CoinShares International — A likely beneficial survivor of the crypto winter

CS is a leading European digital asset firm that provides institutional and retail investors access to digital assets in a secure, transparent and regulated way. The company is built on a strong technology backbone (the ‘Galata’ platform), which is the foundation of its two major business verticals: asset management platforms, including the passive investment products (ETPs) and exchange traded fund (ETF) platform, and the capital markets infrastructure, which is active in liquidity provisioning (for its XBT Provider products), fixed income investments, DeFi investments and proprietary trading based on low-latency delta-neutral (ie non-directional) strategies aimed at exploiting market inefficiencies. Consequently, the company is more than a simple beta play/proxy on the bitcoin (BTC) price, as it provides the opportunity to benefit from both overall progress in terms of digital asset adoption (and the potential accompanying increase in the market capitalisation of major cryptocurrencies) and market volatility in the sector.

Our discounted cash flow valuation implies a fair value per share of SEK77.4 (vs SEK70.0 previously), which represents a more than 100% upside to the current share price. This is supported by a combination of expanding addressable market (see below) and CS being able to keep a significant market share in the European digital asset ETP/ETF market given its current leadership position. As the management fee on XBT Provider Trackers is accrued daily but converted into cash to CS only on redemption of the units (c US$40m inflow for CS in 2022), we are factoring in a working capital adjustment in our model. However, this should diminish as CoinShares Physical’s assets under management (AUM) (where fees are accumulated in digital assets daily and converted by CS into cash at will) becomes more significant and as earlier investors in the XBT Provider ETPs decide to cash out.

Predicting the exact prospective price path for digital assets is quite challenging. Consequently, we have decided to present a summary of our forecasts and valuation for CS in a scenario in which digital asset prices grow at 2% pa from the current level (ie BTC at c US$28,000 and Ether (ETH) at c US$1,800). Under this scenario, we value CS at SEK33.9 per share. Other major sensitivities include the adoption path of digital assets, crypto contagion from recent high-profile failures in the industry, competitive pressure, regulatory risks and the XBT Provider Tracker’s redemption pattern.

Despite last year’s bear market (which brought CS’s total AUM down to £1.44bn (c US$1.74bn) at end-2022, from £4.18bn (c US$5.66bn) at end-2021 and £1.74bn (c US$2.38bn) at end-2020), we still anticipate that the secular trend of digital assets adoption will continue in the coming years, driving global portfolio allocations to c 1.80% by 2026 and 2.50% by 2030 (compared to c 0.5% currently and c 1% at end-2021). We believe that the recent high-profile collapses of centralised crypto players (see our recent Edison Explains piece for details) will further improve the market share of regulated and transparent investment products such as CS’s exchange-traded products (ETPs). Based on this, we forecast CS’s total ETP AUM to grow from US$1.22bn at end-2022 to US$6.8bn at end-2026 and US$10.6bn by 2030 (and the blockchain equity ETF AUM to grow from US$525m at end-2022 to US$1.6bn in 2026 and US$2.9bn in 2030). CS’s capital markets business was affected by two major events in 2022 (the Terra/LUNA and FTX/Alameda collapses), which we think will translate into a more cautious approach from CS to generating income and gains from its trading strategies, which we forecast at £20.9m and £32.1m in FY23e and FY24e, respectively (vs c £26.5m in FY22 excluding exceptional losses), see Exhibit 1. In turn, we estimate CS’s adjusted EBITDA at £25.2m and £41.0m in FY23e and FY24e, respectively (vs a £6.5m loss in FY22 and a £121.1m profit in FY21).

CS is one of the pioneers in the emerging digital assets sector, formed in 2013 and headquartered in Jersey, with offices in London and New York. It is a well-established player in a nascent, high-growth industry and one of the largest digital asset companies in Europe and globally, with total AUM of c £1.44bn at end-2022. It has been at the forefront of introducing innovative investment products based on digital assets since its inception. The company’s backbone is its in-house technology infrastructure (the ‘Galata’ platform), required to operate efficiently in markets that are open 24/7 with very fragmented liquidity across trading venues (centralised and decentralised crypto exchanges, as well as OTC markets) and also used to stay connected to traditional exchanges. CS’s focus on continuous development of its infrastructure and technology layer is a critical component of its product innovation in the fast-changing digital assets industry, which is heavily reliant on code development capabilities.

The team behind CS consists of experienced professionals from the commodities trading business. Two of its co-founders (Daniel Masters and Russell Newton) set up the specialist commodities hedge fund manager Global Advisors in 1999, leveraging their experience from, among others, JP Morgan (where Daniel Masters was global head of energy trading), Royal Dutch Shell, Phibro and Salomon Brothers. Jean-Marie Mognetti, CS’s third co-founder, current CEO and a major shareholder, is a former commodities quantitative trader and joined Daniel Masters and Russel Newton at Global Advisors in 2011.

Daniel Masters witnessed the emergence of commodities as a widely accepted investible asset class from the mid-1990s to the cycle peak in 2008. Around 2012–13, the above-mentioned three member team concluded that BTC and other digital assets are likely to follow the same pattern as they represent a similar theme, which they summarised as the ‘three Ds’: 1) demand in the form of utility of digital assets beyond financial speculation; 2) depletion associated with Bitcoin’s periodic halving (see our Edison Explains piece for details); and 3) the dollar, that is deteriorating confidence in fiat currencies following the global financial crisis (GFC) in 2008 and the accommodative monetary policy of the Federal Reserve and other major central banks ever since.

CS has been a pioneer in the digital asset space (see our initiation note for details) with the first regulated BTC hedge fund (co-managed by Daniel Masters and Jean-Marie Mognetti) introduced by Global Advisors in April 2014. CS’s current product suite in its asset management vertical can be divided into three groups:

Moreover, CS has designed and maintained the CoinShares Bitcoin Hourly Reference Rate, an index that is used, for example, by the Invesco Physical Bitcoin ETP. CS also launched the CoinShares Equally Weighted Crypto Index, offering exposure to the five most liquid digital assets.

The CoinShares Capital Markets (CSCM) division, which traded US$10.9bn of notional value during the 12 months to end-September 2022, began as the algorithmic trading arm of the Global Advisors Group (see above) and has been trading in spot and derivative crypto markets since 2014. CS’s infrastructure, connecting ‘analogue’ and digital finance (which now offers connectivity to more than 30 counterparties), was initially built primarily to facilitate a tight bid-ask spread and liquidity for its XBT Provider Trackers. The connectivity network and infrastructure layer that CS has developed over time allows it to deploy its algorithms to both support the asset management platform (eg liquidity provisioning for the XBT Provider Trackers) and execute a variety of trading strategies.

CS has followed a few core principles in developing its infrastructure trading division: 1) all activities should be algorithm-driven (ie minimising manual trading); 2) the technology is utilised exclusively for its own internal purposes (CS has no interest in becoming an OTC broker, although it started allowing some third parties to use its technology as a white-label solution and interact directly with their flow); and 3) CS does not carry out any directional trading but focuses on exploiting market inefficiencies through delta-neutral strategies (statistical arbitrage strategies in particular). CSCM is also active in fixed-income investments, mostly digital asset reverse repurchase agreements, with its counterparties including, for example, hedge funds and family offices. Finally, it is active in the DeFi space, mostly as a lender in decentralised lending protocols. As illustrated in Exhibit 3, CSCM generated a profit throughout FY18 to FY21 during both bull and bear markets, while its FY22 results were burdened by two one-time events (see the forecast section below for details).

CS also invests from its own balance sheet in early-stage technology companies and channels to facilitate the distribution of its products and services. Together with some minor proprietary investments in digital assets and other receivables, its principal investment portfolio was valued at £47.3m at end-2022. Its current major holdings include:

The CS team positions itself to benefit from the way that blockchain technology will disrupt the global financial industry. Its management believes that in the long run, all financial assets will exist in digital form and be traded in a unified 24/7 global market. CS’s vision is to be ahead of the curve in introducing innovative, tech-driven financial products and services to a broad institutional and retail investor audience through a business model based on a combination of platforms making use of its talent pool of tech engineers and financial professionals (CS’s overall headcount at end-2022 was 90). It aims to expand in a capital-efficient manner by staying low-touch and tech-focused, scaling through API integrations and connectivity. It pursues a ‘driverless bank’ approach, which means leveraging automation and programmatic execution to reduce cost and systemic risk, while improving efficiencies of on-chain transactions. Moreover, it puts emphasis on assuring it is investing in its tech infrastructure and risk management systems to exploit trends such as 1) the shift of services to mobile devices, providing more direct access to customers seeking payments, lending and other financial services, and 2) blockchain enabling the emergence of an open and interoperable platform, changing the way clients consume financial services.

Overall, CS’s long-term strategic priority is to leverage its proprietary tech infrastructure to be a provider of 1) asset management solutions (B2B2C, such as its existing XBT Provider and CoinShares Physical platforms) deriving revenues from fees charged on AUM and 2) business solutions (B2B) with a licensing model (platform-as-a-service).

In late 2021, CS acquired Napoleon, a French crypto-focused fintech company, which offered, among others, pre-built portfolios and algorithmic trading strategies. CS considered the acquisition of Napoleon as an important step into the B2C, subscription-based business model providing direct access to customers, thus allowing CS to better understand their needs and drive an enhanced user experience. However, the FTX collapse in November 2022 had a significant impact on CS’s ability to deploy its B2C offering in Europe, as FTX had a 75% market share in derivatives trading in Europe following Binance’s shutdown of its derivatives marketplace in the region. Consequently, CS decided to wind down its B2C business, redeploying its human resources to its two existing core verticals.

The company’s long-term growth will be driven by a combination of 1) in-house, ‘organic’ project development to build its own IP (eg CoinShares Physical or CSCM), 2) partnerships providing faster go-to-market and lower opportunity costs (eg Komainu, ETFs launched with 3iQ) and 3) M&A to consolidate new capabilities immediately (eg the acquisition of Elwood’s index business).

CS’s board of directors consists of Daniel Masters as non-executive chairman (he is also the largest shareholder with a 22.44% stake), Jean-Marie Mognetti and four independent non-executive directors: Christine Rankin, Johan Lundberg, Carsten Køppen and Viktor Fritzén. CS’s management team is made up of seven members:

Despite the recent crypto winter, we remain optimistic towards the long-term prospects of the digital asset space. This stance is underpinned by the following factors (discussed in detail in our recent thematic piece):

Nevertheless, we are also mindful of the extent of the turmoil in 2022 and the high-profile failures of key centralised industry players and their impact on the digital asset adoption path. We acknowledge that near-term adoption may be dampened by low market liquidity and gaps in infrastructure left by the collapse of some service providers (eg Silvergate Bank). We now expect average global spot allocations to digital assets of 1.8% and 2.5% in 2026 and 2030, respectively (vs 2.2% and 2.5% at the time of our initiation). This compares with c 1% at end-2021 and c 0.5% currently, according to our estimates. Given the complexity associated with storing, trading and reporting digital asset investments, we expect the share of ETPs in total digital asset allocation to be higher than for gold (which is c 2%) and therefore assume a gradual increase from the c 2.3% at end-2022 to around 4% by 2030. As a result, we forecast that digital asset ETP AUM in Western Europe will reach US$26.6bn and US$50.4bn by 2026 and 2030, respectively (see Exhibit 4), compared to US$43.9bn and US$60.1bn at the time of our initiation.

Our forecasted financial assets excluding currency and deposits are based on financial wealth figures for 2021 and projections for 2026 from Boston Consulting Group’s (BCG’s) Global Wealth 2022 report published in June 2022 (2022–25 estimates calculated based on the CAGR implied by BCG’s 2026 forecast, while 2027–30 estimates assume the same CAGR as in the period 2021–26). We then remove from these financial wealth figures the part which is allocated to currency and deposits, estimated based on 2021 country-level data from the OECD (includes OECD members only) and weighted by each country’s 2021.

CS is still by far the largest European digital asset ETP issuer, with a c 44% market share by AUM as at end-2022, according to our estimate (see Exhibit 5). This represents a moderate decline from c 50% at end-2021, which was driven by continued redemptions of CS’s legacy XBT Provider units (leading to net outflows in 2022 of US$446m), likely on the back of profit taking from early BTC and ETH investors (as discussed in our previous notes). However, the CS Physical product suite saw at the same time inflows of c US$142m (excluding seed assets). This includes US$17.2m in Q422, which, according to CS’s calculations, represented a 48% market share in terms of net inflows captured across the European market in Q422. Beyond Europe, CS is the second-largest digital assets firm after the undisputable leader Grayscale Investments, which had US$14.6bn in AUM at end-2022 across its US OTC-listed trusts. Here, we note that the overall market for financial products is much larger in the United States compared to Europe.

CS’s blockchain equity ETF business represented AUM of US$640m as at 17 February 2023, positioning it as the leader in ETFs with exposure to blockchain companies, with the second player having AUM of c US$450m, according to CS’s weekly funds flow report (see Exhibit 6).

As discussed in our initiation note, CS’s first-mover advantage allowed it to introduce the XBT Provider Trackers with a high 2.5% management fee pa, while its CoinShares Physical Bitcoin ETP charges a fee of 0.98% pa. Until recently, its CoinShares Physical Ethereum ETP charged a 0.98% fee as well, but CS reduced it to 0.00% starting from 1 February 2023 in anticipation of the Shanghai upgrade on the Ethereum network. This upgrade will enable withdrawals of staked ETH, therefore allowing CS to freely stake and un-stake ETH held on behalf of the CoinShares Physical ETP. We expect CS to introduce a fixed percentage staking reward for this ETP soon (similar to its other ETPs investing in native tokens of proof-of-stake (PoS) blockchains, see Exhibit 2). We believe that the excess staking rewards it will retain may be in excess of the forfeited management fee (see below).

Most of the BTC and ETH ETPs of CS’s major European competitors charge management fees of c 0.75–1.50% (see Exhibits 7 and 8). While some more recent entrants offer products at even lower fees, it has not allowed them to significantly increase their AUM, at least for now. In the long term, as single-asset BTC and ETH ETPs become a more commoditised product, we expect their management fees to gravitate towards levels common for precious metals ETPs, which stand at c 0.00–0.40% for most major providers (see the initiation note for a detailed discussion). In the case of ETH, some competitors may at some stage also reduce the fees on their ETPs providing exposure to native tokens of PoS blockchains and instead retain some of the staking rewards.

In line with our predictions outlined in the initiation note, the crypto ETP market in Europe has been gradually expanding beyond plain vanilla BTC and ETH ETPs to single-asset ETPs investing in other digital assets, products offering a yield to investors (either from staking or digital asset lending), as well as multi-asset products. Having said that, this process has been gradual and has been affected by the ‘crypto winter’ in 2022. BTC and ETH ETPs still made up 50% and 29% of total digital asset ETP AUM at end-2022, respectively, followed by other single-asset ETPs at 16% and multi-asset ETPs at 6% (according to our calculations).

CS’s financial statements are influenced by the current accounting treatment of digital assets as intangible assets under IFRS. CS records digital assets (including those held to hedge its liability to ETP investors) under current assets as a separate line item, held at fair value through the revaluation model. Consequently, unrealised gains and losses on these holdings arising from the movements in digital asset prices are recognised within other comprehensive income (unless reversing previously recognised gains). At the same time, changes in the value of CS’s liability to its ETP holders is recognised as an income or expense within the P&L. This also applies to non-leveraged, digital asset-backed products such as ETPs (which are recorded under trade receivables on CS’s balance sheet) used to hedge the liability related to XBT Provider products. The above accounting policies significantly distort CS’s reported net income. Therefore, we consider CS’s adjusted EBITDA and total comprehensive income as more meaningful performance measures, as these reflect the movements in the value of both digital assets and the liability to ETP holders (see Exhibit 9).

We also note that fees on CS’s XBT Provider Trackers are accrued in euros and Swedish krona but hedged to the US dollar (which is CSCM’s reference currency). Hence CS’s consolidated accounts are subject to FX risk arising from changes in the £/US$ rate (given that CS reports its results in sterling while most of its activities are carried out in US dollars).

CS’s market neutral approach allowed it to generate a profit between 2018 and 2021 irrespective of the stage of the market cycle. In 2022, its CSCM’s results were burdened by two events affecting the broad digital asset space: the collapse of the Terra/LUNA protocol in May (resulting in an exceptional loss of £17m for CS, see our previous update note for details) and the collapse of FTX and Alameda Research in November (leading to a full write-down of CS’s £26m assets held at the FTX exchange). This demonstrates that, while CS’s strategies are non-directional, the company is still exposed to some inherent risks associated with the early development stage and unregulated nature of parts of the current digital asset ecosystem. CS’s management highlighted that it is putting emphasis on further strengthening its risk management framework and has elected to amend its approach to counterparty risk, placing the vast majority of digital assets held in its CSCM activities with regulated digital asset custodians (FTX was an unregulated exchange).

While industry-wide impacts from further high-profile bankruptcies cannot be ruled out, we assume that CSCM will return to generating a profit from its various capital markets activities given the one-off nature of the loss triggers in 2022 (see Exhibit 10). We conservatively assume that CSCM will generate a return on its trading strategies of c 9% pa in the long run, though we factor in a higher return in the next few years on the back of resumed interest in digital assets from various investor groups at a still early adoption stage.

In our base scenario, we assume continued outflows from the legacy XBT Provider products (as a result of profit taking and investors switching to products with a lower management fee), though initially offset by a recovery in digital asset prices during the next bull run. Meanwhile, CoinShares Physical ETPs should further strengthen its market position and benefit from the industry-wide pick-up in fund inflows. Over time, this should increasingly apply to products beyond BTC and ETH ETPs (which, however, will remain a core part of the sector’s offering). We assume that CS will launch at least one multi-asset ETP in 2024, which will build mass over subsequent years. Here, we note that the launch of such a product (based on CS’s cooperation with Imperial College London’s Centre for Cryptocurrency Research and Engineering) was heralded by the management back in late 2021 but has not materialised yet and management has not provided an updated roadmap for the product. We expect CS’s ETP AUM to increase from c US$1.22bn at end-2022 to US$6.8bn at end-2026 and US$10.6bn by 2030. This compares with c US$4.5bn at end-2021. We also anticipate that CS will be able to substantially grow its blockchain equity ETF AUM from US$525m at end-2022 to US$1.6bn in 2026 and US$2.9bn in 2030, with a 2022–30 CAGR of c 24%.

As a result of the changing product mix (in favour of CoinShares Physical ETPs, which charge lower fees), as well as an industry-wide decline in management fees (see above), we expect to see the average management fee on CS’s ETPs decline from c 2.18% at end-2022 to 0.64% by 2030. At the same time, we have started factoring in the income from staking rewards (in excess of what is distributed to ETP holders) for the CoinShares Ethereum ETP and prospective single- and multi-asset products (see Exhibit 12). We assume that CS will generate 150bp of staking yield over what is distributed to the holders of its CoinShares Ethereum ETP.

As a result of the above assumptions, we arrive at the EBITDA forecasts presented in Exhibit 13. We forecast an EBITDA recovery to c £25.2m and £41.0m in FY23 and FY24, respectively, and close to double over our forecast horizon (with an EBITDA margin settling at around 53–54%).

As at end-2022, CS had a net amount due from brokers of £98.1m versus £173.7m net due to brokers at end-2021. The more muted activity within its capital markets infrastructure business in H222 meant that CS significantly reduced the utilisation of its credit lines with brokers, which resulted in a lower interest expense. However, these credit facilities remain available and can be drawn by CS as new trading opportunities arise. CS also had cash at bank of £26.6m at end-2022. Finally, based on our discussion with CS’s management, we understand that its accrued management fees related to XBT Provider (which will be released in cash to CS once investors redeem their units) stood at c US$166m (c £137m) at end-2022. Given the above and its total equity of £204.0m as at end-2022, we believe CS’s balance sheet is in a good position. CS’s confidence in its balance sheet is somewhat illustrated by the small £0.4m share buyback it performed in 2022 (and it has resumed share buybacks in Q123).

We value the company’s shares using a discounted cash flow (DCF) approach (Exhibit 14). Given that we are in the initial stage of digital assets adoption, we have applied an extended detailed forecast horizon to FY30. We have used CS’s approach to calculating adjusted EBITDA, but for the purposes of our valuation we remove any income and gains in CSCM arising from earlier income/gains recycled back into the trading activity (in order to avoid double-counting of cash flows). Our DCF is sensitive to the change in working capital associated with accrued management fees on the XBT Provider Trackers (see our initiation note for details).

We have applied a conservative weighted average cost of capital of 13.3% (which represents a 30%+ premium to the broader market average) to account for the sensitivity of our forecasts to the price movements of digital assets, as well as risks to our digital asset adoption scenario. We further assume a 2.0% residual growth rate. We account for CS’s principal investments (including digital assets) in line with the last reported fair value at end-2022 of £47.3m. Conservatively, we have not pencilled in any gains on principal investments. As a result, we arrive at a fair value per share of SEK77.4, which implies a 150% upside potential to the current share price. Exhibit 15 shows our valuation sensitivity to different WACC assumptions.

We have not identified any close listed comparators for CS for which complete consensus figures are available. Having said that, an additional reference point for our CS valuation may be the fact that CS’s gross cash at end-2022 and XBT Provider fees accrued to date are equal to c 100% of CS’s current market capitalisation, according to our estimates. If we also include CS’s net amounts due from brokers, this increases to 159%.

Our base case valuation of CS remains conditional on a continued increase in average portfolio allocations to digital assets in the coming years as the asset class establishes itself as an inherent (even if small) part of most diversified portfolios. Given the limited supply of new digital assets (BTC and ETH in particular), we expect the above to translate into a visible increase in digital asset prices (our model implies a BTC and ETH price of c US$115,000 and US$12,000 by 2030, respectively).

Having said that, digital asset are very hard to value (as discussed in our Edison Explains piece) and it is difficult to gauge the extent to which the value of a blockchain network should be reflected in the market capitalisation of its native token. Hence, predicting the exact prospective price path for digital assets is quite challenging. Consequently, we have decided to present a summary of our forecasts and valuation for CS in a scenario in which digital asset prices grow in line with the European Central Bank’s and Federal Reserve’s inflation target of 2% from the current level (ie BTC at c US$28,000 and ET at c US$1,800). Under this more cautious scenario, we value CS at SEK33.9 per share. In Exhibit 16, we present a summary of our forecasts assuming stable digital asset prices.

We have also identified other factors that may affect CS and our base case scenario: