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Introducing the Exchanges: Coinbase (Part 1)

Op-ed - Introducing the Exchanges: Coinbase (Part 1)

See also: our “Introducing The Exchanges” article on BitStamp.

In the year since the site first launched, Coinbase has come to be one of the most important and influential companies in the US Bitcoin economy. The company was originally founded by Brian Armstrong in the summer of 2012, and started out with a simple mission: make Bitcoin as easy to use as possible for the masses. At first, the company offered little more than basic merchant tools and a Bitcoin wallet. Even still, however, Brian Armstrong’s past as a fraud-prevention engineer at Airbnb earned the company credibility, and in September it received a $600,000 funding round from a number of high-profile investors, including Reddit co-founder Alexis Ohanian. Fortunately, the original investors’ confidence proved to be well-founded. In October 2012, the company launched a new service, allowing anyone in the US to buy and sell bitcoins straight from their bank account with a few clicks of a mouse. As soon as the service was announced, volume picked up quickly. By January 2013, the company was processing $1 million in buys and sells every month, and weeks after that volume became so high that the company was shutting down daily because it simply could not come up with enough bitcoins to sell.

Over the next few months, volume continued to consistently increase, and the company also brought a number of large companies, including Reddit, the popular dating site OkCupid and the Humble Bundle, into the Bitcoin economy with its merchant tools. In May 2013, the company received its second investment round of $5 million, with money from the Silicon Valley venture capital fund Union Square Ventures, Ribbit Capital, SV Angel and Funders Club. Today, Coinbase is processing one million dollars of Bitcoin buys and sells every day – roughly a quarter of all Bitcoin trade on exchanges put together.

Going In-Depth

In order to buy and sell bitcoins with Coinbase, you first need to verify your phone number and your bank account. Verifying a phone number is a basic SMS confirmation; you enter your phone number, receive a text message containing a code, and must then enter the code in a textbox to confirm that you own the phone number. Verifying a bank account is somewhat more difficult, but Coinbase’s interface tries hard to make the process as easy as possible. To go to the bank account verification form, navigate to “Buy/Sell Bitcoin” -> “Verify A Bank Account” -> “Link A Bank Account” in Coinbase’s interface. At that point, a form will ask you to enter the routing number, account number and full name on your bank account. Once you are done that, you are presented with two options: instant verification and delayed verification. If you select instant verification, you need to enter the online ID and password to your bank account, and Coinbase verifies your bank account instantly by logging into it. If you are not comfortable giving Coinbase your banking data, the alternative is challenge-response verification, where Coinbase credits your bank account with two small amounts and you need to fill in a form saying what the amounts are. However, the higher level of security provided by challenge-response verification comes at a price: you need to wait two or three days for the “challenge” deposits to be credited to your bank account.

Once bank account verification and phone verification are complete, buying bitcoins is as easy as filling out a checkout form. Once you click “Confirm”, the money is debited from your bank account and your order is put into the queue to be processed. Buy orders usually take four business days to process, although Coinbase recently unveiled a feature that allows instant Bitcoin purchases for those who are willing to submit to a higher level of identity verification. The process for selling is roughly symmetrical, although there is no “instant sell” feature; because of that way the traditional banking system works, waiting a few days to receive the USD credit to your bank account is unavoidable.

Coinbase is certainly not for everyone. Unlike Bitcoin exchanges like MtGox and BitStamp, where users can submit orders and trade back and forth between Bitcoin and fiat currency internally, on Coinbase you can only trade between bitcoins and dollars in your bank account directly. This makes Coinbase useless for day traders and bots, which rely on the ability to trade back and forth many times per hour. Coinbase’s limit of 10 BTC per day per customer (50 BTC per day with level 2 verification) also limits the exchange’s utility for high-volume buyers and sellers. However, high-volume buyers and sellers and bots are not what Coinbase is targeting; rather, the company is focusing its efforts solely on making the purchasing and selling experience as simple and safe as possible for the average user. At Coinbase, there is no need to worry about choosing between different deposit methods, repeatedly logging in to one’s account to check if a deposit was processed, and then figuring out whether one should place an instant order or a limit order; instead, buying and selling bitcoins is a simple click of a button.

The company has also had its share of problems with reliability. A number of people have complained about slow or lacking customer support, and others report having to wait over a week for their orders to process. Sometimes, customers would not receive their bitcoins at all; instead, their bank account payment would be refunded, and they would receive an email saying that the order had been cancelled for being too “high risk“. Another problem that was common earlier in the year was that users trying to buy bitcoins would be turned away and told to come back the next day, as the bitcoins for the day were “sold out“. However, in the past few months the number of complaints has reduced considerably, and for those complaints that do appear Coinbase employees are generally quick to respond.

Some of the customer support issues at the beginning of the year can arguably be justly blamed on Coinbase itself; when the Bitcoin community started expanding rapidly between January and April 2013, Coinbase, like many other companies in the Bitcoin ecosystem, failed to act quickly enough to expand its customer support staff to meet the new requirements. However, what is often very much underappreciated is the sheer difficulty of the business that Coinbase is in: navigating the fine boundary between the fiat currency and Bitcoin worlds. For example, Coinbase frequently “selling out” of bitcoins in early 2013 was a result of the company’s banking partner, which restricted the amount of money that the company could process daily to a percentage of their bank balance. When the company secured the $5 million investment round from Union Square Ventures, most of the money went straight into the company bank account, and the bank-imposed limit increased to the point where it was no longer a problem.

Another major issue that deserves explanation is that of delays and cancellations. The four-day delay in Coinbase’s bitcoin buying process is introduced deliberately; this much is obvious from the simpler fact that Coinbase is able to waive the delay for customers that have submitted to level 2 verification. However, the delay and occasional cancellations are necessary to fight fraud. One of the most difficult aspects of handling the fiat/cryptocurrency boundary is that fiat currency payments are usually reversible, whereas Bitcoin payments are irreversible. In general, mixing the two is considered to be nearly impossible; every company that has tried to sell bitcoins for credit card payments has been crushed under the weight of “chargeback fraud”, where fraudulent buyers purchase bitcoins and then initiate a chargeback to get the (fiat) money back. Coinbase deals with bank transfers, where chargebacks are harder, but even still the company is forced to rely on advanced machine-learning algorithms to detect orders that are likely to be fraudulent. These algorithms look at features of an order, like the name, purchase amount, originating bank account and status of the customer, and attempt to detect which orders are likely to be fraudulent. An order can be flagged as high-risk, in which case it is rejected immediately, low-risk, in which case the order goes through, or medium-risk, in which case a human makes the final decision.

According to Coinbase, waiting for four days to release the bitcoins is simply another necessary step to reduce the chargeback fraud to an acceptable level. If you submit to level 2 verification, then you become a much smaller risk, and so in that case Coinbase is willing to waive the waiting period. One common conspiracy theory is that Coinbase is manipulating cancellations for their own benefit; the claim is that Coinbase is cancelling orders if the price goes up during the four day waiting period, and pocketing the difference if the price goes down. However, Coinbase employees have gone on record multiple times saying that Coinbase buys the bitcoins as soon as you make the order, so the company does not stand to profit or lose from manipulating cancellations.

Coinbase’s “instant account verification” option, which requires users to give Coinbase their bank account password to verify their account, has also aroused some controversy. Coinbase’s defense is simple: the procedure is voluntary, and for those who do not wish to give Coinbase any private data there is the option of challenge-response verification as well. Furthermore, Coinbase itself is a highly reputable institution, with Union Square Ventures and a Reddit co-founder, among others, backing it with their investment money. The company takes special precautions with privacy, only using users’ bank login information once to log into their accounts and then immediately forgetting the data. Some do argue that Coinbase is doing the financial community a disservice by legitimizing what is ultimately a highly dangerous practice if used by less reputable organizations; to this, Brian Armstrong’s response is simple: there are plenty of people that want instant verification enough to trust Coinbase with their banking data, and this is the only way it can be done. “60-70 of people use it,” Armstrong says, “so there is probably some value.”

As far Coinbase’s basic buy and sell Bitcoin service is concerned, at this point the core product is essentially settled. The company last added the instant verification option two months ago, and, aside from the convenience option of ordering bitcoins by SMS, the service has been essentially unchanged ever since. Volume did decrease slightly after the peak in April and May, but Coinbase usage is once again on the rise with roughly six percent growth every week; currently, the company processes about $1 million worth of combined Bitcoin buys and sells per day. Aside from perhaps doing additional advertising, there is little the company can do to speed up its growth; at this point, the only way forward is to focus on maintaining a reliable service and increasing its customer support staff as necessary. Rather, where Coinbase has chosen to innovate now is in the direction of its merchant services and its wallet, and in time these parts of its business may come to be just as important as its exchange. For a more in-depth look at what this side of the business has in store, continue reading the second part of this article.