What is a direct listing? How the Coinbase public offering differs from a traditional IPO

When Coinbase shares officially hit the market Wednesday, everyone, from the little guy to big, institutional investors, will get a crack at the stock at the same time.

That’s because the highly-anticipated shares in Coinbase
COIN,
40.90%
,
the cryptocurrency exchange, are coming via a direct listing.

The exchange’s stock price opened at $381 per share Wednesday afternoon and jumped past the $400 mark.

So here’s what a growing crowd of retail investors might want to know: What’s the difference between a direct listing and a traditional IPO, and how does that affect my bottom line?

“The direct listing is more democratic,” said University of Florida Professor Jay Ritter, an expert on the process of companies going public. “Individuals aren’t being shut out of the opportunity to buy at the lower offer price.”

That’s exactly the point, Brian Armstrong, Coinbase’s CEO said Wednesday during a CNBC interview.

“I wanted there to be just a true market on day one that set the price, not something that was set behind closed doors. … I felt like it was more true to the ethos of crypto,” he said.

The traditional IPO process starts between the company that’s going public and its underwriters (think massive investment banks). The sides figure out the terms and structure of the offering, including the opening share price.

The underwriter then turns around and offers those IPO shares to clients that can include hedge funds and mutual funds, said Ritter, who teaches at University of Florida’s Warrington College of Business.

Company staff can receive pre-IPO shares as well, but they may be subject to lockup periods. Those periods usually last up to 180 days from the start of trading, Ritter said.

The Securities and Exchange Commission notes that it does not regulate how IPO shares are allocated. But, it notes, “underwriters believe that institutional and wealthy investors are better able to buy large blocks of IPO shares, assume the financial risk, and hold the investment for the long term.”

To understand the direct listing approach, just subtract the underwriter from the sequence of events, according to Ritter. “Anybody can buy, once the stock starts trading,” he said.

“With a direct listing, it’s kind of more likely the opening price reflects the long-term value,” said Ritter, because there’s no portion of the stock that’s being held back from trading and potentially altering the supply-demand market determinations.

Coinbase joins other tech-heavy firms that came to the investing public via direct listings. They include Spotify
SPOT,
-2.15%
,
Slack
WORK,
-0.95%
,
Palantir Technologies
PLTR,
-5.09%

and Roblox
RBLX,
-8.13%
.

“With traditional IPOs, tech stocks tend to be underpriced more than other IPOs,” Ritter said. “These are the companies that are most worried about selling stock to underwriters at $20 and seeing it trade at $30.”

But retail investors have their own things to worry about, like how much money to actually spend on Coinbase shares if that’s an investment they want to make.

Some financial advisers say investing in any type of newly-public company has its risks. One approach is only devoting a certain portion of “play money” that wouldn’t deeply dent a portfolio if the investment goes south.

Though advisers differ on how much to devote, many say it could be between 5% and 10% of investible assets.