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The Ratings Game: Coinbase stock gets another downgrade, but not for the reason you’d think

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Bank of America downgraded Coinbase Global Inc.’s stock last month amid concerns that the FTX collapse could weaken confidence in the world of cryptocurrency.

That challenge, raised by other analysts too, is likely well understood by now, but it may not be the only risk to Coinbase’s stock
COIN,
+3.76%
.
Mizuho analyst Dan Dolev went a different route in a downgrade of his own Friday, pondering whether investors were underestimating possible risk to Coinbase’s interest income stemming from a relationship with stablecoin issuer Circle.

Dolev noted that interest income from Circle’s USD Coin
USDCUSD,
-0.01%

“has been increasingly important for COIN amid deteriorating crypto sentiment and trading volume,” accounting for perhaps 10% to 15% of the Coinbase’s third-quarter revenue, by his estimates. He explored how Coinbase’s profits could be affected in the event of any “downward adjustment in its share of interest income from Circle.”

It’s first worth understanding the relationship between the two parties. Dolev notes that “Circle earns interest income on USD held in reserves that back USDC, by investing those reserves in short-term treasuries and interest-bearing cash account,” and Circle has a revenue-sharing arrangement with Coinbase that means the crypto exchange gets some of that reserve interest income.

While Dolev has “no grounds to believe that a renegotiation would occur,” he sees a few reasons why Circle might want to try to change the relationship. “We stress that this is purely a hypothesis on our part, based on observed trends in the industry,” he wrote.

Among the factors that could drive Circle to want an amended agreement are that “Circle’s USDC issuance revenue attributable to COIN is growing rapidly,” Circle has leverage stemming from the fact that other parties can’t mint its tokens, and the recent collapse of Circle’s special-purpose-acquisition-company (SPAC) deal “could potentially make Circle’s management rethink its business model.”

Coinbase and Circle didn’t immediately respond to a MarketWatch request for comment on whether there had been talks on changing the relationship.

Mizuho’s Dolev commented that if the agreement were to be amended, it could have an “amplified adverse effect” on Coinbase’s profitability.

“Our assessment of consensus estimates for interest income for COIN suggests that the Street is underestimating the potential risks” he wrote, since the interest income “is likely coming at a near-100% margin.”

He downgraded the stock to underperform from neutral Friday, while reducing his price target to $30 from $42. Shares closed Thursday at $42.81.

Shares of Coinbase were off more than 1% in premarket trading Friday. They’ve lost 83% so far in 2022, as the S&P 500
SPX,
+0.75%

has lost 17%.

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