you’re half way there to totaling up Coinbase’s budget for legal.

Coinbase isn’t aiming small, and I say this without a hint of sarcasm or mean-spiritedness at all: their board has more ideas in a week than CME probably has had in the last five years. The CME’s crypto foray thus far is one measly futures contract than can barely gain any momentum; CME’s not exactly setting the crypto world on fire.

OK., Vegas: Give me the Odds

The odds in fact are very low, of course, because I am making this all up. Well, you know what I mean. The facts and figures and comments are in the public domain, so hopefully I got that right. The rest is utter guesswork. Still, let’s look at some actual “odds”

Odds of Coinbase even wanting CME in the first place: 1/5 at best. Coinbase is bullet proof; they can do whatever they want. The only reason I feel so strongly about CME is because I’ve been a client, shareholder and membership owner for two decades, so I understand the inherent synergies better.

Odds of CME buying Coinbase: Zero. Duffy and his team wouldn’t dream of it, and Coinbase would say no, anyways. Do you think for one second anyone could put the Coinbase genie back in the staid CME bottle?

Let’s put it in boating terms: one the one hand, you have the CME as an aircraft carrier; on the other hand, you have in Coinbase as a cigarette boat. With his gal Pea Galore on his side, I can assure you James Bond ain’t tapping the breaks – no chance.

Would James Bond leave his cigarette boat for an aircraft carrier?

Odds of a 5.5% $50 billion Coinbase/CME debt offering getting done? 7.5/10.

Odds of CME stock doubling to $340 a share from its current $170 on a Coinbase buyout proposal worth $125 billion with $50 billion in debt? Fifty-Fifty.

Odds of Mr. Duffy being asked to stay on as Non-Executive Chairman to run interference in DC (and extend the LPGA as corporate sponsors until 2118)? 8/10. No one is better at keeping Washington pols happier– how could they let him go?

Please, Wrap it Up

A whole lot of idle speculation, two thousand-plus words and a bunch of cool photos later, what do we have. Probably less than a 3% chance of this ever happening. But if it does, I want you to remember this “stupid” article and remind yourself something: as a global society, we’re on the cusp of some pretty radical new ideas in Artificial Intelligence, Machine Learning, Big Data, cybersecurity, cloning, self-driving cars, space travel, and yes, cryptocurrencies.

Changes sometimes come at you so quickly you can’t recognize them.

Everyone is familiar with the term “Moore’s Law”, which is the observation that the number of transistors in a dense integrated circuit doubles about every two years. The observation is named after Gordon Moore, the co-founder of Intel who once told The New York Times: “For the first 20 years I couldn’t utter the term Moore’s law. It was embarrassing. Finally, I got accustomed to it where now I could say it with a straight face.”

In a blink of an eye, Coinbase has come onto the global financial markets scene. What will be their Second Act?

Remember this guy? Wow – that happened fast.

2018-06-12T02:37:50+00:00 June 10th, 2018|

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