Coinbase joins the Ethereum scaling race with both opportunities and challenges

Coinbase (COIN), the largest cryptocurrency exchange in the United States, announced on Thursday the launch of Base, a Layer 2 network built using Optimism’s OP Stack.

Base will be incubated within Coinbase but plans to be fully decentralized in the future. It will join as the second core contributor to OP Stack, a developer toolkit for the Optimism network. However, Base will not be limited to Ethereum, it will also provide easy and secure access to Layer 2 networks such as Optimism, as well as other blockchain ecosystems such as Solana, Avalanche, and Polygon, ultimately aiming to bring 1 billion people into the crypto space by “buying, building, or investing” in projects in an “open financial system.”

Coinbase's Diversification Strategy Attempt

The new announcement comes at a critical time for Coinbase as it hits a growth wall, with the company's latest quarterly report showing its core trading volume revenue drying up amid the crypto bear market. Meanwhile, other potentially profitable business lines are starting to grow, like staking and other services. Base, a protocol that Coinbase intends to "decentralize" over time, could become a cash cow for the company, which has long been looking to diversify its balance sheet.

According to TechCrunch, Base will initially charge fees of 10 to 50 cents - comparable to mainstream Ethereum Layer 2 networks such as Arbitrum and Optimism. And, despite still being just a testnet, Base does not seem to be lacking in early adopters: mature projects including Chainlink, Etherscan, Aave, Animoca Brands, Dune, Nansen, Magic Eden, and Wormhole have publicly expressed support. Crucially, Coinbase has made it clear that it has no plans to issue new network tokens, avoiding the way to earn transaction traffic through airdrops, which is enough to show its sincerity in focusing on "building".

To spur development, Coinbase and its venture capital arm, Coinbase Ventures, will offer a grant program for software engineers working on Base, but the exact amount was not disclosed.

The competition

Coinbase has long pursued a strategy of contributing technology and guidance to the crypto industry, including investing 10% of its cash holdings in venture capital, but not all strategies have gone smoothly. For example, its non-fungible market (NFT) platform has struggled to carve up market traffic since its launch last year, despite the Coinbase brand.

The release of Base also coincides with the increasingly fierce and complex competition in the Ethereum expansion market. Earlier this week, data tracked by L2BEAT showed that Arbitrum One processed more transactions than Ethereum, becoming the first Rollup with a daily transaction volume exceeding the Ethereum mainnet. Its parent company Offchain Labs was valued at $1.2 billion in its Series B in August 2021. Optimism, the second largest Rollup and Arbitrum's main competitor, was valued at more than $1.6 billion in its Series B in March last year.

Meanwhile, several competing projects are working on Ethereum-compatible “zero-knowledge Rollups,” also known as zkEVMs, that are expected to change the Layer 2 landscape, such as Scroll, Polygon, Matter Labs, and ConsenSys. Some industry experts believe that Rollups powered by ZK cryptography are the most promising way to scale Ethereum, as they have the potential to improve on existing Later 2 blockchains in terms of speed and security.

Polygon said it will release its zkEVM on March 27. Last week, Matter Labs invited developers to register to deploy their applications on its zkEVM zkSync.

Despite the rapid development of zk technology, Jesse Pollak, head of Coinbase protocol, said in an interview with Blockworks that the difference in technology does not define the product, and how to deploy the details is the key. A key goal of Base is to create technology that can be easily upgraded. This goal is one of the main reasons why Coinbase chose Optimism as its partner, especially the modular solution of OP Stack.

Pollak said: "We believe that in the future we may launch Rollups that have both zk components and Optimism components. What is important now is to build the technology stack in a way that can be easily upgraded. The reality is that you need to build infrastructure to make the blockchain work well."

Pollak also mentioned that since last year, Coinbase has been working on proto-dank sharding (EIP 4844), an upgrade to Ethereum that will reduce fees on the Layer 2 network to 10-100 times their current levels. EIP 4844 is expected to be completed this summer.

In addition, people are increasingly aware of the risks that centralized entities bring to decentralized finance (DeFi), which may hinder the development of Base. It is unclear how long Base will be planned or developed (Coinbase is the first centralized exchange to launch a second layer network). In recent months, Coinbase has withdrawn from India and other markets and laid off hundreds of employees. It is unknown whether Coinbase has enough developers or resources.

Coinbase's ultimate vision is to become a "contributor" to the network and hand over governance decisions to the community. It will take time to test every detail of this.