Exploring the Hidden Risks of Coinbases Direct Listing

Coinbase's Direct Listing

Discover the hidden risks behind Coinbase’s direct listing with this informative blog post. Gain insights into the unique dangers that investors need to be aware of and learn how these risks can impact your investment strategy. Make informed decisions and navigate the potential perils that come with Coinbase’s unconventional IPO approach. Don’t miss out on this essential information that will help you make the right choices.

Delve into the lesser-known perils associated with Coinbase’s decision to forgo the traditional initial public offering (IPO) and embrace the unconventional path of direct listing. In this blog post, we uncover the unique risks that investors need to understand and how these risks can impact their investment strategy. Gain insights into the potential dangers that come with Coinbase’s direct listing and make informed decisions with this essential information.

Coinbase began publicly trading on the Nasdaq stock exchange Wednesday, surging past its initial reference price and opening above $380 per share. Its the first company specializing in cryptocurrencies to hit the market, cashing in on the rising interest in digital currencies such as Bitcoin and Ethereum. This hot IPO may soon usher in a tide of other crypto-related companies making a play for investor dollars.

But theres a twist: Coinbase (ticker symbol: COIN) bypassed the usual method of going public an initial public offering (IPO) in favor of a direct listing. And this difference poses some different risks to investors from the typical IPO route through an investment bank.

Heres what you need to know about direct listings and why they offer some unusual risks.

Direct listing vs. IPO: Here are the key differences

To debut on the Nasdaq stock exchange, Coinbase is using a direct listing, and that process differs from the more traditional IPO route.

  • In an IPO, a company hires an investment bank to manage the process, offer advice and ultimately sell stock to the public. In this kind of process the company raises capital for itself by selling newly issued stock to the public, and some insiders may cash out some of their stock as well. So the company gets both a fresh influx of capital and an opportunity for certain insiders to take some money off the table.
  • In a direct listing, its the companys insiders or shareholders not the company itself who sell stock through the exchange directly to the public. So when the stock debuts, public investors are buying directly from insiders. Thats what Coinbase is doing. Its not raising money for itself by selling new shares; only insiders are initially selling the stock.

Direct listings are rare. Usually the maneuver is reserved for smaller, under-the-radar firms, but its been more high-profile in recent years as a few well-regarded companies have gone public this way. Office messaging app Slack, music streamer Spotify, data-mining firm Palantir Technologies and productivity app Asana all used this method in the last few years.

A company may benefit by going public with a direct listing, avoiding Wall Streets hefty deal fees and not diluting its own stocks value by issuing more of it. So if the company doesnt need more cash to run its business, then it may make little sense to pay for it.

But a direct listing also exposes investors to some unusual risks that they wouldnt typically have to face with the traditional IPO route. Here are four key risks to consider with the Coinbase direct listing:

1. The market may be thin or non-existent

In a traditional IPO, Wall Street investment banks round up buyers and hype a stock to attract interest, both in the deal itself and in the aftermarket where it can be bought by the general public. Investors know how many shares are slated to be sold, and even if theyre not among the privileged few to buy in the IPO, they can buy publicly along with anyone else who wants to.

However, in a direct listing, the number of shares to be floated on the market depends on whether insiders want to sell and how much. Supply could be much lower than demand or much higher, though given investors furor over Coinbase, its hard to imagine supply outstripping demand. New shares of stock will enter the market as insiders want to sell.

That all means that theres no guaranteed market for the new stock, making it potentially difficult to access, at least for a while and also at a price that you would want to pay.

2. Volatility

With relatively few shares traded on the exchange, the price of Coinbase stock could fluctuate significantly, especially initially.

In a traditional IPO, the underwriters support the stock price in a few ways. They market the stock to institutional investors and build interest. They set an IPO price, creating a psychological fair value and trading range for the stock. In addition, they typically support the stock through some technical means, helping the stock stay above the IPO price, at least in the short term.

But because a direct listing bypasses the investment banks, it doesnt enjoy the same benefits. And it may have relatively few shares trading, compared to strong demand, meaning the stock may fluctuate significantly in its early days. So investors trading in a thin market may wildly swing the price up and down as the market rushes to stake a position or sell one.

These technical factors could end up driving the stock price more than Coinbases business performance. High levels of volatility can scare investors into selling or buying just when they shouldnt.

Coinbase will go public with a dual-class share structure, meaning that it has two classes of stock. This structure gives some insiders, often officers, extra voting control. For example, insiders may get 10 votes per share, while normal shares receive one vote per share.

For Coinbase, insiders hold more than 60 percent of voting control, meaning theyll hold enough power to direct the company and manage other important issues, such as how theyre paid.

A dual-class share structure is not popular with outside investors because the structure means they have less say in how the company is run. Instead, the structure makes it easier for insiders to entrench themselves and run the company as they see fit.

While this issue is distinct from the risks of a direct listing, a small direct listing might attract investors who are less sensitive to this dual-class structure than institutional investors. Still, some highly successful companies, such as Alphabet, have established similar structures.

4. Insiders — and only insiders — are selling out

In most market debuts, whether theyre traditional IPOs or direct listings, insiders are selling stock to outsiders. Why does that insider who presumably knows the company best want to cut an outsider in on the action? Investors always want to be asking themselves this question.

In a direct listing such as Coinbase, the company itself is not raising cash, so only insiders are looking to cash out. Insiders might sell for any number of reasons, such as having most of their assets tied up in one investment, creating a lot of risk for them personally. But the reasons may also be less benign, and insiders may want to sell out permanently and put the risk on outsiders.

In a traditional IPO, investors have some protections against such insider self-dealing. The conditions of the IPO often restrict insiders from selling further shares in the public market until some period of time after the IPO (a lock-up), giving investors time to evaluate the company.

However, restrictions are typically lower in a direct listing, and in the case of Coinbase, none of its stockholders is under a lock-up, so they could sell and release all their shares onto the market.

So these elements all together insider selling, the ability to sell stock with no restrictions, a dual-share structure that privileges insiders and create an unattractive perception. So theres a setup that looks like insiders could be taking advantage of outsider investors. But thats a question of optics, and this trifecta does not look pretty.

Bottom line

While certain risks involved in a direct listing may make Coinbase look initially unattractive to some, it could go on to be a great investment. But investors need to consider the risks, including going public via this oddball-style IPO, and what they may indicate.

All that said, other recent trendy direct listings including Slack and Palantir have come off without any significant issues, so a direct listing can work.

Of course, the direct listing is but one risk, and investors need to examine the many other risks associated with Coinbase, as they would for any investment. Coinbase may become a great investment, as cryptocurrency such as Bitcoin increases in popularity. Either way, investors will want to understand the business, how to invest smartly and how to diversify before plunging in.

Learn more:

  • Best online brokers for buying and selling cryptocurrency
  • NFTs, explained: What are these hot digital collectibles bringing in millions?
  • Best online stock brokers for beginners

Editorial Disclaimer: All investors are advised to conduct their own independent research into investment strategies before making an investment decision. In addition, investors are advised that past investment product performance is no guarantee of future price appreciation.

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Coinbase’s Direct Listing

Coinbase’s Direct Listing

Coinbase’s Direct Listing