Coinbase Joins the Ethereum Layer 2 Rat Race – Can It Grow?

The U.S. exchange, which has long looked for ways to diversify its revenue, will compete in and contribute to the crowded rollup sector.

AccessTimeIconFeb 23, 2023 at 7:21 p.m. UTC
Updated Sep 28, 2023 at 2:28 p.m. UTC
AccessTimeIconFeb 23, 2023 at 7:21 p.m. UTCUpdated Sep 28, 2023 at 2:28 p.m. UTC
AccessTimeIconFeb 23, 2023 at 7:21 p.m. UTCUpdated Sep 28, 2023 at 2:28 p.m. UTC

Coinbase (COIN) has big plans for its newly announced Ethereum scaling product. The project, Base, built in collaboration with layer 2 network Optimism on Optimism’s Massachusetts Institute of Technology-licensed OP Stack, aims to reduce ETH transaction fees to 1 cent, integrate with other blockchains like Solana, Avalanche and Polygon, and serve as a springboard for the company’s “Master Plan” to bring 1 billion people into crypto by “buying, building or investing” projects in the “open financial system.”

The announcement comes at a pivotal time for the largest U.S. crypto exchange. Coinbase’s most recent quarterly report showed a company in transition, with its core revenue stream of transaction volumes drying up amid the crypto winter. At the same time, it’s seeing growth in other potentially profitable business lines like staking and with other service fees. Base, a protocol Coinbase intends to “decentralize” over time, could become a moneymaker for the company that has long looked to diversify its balance sheet.

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According to TechCrunch, Base will initially charge fees in the 10- to 50-cent range – comparable with leading Ethereum layer 2 networks such as Arbitrum and Optimism. And, although still just a testnet, it doesn’t seem like Base will want for early adopters: Established projects including Chainlink, Etherscan, Aave, Animoca Brands, Dune, Nansen, Magic Eden and Wormhole, among others, have signaled support. This is big news considering “Coinbase has no plans to issue a new network token,” as CoinDesk’s Shaurya Malwa put it bluntly.

Coinbase's experiments

Coinbase has long taken a strategy of contributing technology and guidance to crypto, including targeting 10% of its cash holdings for venture opportunities. Not all of those experiments have fared well. For example, its non-fungible market (NFT) platform has struggled to gain market share since it launched last year, despite the company’s brand. Base will be released into an increasingly competitive and complex market of Ethereum scaling tools. On Tuesday, Arbitrum, a dominant layer 2 network, surpassed Ethereum in daily transactions.

Meanwhile, several rival projects are working on Ethereum-compatible “zero-knowledge rollups,” aka zkEVMs, promising to shake up the layer 2 landscape. Polygon and ConsenSys are just two of the major firms working on breakthrough ZK technologies, which differ from existing “optimistic” products like Arbitrum and Optimism by authenticating transactions instantaneously through “validity proofs.” (Arbitrum and Optimism assume transactions are valid during a weeklong dispute window before “rolling” a block onto the Ethereum mainchain – a system that could be abused.)

Base, which is intended to be integrated across Coinbase’s exchange, wallet and developer products, is a way to help guide existing users “to places they can go that aren’t controlled by Coin]base,” the project’s lead developer Jesse Pollak told TechCrunch. This is significant. Earlier this week Consensus Magazine published an op-ed by Łukasz Anwajler about the need for more secure “user journeys” across the crypto ecosystem. People need to stay in control of their funds from “on-chain to off-chain,” he said.

Indeed, there is a clear need for scaling products and further experimentation. Ethereum co-founder Vitalik Buterin’s “road map” for Ethereum looks more like a guide to the U.S. highway system, with forking and intertwining and paths, rather than MapQuest directions to a known location. But there is still a concern about how to incentivize lasting use of protocols. Other layer 2s have had the benefit of issuing tokens or implicitly promising a future airdrop to bring transactions on-chain – a path likely foreclosed to Coinbase, an exchange somewhat notable for not having a “native token,” amid the current regulatory regime.

That, coupled with the growing awareness of the risks centralized entities bring into decentralized finance (DeFi), may play against Base’s growth. It’s now unknown how long Base was being planned or under development (Coinbase was the first exchange to launch a layer 2 network), but its introduction comes as Coinbase scales back. In recent months, Coinbase pulled out of India and other markets, and laid off hundreds of employees. If Base is a core area of growth, it isn’t clear Coinbase will have all the resources necessary to fully develop it.

Apparently, the ultimate vision is for Coinbase to become a “contributor” to the network, and hand off governance decisions to the community. That process has strong precedence in the crypto industry. But, without details, that message reads a bit like “if we build it, they will come” – something that rings hollow in an industry still looking for a use case.

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Daniel Kuhn

Daniel Kuhn is a deputy managing editor for Consensus Magazine. He owns minor amounts of BTC and ETH.