Ecommerce, Crypto and Coinbase

In this week’s article we answer three burning questions:

• What is the next evolution in ecommerce advertising?
• Why is crypto so volatile?
• How did Coinbase do in the first quarter of 2021?

What is the next evolution in e-commerce advertising?

Imagine you’re scrolling through your social media feed. You see an item you’re interested in. You click through the link to the item in the comments. You proceed to add the item to your shopping cart. The website then prompts you to create an account, enter payment information, and enter shipping information before you can complete the payment. That’s five different steps before the purchase can be completed. Each step introduces additional inefficiencies, as people leave and abandon their cart.

To improve on this process, the social media giants are deploying a strategy to internalize the shopping experience pursued. We will give several examples here, but you will see the following common themes:

• The shopping is integrated within the social media feed. No more clicking outside the platform.
• The social media platforms know the user’s identity. So shoppers do not have to enter personal information upon every purchase.
• The social media platforms can now vertically integrate into payments.

As a result, the shopping experience is much smoother. This is called Direct Response advertising, and it is a strategy being deployed by the leading social media companies in China and the US (TikTok, Facebook, and Google).

How TikTok is doing it in China (TikTok in China is called Douyin)

Here is how Douyin (TikTok in China) is doing it: 

• Native ecommerce link within the feed.
• Link takes the shopper to the product page within the app (you no longer have to open a browser and visit the shop’s website).
• You are then directed to Taobao to complete the purchase (an Alibaba company).

How Facebook is doing it

Here is how Facebook is doing it: 

• Similar to Douyin, there’s a native ecommerce link within the feed.
• Link takes the shopper to the item selection and checkout page.
• Facebook integrates its own payment solutions (and charges a fee – currently the fee is waived, but in the near future it will be 5%. The low fee is probably to incentivize adoption).
• Shopper completes purchase.

For Facebook, the direct response strategy is important because it accomplishes the following:

• This can help the company mitigate the business impact on the new privacy policies that Apple introduced in iOS 14.5, which limits cross domain tracking.
• This can improve ad efficiency on Facebook platforms, which means advertisers will spend more on Facebook’s platform.
• The payment solution will be important for future monetization. More on this later. 

How YouTube is doing it

Here’s how direct response ads look on YouTube.

YouTube’s approach is a bit different. Unlike Facebook or TikTok, who primarily serve discovery ads (serving ads that might be relevant to you, but you are not actively looking for), YouTube is popular for “how to” videos, “unboxing”, and other videos. Viewers of YouTube have high intent. So YouTube primarily serves intent based advertising (ads are served while you are actively looking for a product or service).

YouTube’s solution is very new and is still in beta with select partners. But similar to the two approaches above, it’s integrated within YouTube’s platform. 

Google is very optimistic about the importance of YouTube for the new direct response push. YouTube revenue grew to US$6 billion in Q1 2021, driven by this new direct response format. 

Who is powering these e-commerce integrations?

For both Facebook’s and YouTube’s e-commerce integrations, the actual e-commerce shop is powered by Shopify, which handles the inventory management and other back office functions. 

As we described previously, Shopify has two business segments: 

• Subscription solutions (geen bar): This segment is the one powering Facebook’s and YouTube’s integrations.
• Merchant solutions (blue bar): This is the fintech segment that takes a portion of the sale.

Growth of the two segments are shown in Figure 4 below. As you can see the merchant solution (blue bar) is the primary driver of revenue growth.

Yes – it’s great that Shopify can acquire distribution through Facebook and YouTube for their e-commerce subscription solutions. But because Facebook and Google will integrate their own payment solutions, Shopify will be relegated to a back-office software provider. This means that the company will not partake in payments revenue from these partnerships (the blue bar in Figure 4 above), which is the primary driver of Shopify’s business.

---

Why is crypto so volatile?

The short answer is because of cascading liquidations in crypto. The use of leverage in crypto trading is extremely common. When crypto prices go down (the trigger could be something as small as a tweet), traders that use leverage face margin calls, which forces them to liquidate, creating further downward price movements. 

Here’s how that works:

• Trader A employs 10x leverage. This means that for every $1 that trader A puts in his account, he borrows $9, to give a total of $10 total investable amount. But if the account declines by 10%, to $9, which is the amount borrowed, the broker will liquidate the remaining balance and collect the loan (this is called a margin call). Because crypto is generally so volatile, the broker actually does this at a price point that is a little higher than $9. 
• This liquidation event pushes the price down even further.
• Now think about the next trader, say trader B, who employs 5x leverage (puts in $2 and borrows $8 to give a total of $10 investable amount). The same rules apply to trader B. If the investment amount declines to the amount borrowed ($8), then the broker will liquidate the account to recover the loan. As crypto prices slide, all of a sudden, trader B sees her account declining to $8. At this point the broker forces the account into liquidation, selling the crypto, creating more selling volume.
• This process continues, creating cascading liquidations.

Here’s how that looks: Figure 5 below shows the liquidation events of both short and long positions for BTC. Anytime there’s a downward price movement, the amount that goes into liquidation spikes (the bars represent amount liquidated in billions USD). 

The use of extreme leverage mostly occurs in foreign (outside the US) crypto-derivatives exchanges. For example, at Binance, traders can get leverage of 125 to 1 for some futures contracts, meaning they can deposit just $1 to acquire the equivalent of $125 of bitcoin.

---

How did Coinbase do in the first quarter of 2021?

A few days ago, Coinbase reported its earnings for Q1 2021 (if you missed our deep dive into the company, watch a quick summary through Video). The stock is down by more than 21% from the IPO day closing price. But the fundamentals of the company has not materially changed since the disclosures before the IPO. 

Here are three key takeaways from the Q1 earnings:
As expected, Q1 trading volume was very strong. Trading volume went up 276% to US$335 billion. Institutions contributed 64% of this volume, but only 5.8% of revenue. Institutional investors are liquidity providers for Coinbase, helping the company extract handsome trading fees from retail investors, which contributed 94.4% of Q1 revenue.

Interest in Ethereum went up. In Q4 2020, the total volume of Ethereum traded was US$12 billion (or 14% of trading volume). In Q1 2021, this number went up US$70 billion (or 21% of total volume). That’s almost a 6x increase from last quarter. The company said that this increase is in part due to increased institutional interest.

2021 Outlook seems rosy. Coinbase also mentioned that its metrics for Q2 2021 are trending higher than the very strong Q1 2021 (as of this writing, we are halfway through Q2 2021). So, the company is updating its projections upwards. Historically, the company makes about US$34 – $45/month per MTU (monthly transacting users). But it expects to generate higher revenue per MTU in 2021 and higher number of MTUs for 2021 (ranging from 5.5 – 9 million, depending on the price performance of the crypto themselves. As of the end of Q1 2021, Coinbase had 6.1 million MTUs).