Some not so obvious reasons why the new Coinbase L2 is a huge deal
Shout out to all the midwits who sold their OP at a dollar.
Yesterday’s announcement that Coinbase built and deployed its own Layer2 blockchain came as a surprise to me and most people I know who work in the space.
The new L2 will be called “Base” and while it’s not yet deployed on Ethereum mainnet, the team has been working on it for over a year and already has a significant number of established players building on it.
Why is Coinbase doing this?
In a recent interview on Bankless, Coinbase’s Senior Director of Engineering, Jesse Pollock said this:
“We believe that on chain is the next online, and our goal is to onboard billions of users, help them get onto Base, help them get onto other Layer2s, help them get on Ethereum, and help them get anywhere they want in the broader crypto economy.”
Real reason one: The proof of reserves narrative
Coinbase migrating to a Layer2 gives it on chain proof of reserves by default.
The previous leader in providing on chain transparency was Kraken with their proof of reserves page.
But with this announcement, Coinbase effectively leapfrogs Kraken on this all-important narrative, which has gained enormous steam in the wake of all the exchange collapses of 2022.
According to Pollock, Coinbase is no longer just an exchange, but a “gateway to web3.”
This shift in orientation by the exchanges is something many in the crypto community have been expecting for a long time, and one that I wrote about last year:
Real reason two: Economies of scale
Base is built on the OP Stack, an MIT-licensed, open-source library developed by Optimism.
The OP Stack is unique amongst Layer2s in the sense that it is organized as a set of SDKs and marketed as a chain that is meant to be forked.
The Optimism Community has dubbed it the “Superchain,” a highly configurable set of tools that can be used for a broad range of use cases, such as blockchian gaming, NFT marketplaces, or perps exchanges.
Importantly, each chain that is built using a fork of the OP Stack is interoperable with other OP Stack chains.
According to Pollock, Base will be permissionless and open source, however the apps that get built on it (such as the Coinbase exchange) do not necessarily need to be.
Inviting other developers to build on Base puts Coinbase at the center of an ecosystem and presumably will allow them to claim the fees generated by the chain as their own revenue.
More on this point at the end…
Real reason three: To improve their existing products
In addition to making the exchange more transparent and decentralized, the Base chain will also benefit Coinbase’s self-custody wallet by conferring the benefits of contract accounts.
I think that if Coinbase were starting on this today rather than a year ago, they may have chosen to fork a zk-rollup so they could launch a smart wallet.
Regardless, I think it’s highly likely they will build account abstraction into Base, both to keep up with the Jonses and to improve the usability of dapps built on Base.
In any event, their choice of the OP Stack will definitely accelerate the adoption and development of the Ethereum Virtual Machine.
Why it’s a step change for the entire space
At time of writing, Coinbase has about 110 million users on their platform and $80 billion in assets.
Only a tiny fraction of these users have taken the next step of moving assets on chain and participating in the crypto ecosystem directly.
In my piece about how crypto exchanges are broken, I argued that this is by design:
Exchanges make the vast majority of their revenue from trading fees and for that reason, the product areas they focus on most are around trading, fiat onramps, and adding more tokens to the platform for people to trade.
Furthermore, they purposefully make it difficult for users to escape the exchange by erecting barriers to exit, for example:
- Strict daily, weekly or monthly withdraw limits
- Withdraw batching, where the exchange processes all withdraws only once every 24 hours
- Or my favorite, whitelisting your send address, which takes some hilarious period of time (Coinbase just increased theirs from 24 to 48 hours, “for your security.”)
But the addition of a Layer2 chain/ ecosystem to the Coinbase product suite completely changes this.
It’s now to Coinbase’s strategic advantage to bring those 110 million users on chain and into web3 in order to bootstrap Base.
For perspective on that number, the Arbitrum chain currently has about half a million unique addresses. And there are only about 10 million daily active users in all of defi.
So we’re talking about an instant 10x of on chain crypto users when Coinbase decides to flick the switch.
A bunch of well known protocols such as AAVE, Sushiswap, Balancer and Euler are already deployed on the Base testnet.
And I expect to see a lot more announcements of web3 and defi apps deploying on Base in hopes of acquiring a chunk of this new market.
Perhaps the most interesting thing
I think the advantages that blockchains confer are about to become much more widely understood by traditional finance.
We are about to have a “public blockchain” that is technically owned by a publicly traded company in the US.
Which means that for the first time ever, the revenue accruing to an on-chain treasury will be reported according to GAAP and Non-GAAP measures.
I for one will be very curious to see what that looks like.
Most investors, particularly those who don’t invest in crypto do not understand how value accrues to blockchains, and I don’t think anyone really understands how blockchains compare to traditional SaaS and other off-chain network models.
But perhaps we’re all about to learn, and that would be very cool.
If successful, the Coinbase path could serve as a much needed blueprint for other large, regulated entities looking to move all or parts of their business on chain.
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Thanks for reading until the end. I work in crypto and think about it non-stop. You can find me on Twitter @danajwright_
